Financial Factors in the Great strongDepressionstrong.pdfVIP

Journal of Economic Perspectives— Volume 7, Number 2—Spring 1993—Pages 61-85 Financial Factors in the Great Depression Charles W. Calomiris eginning with Irving Fisher (1933) and John Maynard Keynes (193 1 [1963]), macroeconomists have argued that financial markets were Bimportant sources and propagators of decline during the Great De- pression. Turning points during the Depression often coincided with or were preceded by dramatic events in financial markets : stock market collapse, waves of bankruptcy and bank failure, and contractions in the money stock. But the mechanism through which financial factors contributed to the Depression has been a source of controversy, as has been the relative importance of financial factors in explaining the origins and persistence of the Depression. This essay reviews the literature on the role of financial factors in the Depression, and draws some lessons that have more general relevance for the study of the Depression and for macroeconomics. I argue that much of the recent progress that has been made in understanding some of the most important and puzzling aspects of financial-real links in the Depression fol- lowed a paradigm shift in economics. A central, neglected theoretical piece of the story for financial factors was the allocative effects of imperfections in capital markets, which can imply links between disruptions in financial markets and subsequent economic activity. Also, the increasing emphasis on learning and path-dependence in economics has helped