BANKING PANICS AND BUSINESS CYCLES *

Abstract

THE nearly universal experience of banking panics has led many governments to regulate the banking industry. Economists, too, have increasingly focused on panics as evidence of bank uniqueness. Yet, competing theories to explain banking panics have never been tested. Are banking panics caused by the same relations governing consumer behavior during nonpanic times? Are panics random events, or are panics associated with movements in expected returns, in particular, with movements in perceived risk which are predictable on the basis of prior information? If so, what is the relevant information? Using newly constructed data this study addresses these questions by examination of the seven panics during the U.S. National Banking Era (1863-1914). Depositor behavior under subsequent monetary regimes is also examined. In all, one hundred years of depositor behavior are examined. A common view of panics is that they are random events, perhaps self-confirming equilibria in settings with multiple equilibria, caused by shifts in the beliefs of agents which are unrelated to the real economy. An alternative view makes panics less mysterious. Agents cannot discriminate between the riskiness of various banks because they lack bank-specific information. Aggregate information may then be used to assess risk, in which case it can occur that all banks may be perceived to be riskier. Consumers then withdraw enough to cause a panic. While the former hypothesis is not testable, it suggests that panics are special events and implies that banks are inherently flawed. The latter hypothesis is testable; it suggests that movements in variables predicting deposit riskiness cause panics just as such movements would be used to price such risk at all other times. This hypothesis links panics to occurrences of a threshold value of some variable predicting the riskiness of bank deposits.