WEBVTT

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The path from cause to effect
is dark and dangerous,

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but the weapons
of econometrics are strong,

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wield differences-in-differences
when witnessing parallel trends.

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♪ [music] ♪

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Masters of metrics

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look for convincing
ceteris paribus comparisons.

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The ideal comparison contrasts
treatment and control groups

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that look similar.

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But sometimes this sort
of comparability is elusive.

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When treatment and control groups

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evolve similarly
in the absence of treatment,

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even if from different
starting points,

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there's hope for causal inference.

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The weapon that exploits
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)
Differences-in-differences

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- ...or DD for short.
- Alright. Nice.

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Let's see how DD
can help us understand

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one of the most important
economic events

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in US history.

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Look back with me now
at the Great Depression--

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the worst economic catastrophe,
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
or their land.

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Suicide spiked, and hungry families

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relied on soup kitchens
and bread lines

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to keep from starving.

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Economists argue fiercely over
the causes of the Great Depression.

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Most agree, however,
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,
your savings disappeared with it,

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Faced with a banking crisis.
The central bank has a choice

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lend freely to troubled
Banks or stand aside

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and refuse to lend

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lending, freely to banks in
trouble, is called Easy Money

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refusing to lend is called Tight money.

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Monitors Masters, Milton
Friedman and Anna,

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Schwartz famously called
the Great Depression.

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The great contraction

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

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on the nation's teetering,
financial institutions.

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They argued that easy money would
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
because of unwise lending decisions,

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then bailouts just
encourage more foolishness.

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Economists call this problem,

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moral hazard the debate over bailouts
in. Moral hazard continues. Today

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should Financial Behemoth.

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

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

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to randomly selected regions,

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but we can still learn a
lot by using differences

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

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How's that even possible? Don't the same
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
into twelve districts each headed by

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

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But in the 1930s Regional, feds
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
6th District, followed an easy money.

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Policy sending wheelbarrows of cash
to rescue insolvent institutions,

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

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Let Veil The foolish
they said in st. Louis

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and so a natural experiment in
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
the eighth districts run smack

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through the middle of Mississippi.

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So northern, Mississippi had tied
money while Southern Mississippi.

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

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

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which had access to Easy
Money during the crisis.

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The control group is the
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
experiment was 1930,

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

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Banking is a business built
on confidence and Trust

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

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Depositors wanted their money
back, causing Banks to go bankrupt

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and shut their doors.

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We'll use differences in
differences to measure the effect

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of contrasting monetary policies
in response to the Caldwell crisis.

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This figure plots. The number
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
before the Caldwell crash.

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There are 169 banks open in the
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
banks fail. In both districts,

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the change in the number of banks
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
District, which had Tight money,

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

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The diverging Trends in this period,

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might be attributable to
easy versus Tight money

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in July, of 1931, the 8th
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
district follows a Tight money policy.

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What might have happened

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if we extrapolate the trend of
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
how much the 6th District deviated From

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the Path implied by
the 8th District trend.

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How many banks did the
Easy Money treatment save

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

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

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The First Column shows the
number of banks in business,

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before The Crisis began in 1930.
The second column shows 1931.

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This is the key period when each district
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
district, 6 lost 14 Banks while District

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

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We subtract the change in banks
in operation, in the 8th District

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from the change in banks
in operation in the sixth.

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Hence. The name
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
were saved by easy money

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in practice tables and figures like
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
statistical, significance of DD, estimates

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turns out to be exceedingly, tricky

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and a regression is typically
part of the solution,

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the key assumption behind a

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DD analysis is that of parallel Trends
recall, the principle of ceteris paribus,

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our ideal comparison would have
the two districts experienced,

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

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Both districts would have identical
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
would be equal and so on

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perfect ceteris, paribus comparisons
would allow us to clearly see

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

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

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

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of banks over.

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

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We see that the two districts move in
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
is when the FED policy is different.

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

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

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What do you mean?

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

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these tornadoes devastate Farms
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
would differ in not one, but two ways

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fed policy, and whether and
we'd have trouble identifying

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

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DD credibility lives or
dies with the claim that the

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only reason northern
Mississippi was special in 1930

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is differing. Regional fed policy.

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We're in DD heaven with strong Visual
Evidence of parallel Trend in general.

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The first step in evaluating whether

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to use DD is usually this type of
visual confirmation of parallel Trends

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outside of the period.

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

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Easy money in the face of bank failures

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metrics Masters, use DD to
explore effects of many policies

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like the minimum, legal drinking age,

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and environmental changes
like access to clean water.

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In our next video.

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We'll see an example of how regression
is used to implement a DD approach.

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

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Make sure this video sticks by taking
a few quick practice questions,

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or if you're ready.
Click for the next video.

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