NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

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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