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VOL. 73 NO. 3 BERNANKE: GREATDEPRESSION 271 distributed lag) was large (comparable to the monetary effect), negative, and significant at the 95 percent level. For the entire interwar sample, however, the statistical significance of this variable was much reduced. This last result is due to the fact that the recovery of 1933-41 was financed by nonbank sources, with bank loans remaining at a low level. 2) Another proxy for the financial crisis that was tried was the differential between Baa corporate bond yields and the yields on U.S. bonds. As described in Section I.C, this variable responded strongly to both bank crises and the problems of debtors, and as such was a sensitive indicator of financial market conditions. The yield differential variable turned out to enter very strongly as an explanator of current and future output growth, overall and in every subsample. As much of this predictive power was no doubt due to pure financial market anticipations of future output declines, I also put the dif- ferential variable through a first-stage regres- sion on the liabilities of bank and business failures. Assuming that these latter variables themselves were not determined by anticipa- tions of future output declines (see below), the use of the fitted series from this regres- sion "purged" the differential variable of its pure anticipatory component. The fitted series entered the output equations less strongly than the raw series, but it retained the right sign and statistical significance at the 95 percent confidence level. In almost every case, then, the addition of proxies for the general financial crisis im- proved the purely monetary explanation of short-run (monthly) output movements. This finding was robust to the obvious experi- ments. For example, with the above-noted exception of the credit variable in 1933-41, coefficients remained roughly stable over subsamples. Another experiment was to in- clude free dummy variables for each quarter from 1931:1 to 1932:IV in the above re- gressions. The purpose of this was to test the suggestion that our results are only a reflec- tion of the fact that both the output and financial crisis variables "moved a lot" dur- ing 1930-33. The rather surprising discovery was that the inclusion of the dummies increased the magnitude and statistical sig- nificance of the coefficients on bank and business failures. Finally, the economic sig- nificance of the results was tested by using the various estimated equations to run dy- namic simulations of monthly levels of in- dustrial production (relative to trend) for mid-1930 to March 1933. Relative to the pure money-shock and price-shock simula- tions described above, the equations includ- ing financial crisis proxies did well. Equa- tions (3) and (4) reduced the mean squared simulation error over (1) and (2) by about 50 percent. The other (nonreported) equations did better; for example, those using the yield differential variable reduced the MSE of simulation from 90 to 95 percent.
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