Bank failures, financial restrictions, and aggregate fluctuations: Canada and the United States, 1870-1913

Abstract

During 1870_1913, Canada had a well-diversified branch banking system while banks in the U.S. unit-banking system were less diversified. Canadian banks could issue large-denomination notes with no restrictions on their backing, while all U.S. currency was essentially an obligation of the U.S. government. Also, experience in the two countries with regard to bank failures and panics was quite different. A general equilibrium business cycle model with endogenous financial intermediation is constructed that captures these historical Canadian and American monetary and banking arrangements as special cases. The model's predictions contradict conventional wisdom about the cyclical effects of banking panics. Support for these predictions is found in aggregate annual time series data for Canada and the United States.