Academic journal article Atlantic Economic Journal

Loan Demand, Bank Failures, and Panics: A Note

Academic journal article Atlantic Economic Journal

Loan Demand, Bank Failures, and Panics: A Note

Article excerpt

The literature disagrees whether the creation of Federal Reserve System (Fed) has reduced the seasonal movement in interest rates. Miron ["Financial Panics, the Seasonality of Nominal Interest Rate, and the Founding of the Fed," AER, 76, 1986, pp. 125-40] argues that the founding of Fed reduced the seasonality of nominal interest rates, whereas Clark ["Interest Rate Seasonals and the Federal Reserve," JPE, 94, 1986, pp. 76-125] claims that the reduction is unrelated to the Fed as seasonality disappeared worldwide after 1914. Miron mentions that pre-Fed panics and associated bank failures occurred when banks faced unusually high loan demand. Data for the 6,288 national banks in 1907 showed that indeed the failed banks held a significantly higher loan-asset (.600 vs. .548) ratio than the surviving banks. The model that Miron proposes to rationalize this finding, however, actually contradicts it. According to Miron's model:

[L.sup.S] = [D.sup.2]i/[s.sup.2](1); [L.sup.d] = Y - bi(2); [L.sup.S] = [L.sup.d] = L(3); and c = [1/2][s.sup.2][(L/D).sup.2](4);

where: [L.sup.S] and [L.sup.d] are loans supplied and loans demanded; D is deposits; Y shifts loan demand; i is the loan rate; c is operating cost; and s and b are parameters.

This model implies that c = [1/2][[(sY / D) / 1 + b[(s / D).sup.2]].sup.2] (5). Consequently, the higher is loan demand (Y) ceteris paribus, the higher operating costs are. …

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