The Macroeconomic Fallout of Shutting Down the Banking System

During the 2008–09 financial crisis, the U.S. government arranged bailouts of major banks to prevent a suspension of bank deposits, where banks cease paying checks and refuse depositors’ requests to withdraw funds. Although these bailouts likely helped firms and households continue to make payments, they have been debated due to potential moral hazard concerns as well as the high cost to taxpayers. Assessing the costs and benefits of preventing deposit suspensions is difficult, as nationwide bank suspensions have not occurred since the Great Depression.

To circumvent this challenge, Qian Chen, Christoffer Koch, Gary Richardson, and Padma Sharma study the effects of more recent deposit suspensions at the state level (Nebraska in 1983, Ohio and Maryland in 1985, and Rhode Island in 1991). They find that the suspension in Rhode Island, which occurred during a recession, lowered employment, gross state product, and per capital personal income. Their results suggest that interventions that prevent large deposit suspensions during recessions, such as those undertaken after 2008, are likely worth the costs. Effective interventions not only help avoid economic losses during recessions, but also prevent losses to output and employment several years into the future.