Financial factors and the propagation of the Great Depression

Abstract

We investigate the role of forward-looking financial factors in propagating the Great Depression. We find that a new hand-collected bank stock index is better at predicting the onset of the Great Depression than the aggregate stock market or failed bank deposits. The bank stock index explains almost one-third of the fluctuations in industrial production after five years. Analysis disaggregated at each Federal Reserve district shows that bank stocks capture forward-looking information about debt defaults and credit. Our results suggest that future studies of the credit channel during the Great Depression should incorporate bank stocks to better identify the impact of credit crunches on economic activity.