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Working Paper 2000-005B

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"Aggregate Price Shocks and Financial Instability: A Historical Analysis"
by Michael D. Bordo, Michael J. Dueker, and David C. Wheelock

This paper presents historical evidence on the relationship between aggregate price and financial stability. We construct an annual index of financial conditions for the United States covering 1790-1997, and estimate the effect of aggregate price shocks on the 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 shock needed to alter financial conditions substantially depends on the institutional environment, but that a monetary policy focused on price stability would be conducive to financial stability.

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Category > Monetary Policy/Macroeconomics
Author > Michael J. Dueker
Author > David C. Wheelock