Nonmonetary Effects of the Financial Crisis in the Propogation of the Great Depression

During 1930-33, the U.S. financial system experienced conditions that were among the most difficult and chaotic in its history. Waves of bank failures culminated in the shutdown of the banking system (and of a number of other intermediaries and markets) in March 1933. On the other side of the ledger, exceptionally high rates of default and bankruptcy affected every class of borrower except the federal government. An interesting aspect of the general financial crises—most clearly, of the bank failures —was their coincidence in timing with adverse developments in the macroeconomy. Notably, an apparent attempt at recovery from the 1929-30 recession was stalled at the time of the first banking crisis (November-December 1930); the incipient recovery degenerated into a new slump during the mid-1931 panics; and the economy and the financial system both reached their respective low points at the time of the bank "holiday" of March 1933. Only with the New Deal's rehabilitation of the financial system in 1933—35 did the economy begin its slow emergence from the Great Depression. A possible explanation of these synchronous movements is that the financial system simply responded, without feedback, to the declines in aggregate output. This is contradicted by the facts that problems of the financial system tended to lead output de-