Working Paper

Aggregate price shocks and financial instability: a historical analysis


Abstract: This paper presents empirical evidence on the hypothesis that aggregate price disturbances cause or worsen financial distress. We construct two annual indexes of financial conditions for the United States covering 1790-1997, and estimate the effect of aggregate price shocks on each index using a dynamic ordered probit model. We find that price level shocks contributed to financial instability during 1790-1933, and that inflation rate shocks contributed to financial instability during 1980-97. Our research indicates that the size of the aggregate price shocks needed to qualitatively alter financial conditions depends on the institutional environment, but that a monetary policy focused on price stability would be conducive to financial stability.

Keywords: Economic policy; Inflation (Finance); Prices;

Status: Published in Economic Inquiry, October 2002, 40(4), pp. 521-38

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Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2001

Number: 2000-005