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The path from cause to effect[br]is dark and dangerous,

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but the weapons[br]of econometrics are strong,

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wield differences-in-differences[br]when witnessing parallel trends.

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♪ [music] ♪

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Masters of metrics

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look for convincing[br]ceteris paribus comparisons.

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The ideal comparison contrasts[br]treatment and control groups

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that look similar.

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But sometimes this sort[br]of comparability is elusive.

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When treatment and control groups

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evolve similarly[br]in the absence of treatment,

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even if from different[br]starting points,

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there's hope for causal inference.

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The weapon that exploits[br]parallel evolution,

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masters say parallel trends,

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is called differences-in-differences...

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(voice whispering)[br]Differences-in-differences

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- ...or DD for short.[br]- Alright. Nice.

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Let's see how DD[br]can help us understand

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one of the most important[br]economic events

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in US history.

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Look back with me now[br]at the Great Depression--

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the worst economic catastrophe,[br]our country has ever known.

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Unemployment hit 25% in 1933--

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a level not seen before or since.

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Millions lost their homes[br]or their land.

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Suicide spiked, and hungry families

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relied on soup kitchens[br]and bread lines

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to keep from starving.

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Economists argue fiercely over[br]the causes of the Great Depression.

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Most agree, however,[br]that a key piece of the puzzle

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is an epidemic of bank failures.

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This was before Deposit Insurance.

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So if your bank went bankrupt,[br]your savings disappeared with it,

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Faced with a banking crisis.[br]The central bank has a choice

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lend freely to troubled[br]Banks or stand aside

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and refuse to lend

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lending, freely to banks in[br]trouble, is called Easy Money

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refusing to lend is called Tight money.

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Monitors Masters, Milton[br]Friedman and Anna,

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Schwartz famously called[br]the Great Depression.

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The great contraction

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accusing, the Federal Reserve of inflicting,[br]a misguided policy of tight money

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on the nation's teetering,[br]financial institutions.

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They argued that easy money would[br]have kept many banks in business.

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Shortening, the Great Depression,

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but others disagree if banks are insolvent[br]because of unwise lending decisions,

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then bailouts just[br]encourage more foolishness.

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Economists call this problem,

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moral hazard the debate over bailouts[br]in. Moral hazard continues. Today

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should Financial Behemoth.

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Lehman Brothers, have been allowed to[br]fail on the eve of the Great Recession

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in an Ideal World. We'd answer this[br]question by applying different fed policies

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to randomly selected regions,

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but we can still learn a[br]lot by using differences

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and differences to compare Trends across[br]areas with different monetary policies.

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How's that even possible? Don't the same[br]fed policies. Apply to all banks in the US?

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Yeah, good question.

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The Federal Reserve System is divided[br]into twelve districts each headed by

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a regional bank. Today fed policy[br]is set at the national level.

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But in the 1930s Regional, feds[br]could do pretty much as they liked,

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and here's what's so awesome about that

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in 1930. The Atlanta fed running the[br]6th District, followed an easy money.

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Policy sending wheelbarrows of cash[br]to rescue insolvent institutions,

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the st. Louis fed running the 8th[br]District, followed a Tight money policy.

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Let Veil The foolish[br]they said in st. Louis

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and so a natural experiment in[br]monetary policy was born even better.

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This is a within State experiment,

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the border between the sixth and[br]the eighth districts run smack

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through the middle of Mississippi.

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So northern, Mississippi had tied[br]money while Southern Mississippi.

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Had easy money, but under the same state[br]laws in banking regulations, in both.

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The treatment group is the[br]district. 6 part of Mississippi,

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which had access to Easy[br]Money during the crisis.

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The control group is the[br]district 8 part of Mississippi,

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which had Tight money during the crisis.

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The key year in our natural[br]experiment was 1930,

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Caldwell and Company a massive Financial[br]Empire. In the South Came Crashing. Down.

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Banking is a business built[br]on confidence and Trust

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the Caldwell meltdown caused a panic that[br]led to a widespread Bank Run all at once.

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Depositors wanted their money[br]back, causing Banks to go bankrupt

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and shut their doors.

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We'll use differences in[br]differences to measure the effect

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of contrasting monetary policies[br]in response to the Caldwell crisis.

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This figure plots. The number[br]of banks in Mississippi by year

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for the eighth and sixth districts.

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Let's start in 1929 a year[br]before the Caldwell crash.

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There are 169 banks open in the[br]eighth and 141 banks open in the

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Over the next year,

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we see a similar handful of[br]banks fail. In both districts,

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the change in the number of banks[br]in operation. Is remarkably similar.

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That's what parallel Trends look like

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in November. 1930, Caldwell, crashes.

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And the Panic begins

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Banks. Fail frequently in the 8th[br]District, which had Tight money,

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but the decline is slower in the[br]6th District which had easy money.

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The diverging Trends in this period,

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might be attributable to[br]easy versus Tight money

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in July, of 1931, the 8th[br]District, abandons type money.

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So now both districts are easy.

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Parallel Trends are restored

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in a counterfactual world where the sixth[br]district follows a Tight money policy.

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What might have happened

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if we extrapolate the trend of[br]the 8th District to the sixth,

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it would look like this.

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So

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The treatment effective easy money is[br]how much the 6th District deviated From

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the Path implied by[br]the 8th District trend.

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How many banks did the[br]Easy Money treatment save

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this table reports data for the treatment[br]group District Six in the first row

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and data for the control group[br]District 8 in the second row.

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The First Column shows the[br]number of banks in business,

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before The Crisis began in 1930.[br]The second column shows 1931.

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This is the key period when each district[br]had differing monetary policies during

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the crisis the rightmost.

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Column

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reports changes within the district[br]district, 6 lost 14 Banks while District

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8 lost 33, the mathematical formula[br]for the treatment effect is simple.

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We subtract the change in banks[br]in operation, in the 8th District

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from the change in banks[br]in operation in the sixth.

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Hence. The name[br]differences in differences,

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negative 14, minus negative, 33 equals 9.

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19.

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We estimate that 19 Banks[br]were saved by easy money

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in practice tables and figures like[br]those shown here are the beginning

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rather than the end of a DD analysis,

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the problem of how to gauge the[br]statistical, significance of DD, estimates

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turns out to be exceedingly, tricky

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and a regression is typically[br]part of the solution,

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the key assumption behind a

0:08:11.100,0:08:17.700
DD analysis is that of parallel Trends[br]recall, the principle of ceteris paribus,

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our ideal comparison would have[br]the two districts experienced,

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an identical business environment, except[br]for one factor easy or tight money.

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Both districts would have identical[br]types of customers who would go bankrupt

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at exactly the same rate.

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The skill of their employees[br]would be equal and so on

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perfect ceteris, paribus comparisons[br]would allow us to clearly see

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the causal effect of different fed[br]policies in this case, that's not possible.

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But the idea of parallel Trends[br]is based on a similar concept.

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If we see that the two regions[br]experienced similar Trends in the number

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of banks over.

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Time in the absence of treatment, we[br]can assume they are good comparisons.

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We see that the two districts move in[br]parallel both before the crisis. And after,

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when they have the same fed policy,

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the only time the district's behave differently[br]is when the FED policy is different.

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In view of this fed policy is a likely[br]cause of diverging Trends from 1930 to 1931.

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But we should also check for other[br]changes unique to northern, Mississippi.

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What do you mean?

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Imagine that bad tornadoes? Hit Northern,[br]but not Southern. Mississippi in 1930,

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these tornadoes devastate Farms[br]causing Farmers to default on loans,

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which drives their Banks out of business.

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Then the sixth and eighth districts[br]would differ in not one, but two ways

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fed policy, and whether and[br]we'd have trouble identifying

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Policy as the causal Factor behind[br]increased bank failures in the eighth.

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DD credibility lives or[br]dies with the claim that the

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only reason northern[br]Mississippi was special in 1930

0:10:13.900,0:10:16.000
is differing. Regional fed policy.

0:10:16.600,0:10:22.100
We're in DD heaven with strong Visual[br]Evidence of parallel Trend in general.

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The first step in evaluating whether

0:10:24.200,0:10:30.200
to use DD is usually this type of[br]visual confirmation of parallel Trends

0:10:30.200,0:10:31.700
outside of the period.

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When we expect to see a treatment[br]effect, the treatment in our example,

0:10:37.100,0:10:39.700
Easy money in the face of bank failures

0:10:40.500,0:10:45.000
metrics Masters, use DD to[br]explore effects of many policies

0:10:45.800,0:10:47.900
like the minimum, legal drinking age,

0:10:48.500,0:10:52.200
and environmental changes[br]like access to clean water.

0:10:52.900,0:10:54.200
In our next video.

0:10:54.500,0:10:59.200
We'll see an example of how regression[br]is used to implement a DD approach.

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Are you a teacher click to explore ways to[br]use these videos in class if your learner

0:11:07.000,0:11:11.200
Make sure this video sticks by taking[br]a few quick practice questions,

0:11:11.600,0:11:14.200
or if you're ready.[br]Click for the next video.

0:11:14.600,0:11:20.000
You can also check out Mr. Use website for[br]more courses, teacher resources and more.