Financial Frictions and Employment during the Great Depression

Efraim Benmelech, Carola Frydman, Dimitris Papanikolaou

NBER Working Paper No. 23216
Issued in March 2017
NBER Program(s):Corporate Finance, Development of the American Economy, Economic Fluctuations and Growth, Labor Studies, Monetary Economics

We provide new evidence that a disruption in credit supply played a quantitatively significant role in the unprecedented contraction of employment during the Great Depression. To analyze the role of financing frictions in firms' employment decisions, we use a novel, hand-collected dataset of large industrial firms. Our identification strategy exploits preexisting variation in the need to raise external funds at a time when public bond markets essentially froze. Local bank failures inhibited firms' ability to substitute public debt for private debt, which exacerbated financial constraints. We estimate a large and negative causal effect of financing frictions on firm employment. Interpreting the estimated elasticities through the lens of a simple structural model, we find that the lack of access to credit may have accounted for 10% to 33% of the aggregate decline in employment of large firms between 1928 and 1933.

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Document Object Identifier (DOI): 10.3386/w23216

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