Currency Elasticity and Banking Panics: Theory and Evidence

Abstract

Existing models of banking panics contain no role for monetary factors and fail to explain why some banking systems experienced panics while others did not. A monetary model is constructed, where seasonal variations in the demand for liquidity and credit play a critical role in generating banking panics. These panics occur when there are restrictions on the issue of currency in private banks, but they do not occur if banks are unrestricted. Empirical evidence from Canada and the United States for the period 1880-1910 is largely consistent with the predictions of the model.