I only met Bernanke once, as I recall it was in the 1990s. He presented a paper at Bentley on the role of bank failures in the Great Depression. I only asked one question: “How much would output have declined if the Fed had successfully stabilized NGDP, but the banking panics had still occurred.” I don’t recall the exact answer, my sense is that he said output would have declined, but obviously much less than it actually did. Bernanke certainly thought the monetary channel was very important, and saw his credit channel paper as supplementing the Friedman and Schwartz explanation.
I’ve always been skeptical about the credit channel. Yes, it certainly matters to some extent, but given the decline in NGDP, and the bad supply-side policies, we got roughly the Depression I would have expected. So I don’t think the bank failures add much, except that they obviously help explain why money was so tight. After all, under the gold standard the hoarding of currency and reserves is even more harmful than under fiat money, as the Fed cannot offset as easily.
In the current recession a policy of NGDP targeting would have prevented a steep rise in unemployment, even if lots of banks had failed. Of course, if we had been doing NGDP targeting, the number of bank failures would have been only a small fraction of what actually occurred. Most of the failures were linked to loans to developers than went bad when the economy tanked, not the subprime mortgage mess.
Mark Sadowski sent me a study by Jeffrey Miron and Natalia Rigol that shows that much of Bernanke’s results hinge on a single month’s data, March 1933. And that’s a very odd month to draw any implications from, as not only was there an extraordinary number of bank failures, but there was also a national bank holiday. So the entire banking system was shut down for much of the month.
We reconsider this issue by reporting regressions that drop March, 1933 from the sample entirely (along with appropriate lags). Columns (5)-(8) of Table 2 show the results. In this specification, the bank and business failure variables still enter negatively, consistent with Bernanke’s hypothesis, but the 7 coefficients are no longer statistically significant. Thus, exclusion of the Bank Holiday does not reverse Bernanke’s results but it weakens them substantially.
. . .
To the extent U.S. experience during the Great Depression – and especially the view that bank failures play a significant, independent role during that period – formed the intellectual foundation for Treasury and Fed actions, however, our results suggest at least a hint of caution. If the Great Depression does not constitute evidence for Too-Big-to-Fail, then what historical episodes do provide that evidence? We leave that question for another day.
In a world of no Too-Big-to-Fail, no FDIC, and NGDPLT, the optimal bank regulatory regime is no regulation at all.
Of course we don’t live in that world. What’s the optimal regulatory regime in a world with TBTF, with FDIC, and without NGDPLT? How the hell would I know?
The good news is that if we ever get to NGDPLT, we won’t need TBTF and FDIC.