Excess Reserves in the Great Depression
NBER Working Paper No. 1374
This article assesses the extent to which government-administered financial shocks and lower interest rates can account for the massive accumulation of bank excess reserves in the Great Depression. Both factors are shown to be statistically significant. Financial shocks did exert astatistically detectable influence on the demand for excess reserves but those shocks at best can account for a step-like increase in the level of reserves held, an increase which was completed in less than a year. Financial shocks can explain no more than 1 percent of the variation in excess reserves during the Great Depression. We demonstrate that the most statistically appropriate form of the demand function is one which flattened rapidly as interest rates fell. The fall in interest rates can account for 80 percent of the movement of excess reserves during the Great Depression.