NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Aggregate Price Shocks and Financial Instability: An Historical Analysis

Michael D. Bordo, Michael J. Dueker, David C. Wheelock

NBER Historical Working Paper No. 125
Issued in April 2000
NBER Program(s):   DAE

This paper presents empirical evidence on the hypothesis that aggregate price disturbances cause or worsen financial instability. We construct two annual indexes of financial conditions for the United States covering 1790-1997, and estimate the effect of aggregate price shocks on each index using a dynamic ordered probit model. We find that price level shocks contributed to financial instability during 1790-1933, and that inflation rate shocks contributed to financial instability during 1980-97. Our research indicates that the size of the aggregate price shocks needed to substantially alter financial conditions depends on the institutional environment, but that a monetary policy focused on price stability would be conducive to financial stability.

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Document Object Identifier (DOI): 10.3386/h0125

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