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Credit deflation due to bank failures is not fun, of course, for the people who see their inflated savings wiped out in the bank failure, but there is no aggregate economic problem that results

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can you rephrase that or restate it b/c the way it sounds now it seems that you're saying bank failures have no negative aggregate economic impact.

is that the point you want to make?

if so i (and many others who have written papers on the subject) disagree strongly witht hat statement.

Barron

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Yes, that is exactly what I'm saying.

It's a good thing for the macro economy when bankrupt institutions are liquidated, because malinvested resources can be reallocated to productive institutions. It sucks for the people who own/are invested in/are owed by the bankrupt institution, but as long as it isn't some monopoly situation (like it's the central bank or something), then there is no aggregate problem for the macro economy.

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i see what you're saying that in the long run it is best that misallocated resources (malinvestments) clear from the market. the problem is that they don't clear in an orderly fashion.

bank failures were examined to see whether they had a macroeconomic impact during the US depression (a labratory for many of these types of questions). when banking failures were included as an independent variable explaining industrial productivity, employment, productive output, and prices it came out both powerful (large beta) and highly significant. moreso than many other indicators included in the study.

so during the "cleansing" process where malinvestments are cleared from the market, there is a period where unemployment increases substantially, output falls, prices fall, and industrial production falls. the clearing of the poor investments of banks has, at least short term, very negative consequences for the economy.

Barron