The path from cause to effect
is dark and dangerous,
but the weapons
of econometrics are strong,
wield differences-in-differences
when witnessing parallel trends.
♪ [music] ♪
Masters of metrics
look for convincing
ceteris paribus comparisons.
The ideal comparison contrasts
treatment and control groups
that look similar.
But sometimes this sort
of comparability is elusive.
When treatment and control groups
evolve similarly
in the absence of treatment,
even if from different
starting points,
there's hope for causal inference.
The weapon that exploits
parallel evolution,
masters say parallel trends,
is called differences-in-differences...
(voice whispering)
Differences-in-differences
- ...or DD for short.
- Alright. Nice.
Let's see how DD
can help us understand
one of the most important
economic events
in US history.
Look back with me now
at the Great Depression--
the worst economic catastrophe,
our country has ever known.
Unemployment hit 25% in 1933--
a level not seen before or since.
Millions lost their homes
or their land.
Suicide spiked, and hungry families
relied on soup kitchens
and bread lines
to keep from starving.
Economists argue fiercely over
the causes of the Great Depression.
Most agree, however,
that a key piece of the puzzle
is an epidemic of bank failures.
This was before Deposit Insurance.
So if your bank went bankrupt,
your savings disappeared with it,
Faced with a banking crisis.
The central bank has a choice
lend freely to troubled
Banks or stand aside
and refuse to lend
lending, freely to banks in
trouble, is called Easy Money
refusing to lend is called Tight money.
Monitors Masters, Milton
Friedman and Anna,
Schwartz famously called
the Great Depression.
The great contraction
accusing, the Federal Reserve of inflicting,
a misguided policy of tight money
on the nation's teetering,
financial institutions.
They argued that easy money would
have kept many banks in business.
Shortening, the Great Depression,
but others disagree if banks are insolvent
because of unwise lending decisions,
then bailouts just
encourage more foolishness.
Economists call this problem,
moral hazard the debate over bailouts
in. Moral hazard continues. Today
should Financial Behemoth.
Lehman Brothers, have been allowed to
fail on the eve of the Great Recession
in an Ideal World. We'd answer this
question by applying different fed policies
to randomly selected regions,
but we can still learn a
lot by using differences
and differences to compare Trends across
areas with different monetary policies.
How's that even possible? Don't the same
fed policies. Apply to all banks in the US?
Yeah, good question.
The Federal Reserve System is divided
into twelve districts each headed by
a regional bank. Today fed policy
is set at the national level.
But in the 1930s Regional, feds
could do pretty much as they liked,
and here's what's so awesome about that
in 1930. The Atlanta fed running the
6th District, followed an easy money.
Policy sending wheelbarrows of cash
to rescue insolvent institutions,
the st. Louis fed running the 8th
District, followed a Tight money policy.
Let Veil The foolish
they said in st. Louis
and so a natural experiment in
monetary policy was born even better.
This is a within State experiment,
the border between the sixth and
the eighth districts run smack
through the middle of Mississippi.
So northern, Mississippi had tied
money while Southern Mississippi.
Had easy money, but under the same state
laws in banking regulations, in both.
The treatment group is the
district. 6 part of Mississippi,
which had access to Easy
Money during the crisis.
The control group is the
district 8 part of Mississippi,
which had Tight money during the crisis.
The key year in our natural
experiment was 1930,
Caldwell and Company a massive Financial
Empire. In the South Came Crashing. Down.
Banking is a business built
on confidence and Trust
the Caldwell meltdown caused a panic that
led to a widespread Bank Run all at once.
Depositors wanted their money
back, causing Banks to go bankrupt
and shut their doors.
We'll use differences in
differences to measure the effect
of contrasting monetary policies
in response to the Caldwell crisis.
This figure plots. The number
of banks in Mississippi by year
for the eighth and sixth districts.
Let's start in 1929 a year
before the Caldwell crash.
There are 169 banks open in the
eighth and 141 banks open in the
Over the next year,
we see a similar handful of
banks fail. In both districts,
the change in the number of banks
in operation. Is remarkably similar.
That's what parallel Trends look like
in November. 1930, Caldwell, crashes.
And the Panic begins
Banks. Fail frequently in the 8th
District, which had Tight money,
but the decline is slower in the
6th District which had easy money.
The diverging Trends in this period,
might be attributable to
easy versus Tight money
in July, of 1931, the 8th
District, abandons type money.
So now both districts are easy.
Parallel Trends are restored
in a counterfactual world where the sixth
district follows a Tight money policy.
What might have happened
if we extrapolate the trend of
the 8th District to the sixth,
it would look like this.
So
The treatment effective easy money is
how much the 6th District deviated From
the Path implied by
the 8th District trend.
How many banks did the
Easy Money treatment save
this table reports data for the treatment
group District Six in the first row
and data for the control group
District 8 in the second row.
The First Column shows the
number of banks in business,
before The Crisis began in 1930.
The second column shows 1931.
This is the key period when each district
had differing monetary policies during
the crisis the rightmost.
Column
reports changes within the district
district, 6 lost 14 Banks while District
8 lost 33, the mathematical formula
for the treatment effect is simple.
We subtract the change in banks
in operation, in the 8th District
from the change in banks
in operation in the sixth.
Hence. The name
differences in differences,
negative 14, minus negative, 33 equals 9.
19.
We estimate that 19 Banks
were saved by easy money
in practice tables and figures like
those shown here are the beginning
rather than the end of a DD analysis,
the problem of how to gauge the
statistical, significance of DD, estimates
turns out to be exceedingly, tricky
and a regression is typically
part of the solution,
the key assumption behind a
DD analysis is that of parallel Trends
recall, the principle of ceteris paribus,
our ideal comparison would have
the two districts experienced,
an identical business environment, except
for one factor easy or tight money.
Both districts would have identical
types of customers who would go bankrupt
at exactly the same rate.
The skill of their employees
would be equal and so on
perfect ceteris, paribus comparisons
would allow us to clearly see
the causal effect of different fed
policies in this case, that's not possible.
But the idea of parallel Trends
is based on a similar concept.
If we see that the two regions
experienced similar Trends in the number
of banks over.
Time in the absence of treatment, we
can assume they are good comparisons.
We see that the two districts move in
parallel both before the crisis. And after,
when they have the same fed policy,
the only time the district's behave differently
is when the FED policy is different.
In view of this fed policy is a likely
cause of diverging Trends from 1930 to 1931.
But we should also check for other
changes unique to northern, Mississippi.
What do you mean?
Imagine that bad tornadoes? Hit Northern,
but not Southern. Mississippi in 1930,
these tornadoes devastate Farms
causing Farmers to default on loans,
which drives their Banks out of business.
Then the sixth and eighth districts
would differ in not one, but two ways
fed policy, and whether and
we'd have trouble identifying
Policy as the causal Factor behind
increased bank failures in the eighth.
DD credibility lives or
dies with the claim that the
only reason northern
Mississippi was special in 1930
is differing. Regional fed policy.
We're in DD heaven with strong Visual
Evidence of parallel Trend in general.
The first step in evaluating whether
to use DD is usually this type of
visual confirmation of parallel Trends
outside of the period.
When we expect to see a treatment
effect, the treatment in our example,
Easy money in the face of bank failures
metrics Masters, use DD to
explore effects of many policies
like the minimum, legal drinking age,
and environmental changes
like access to clean water.
In our next video.
We'll see an example of how regression
is used to implement a DD approach.
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