The Seasonality of Banking Failures During The Late National Banking Era∗

In this paper, we consider a model in which spatial separation and limited communication create a transactions role for currency, and in which aggregate uncertainty associated with agents’ patterns of movement, creates a role for banks and allows the possibility of banking failures. We show that banks provide complete insurance in states of the world where there are no banking failures and that not all banking failures have associated large output losses. When bank failures occur currency premiums are observed. Furthermore, the scope for a fragile banking system decreases as the nominal rates of interest increase. However, a policy of letting nominal interest rate equal to zero is not an optimal policy in all states of the world. Furthermore, when income, real rate of return and the return on scrapping fluctuate seasonally, the bank’s optimal return schedule, optimal reserve to deposit ratio, currency premiums, and the probability of banking failures will also fluctuate seasonally. Finally, when seasonals are present, the operating procedure for monetary policy of affecting the supply of reserves is indeed a desirable policy. ∗We would like to thank Bruce Champ and Jeffrey Miron for making their data available to us. We also like to thank Doug Dacy for his encouragment in pursuing this project and Paula Hernandez-Verme for her suggestions. †While working on this paper Bruce Smith passed away, I would like to dedicate this finished paper to him, a mentor, a friend and an inspirational figure in my life.