1930: First Modern Crisis
Modern financial crises are difficult to explain because they do not always involve bank runs, or the bank runs occur late. For this reason, the first year of the Great Depression, 1930, has remained a puzzle. Industrial production dropped by 20.8 percent despite no nationwide bank run. Using cross-sectional variation in external finance dependence, we demonstrate that banks' decision to not use the discount window and instead cut back lending and invest in safe assets can account for the majority of this decline. In effect, the banks ran on themselves before the crisis became evident.
We thank Andy Law, Chase Ross, Alex Yang, and Arwin Zeissler for research assistance. We thank Joshua Rosenbloom and William Sundstrom for sharing their Census of Manufacturing data with us; see Rosenbloom and Sundstrom (1999). Also, thanks to Mrdjan Mladjan for sharing his data on the instruments used in Mladjan (2016). The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Gorton has nothing to currently disclose. He was a consultant to AIG Financial Products from 1996-2008.