1
00:00:00,400 --> 00:00:05,700
The path from cause to effect
is dark and dangerous,

2
00:00:05,700 --> 00:00:08,900
but the weapons
of econometrics are strong,

3
00:00:09,700 --> 00:00:13,700
wield differences-in-differences
when witnessing parallel trends.

4
00:00:14,450 --> 00:00:17,000
♪ [music] ♪

5
00:00:20,100 --> 00:00:21,423
Masters of metrics

6
00:00:21,423 --> 00:00:24,800
look for convincing
ceteris paribus comparisons.

7
00:00:25,100 --> 00:00:29,419
The ideal comparison contrasts
treatment and control groups

8
00:00:29,419 --> 00:00:30,600
that look similar.

9
00:00:30,600 --> 00:00:34,700
But sometimes this sort
of comparability is elusive.

10
00:00:34,700 --> 00:00:36,805
When treatment and control groups

11
00:00:36,805 --> 00:00:40,100
evolve similarly
in the absence of treatment,

12
00:00:40,100 --> 00:00:42,307
even if from different
starting points,

13
00:00:42,307 --> 00:00:44,900
there's hope for causal inference.

14
00:00:45,600 --> 00:00:48,400
The weapon that exploits
parallel evolution,

15
00:00:48,664 --> 00:00:50,886
masters say parallel trends,

16
00:00:50,886 --> 00:00:53,363
is called differences-in-differences...

17
00:00:53,363 --> 00:00:54,300
(voice whispering)
Differences-in-differences

18
00:00:54,400 --> 00:00:56,900
- ...or DD for short.
- Alright. Nice.

19
00:00:56,900 --> 00:00:59,987
Let's see how DD
can help us understand

20
00:00:59,987 --> 00:01:03,058
one of the most important
economic events

21
00:01:03,058 --> 00:01:04,370
in US history.

22
00:01:05,300 --> 00:01:08,300
Look back with me now
at the Great Depression--

23
00:01:08,800 --> 00:01:12,200
the worst economic catastrophe,
our country has ever known.

24
00:01:13,100 --> 00:01:16,200
Unemployment hit 25% in 1933--

25
00:01:16,600 --> 00:01:19,507
a level not seen before or since.

26
00:01:19,507 --> 00:01:22,100
Millions lost their homes
or their land.

27
00:01:22,600 --> 00:01:24,737
Suicide spiked, and hungry families

28
00:01:24,737 --> 00:01:26,766
relied on soup kitchens
and bread lines

29
00:01:26,766 --> 00:01:28,155
to keep from starving.

30
00:01:29,400 --> 00:01:34,000
Economists argue fiercely over
the causes of the Great Depression.

31
00:01:34,000 --> 00:01:36,983
Most agree, however,
that a key piece of the puzzle

32
00:01:36,983 --> 00:01:39,620
is an epidemic of bank failures.

33
00:01:39,800 --> 00:01:41,900
This was before deposit insurance.

34
00:01:42,100 --> 00:01:46,490
So if your bank went bankrupt,
your savings disappeared with it,

35
00:01:52,600 --> 00:01:56,100
Faced with a banking crisis,
the central bank has a choice:

36
00:01:56,400 --> 00:01:58,524
lend freely to troubled banks

37
00:01:58,524 --> 00:02:01,100
or stand aside and refuse to lend.

38
00:02:01,500 --> 00:02:05,440
Lending freely to banks in trouble
is called easy money.

39
00:02:05,440 --> 00:02:08,100
Refusing to lend is called tight money.

40
00:02:10,200 --> 00:02:12,872
Monetarist masters Milton Friedman
and Anna Schwartz

41
00:02:12,872 --> 00:02:14,611
famously called
the Great Depression

42
00:02:14,611 --> 00:02:16,350
the "Great Contraction,"

43
00:02:16,800 --> 00:02:18,367
accusing the Federal Reserve

44
00:02:18,367 --> 00:02:21,200
of inflicting a misguided policy
of tight money

45
00:02:21,200 --> 00:02:24,000
on the nation's teetering
financial institutions.

46
00:02:24,400 --> 00:02:25,873
They argued that easy money

47
00:02:25,873 --> 00:02:27,985
would have kept
many banks in business,

48
00:02:27,985 --> 00:02:29,700
shortening the Great Depression,

49
00:02:30,400 --> 00:02:32,239
But others disagree!

50
00:02:32,239 --> 00:02:33,769
If banks are insolvent

51
00:02:33,769 --> 00:02:35,954
because of unwise
lending decisions,

52
00:02:35,954 --> 00:02:38,900
then bailouts just encourage
more foolishness.

53
00:02:39,600 --> 00:02:42,965
Economists call this problem
"moral hazard."

54
00:02:42,965 --> 00:02:46,100
The debate over bailouts
in moral hazard continues today.

55
00:02:46,500 --> 00:02:48,599
Should financial behemoth
Lehman Brothers

56
00:02:48,599 --> 00:02:51,500
had been allowed to fail
on the eve of the Great Recession,

57
00:02:52,000 --> 00:02:54,703
in an ideal world,
we'd answer this question

58
00:02:54,703 --> 00:02:58,400
applying different Fed policies
to randomly selected regions.

59
00:02:59,000 --> 00:03:00,250
But we can still learn a lot

60
00:03:00,250 --> 00:03:02,119
by using differences-in-differences

61
00:03:02,119 --> 00:03:06,300
to compare trends across areas
with different monetary policies.

62
00:03:10,900 --> 00:03:12,522
How's that even possible?

63
00:03:12,522 --> 00:03:15,779
Don't the same Fed policies
apply to all banks in the US?

64
00:03:15,779 --> 00:03:17,400
- Yeah.
- Good question.

65
00:03:17,700 --> 00:03:21,484
The Federal Reserve System
is divided into 12 districts,

66
00:03:21,484 --> 00:03:24,301
each headed by a regional bank.

67
00:03:24,301 --> 00:03:27,467
Today, Fed policy is set
at the national level.

68
00:03:27,467 --> 00:03:32,200
But in the 1930s, regional Feds
could do pretty much as they liked.

69
00:03:32,200 --> 00:03:33,276
Ah, interesting.

70
00:03:33,276 --> 00:03:35,500
And here's what's
so awesome about that.

71
00:03:35,500 --> 00:03:39,302
In 1930, the Atlanta Fed,
running the 6th District,

72
00:03:39,302 --> 00:03:41,473
followed an easy money policy,

73
00:03:41,473 --> 00:03:45,400
sending wheelbarrows of cash
to rescue insolvent institutions,

74
00:03:45,900 --> 00:03:48,816
The St. Louis Fed,
running the 8th District,

75
00:03:48,816 --> 00:03:50,668
followed a tight money policy.

76
00:03:51,100 --> 00:03:53,900
"Let fail the foolish!"
they said in St. Louis.

77
00:03:54,300 --> 00:03:58,701
And so a natural experiment
in monetary policy was born.

78
00:03:58,701 --> 00:04:02,000
Even better, this is
a within-state experiment.

79
00:04:02,000 --> 00:04:04,347
The border between the 6th
and the 8th districts

80
00:04:04,347 --> 00:04:06,762
ran smack through
the middle of Mississippi.

81
00:04:07,300 --> 00:04:09,321
So northern Mississippi
had tight money,

82
00:04:09,321 --> 00:04:11,870
while southern Mississippi
had easy money,

83
00:04:11,870 --> 00:04:15,200
but under the same state laws
in banking regulations in both.

84
00:04:15,770 --> 00:04:16,853
The treatment group

85
00:04:16,853 --> 00:04:20,151
is the District 6th part
of Mississippi,

86
00:04:20,151 --> 00:04:23,100
which had access to easy money
during the crisis.

87
00:04:23,800 --> 00:04:25,091
The control group

88
00:04:25,091 --> 00:04:27,800
is the District 8th part
of Mississippi,

89
00:04:27,800 --> 00:04:30,225
which had tight money
during the crisis.

90
00:04:31,300 --> 00:04:34,040
The key year
in our natural experiment

91
00:04:34,040 --> 00:04:35,400
was 1930,

92
00:04:35,800 --> 00:04:37,563
Caldwell & Company,

93
00:04:37,563 --> 00:04:40,377
a massive financial empire
in the South

94
00:04:40,377 --> 00:04:41,987
came crashing down.

95
00:04:42,700 --> 00:04:46,000
Banking is a business
built on confidence and trust.

96
00:04:46,500 --> 00:04:49,151
The Caldwell meltdown
caused a panic

97
00:04:49,151 --> 00:04:53,049
that led to a widespread
bank run all at once.

98
00:04:53,049 --> 00:04:55,114
Depositors wanted their money back,

99
00:04:55,114 --> 00:04:58,200
causing banks to go bankrupt
and shut their doors.

100
00:05:01,000 --> 00:05:03,321
We'll use differences-in-differences

101
00:05:03,321 --> 00:05:06,614
to measure the effect
of contrasting monetary policies

102
00:05:06,614 --> 00:05:09,164
in response to the Caldwell crisis.

103
00:05:12,500 --> 00:05:16,439
This figure plots the number
of banks in Mississippi by year,

104
00:05:16,439 --> 00:05:19,273
for the 8th and 6th districts.

105
00:05:19,273 --> 00:05:24,200
Let's start in 1929 - a year
before the Caldwell crash.

106
00:05:24,200 --> 00:05:27,646
There are 169 banks
open in the 8th,

107
00:05:27,646 --> 00:05:31,366
and 141 banks open in the 6th.

108
00:05:31,366 --> 00:05:32,784
Over the next year,

109
00:05:32,784 --> 00:05:37,000
we see a similar handful
of banks fail, in both districts.

110
00:05:37,400 --> 00:05:40,135
The change in the number
of banks in operation

111
00:05:40,135 --> 00:05:42,168
is remarkably similar.

112
00:05:42,168 --> 00:05:44,600
That's what parallel trends look like.

113
00:05:45,500 --> 00:05:48,783
In November 1930, Caldwell crashes,

114
00:05:48,783 --> 00:05:50,400
and the panic begins.

115
00:05:51,200 --> 00:05:53,917
Banks failed frequently
in the 8th district,

116
00:05:53,917 --> 00:05:55,300
which had tight money.

117
00:05:55,800 --> 00:05:58,712
But the decline is slower
in the 6th District,

118
00:05:58,712 --> 00:06:00,247
which had easy money.

119
00:06:00,800 --> 00:06:03,000
The diverging trends in this period

120
00:06:03,000 --> 00:06:06,602
might be attributable
to easy versus tight money.

121
00:06:06,602 --> 00:06:12,020
In July of 1931, the 8th district
abandons tight money,

122
00:06:12,020 --> 00:06:14,420
so now both districts are easy.

123
00:06:14,700 --> 00:06:16,900
Parallel trends are restored.

124
00:06:17,300 --> 00:06:19,229
In a counterfactual world,

125
00:06:19,229 --> 00:06:22,420
where the 6th district
follows a tight money policy,

126
00:06:22,420 --> 00:06:23,800
what might have happened?

127
00:06:24,201 --> 00:06:28,547
If we extrapolate the trend
of the 8th district to the 6th,

128
00:06:28,547 --> 00:06:29,900
it would look like this.

129
00:06:30,290 --> 00:06:33,095
So the treatment effective
easy money

130
00:06:33,095 --> 00:06:36,646
is how much the 6th district
deviated from the path

131
00:06:36,646 --> 00:06:38,900
implied by the 8th district trend.

132
00:06:41,244 --> 00:06:44,475
How many banks
did the easy money treatment save?

133
00:06:44,475 --> 00:06:49,021
This table reports data
for the treatment group, District 6,

134
00:06:49,021 --> 00:06:50,162
in the first row

135
00:06:50,162 --> 00:06:54,237
and data for the control group,
District 8, in the second row.

136
00:06:54,237 --> 00:06:57,494
The first column shows
the number of banks in business

137
00:06:57,494 --> 00:07:00,613
before the crisis began in 1930.

138
00:07:00,613 --> 00:07:03,976
The second column shows 1931.

139
00:07:03,976 --> 00:07:05,607
This is the key period

140
00:07:05,607 --> 00:07:08,663
when each district
had differing monetary policies

141
00:07:08,663 --> 00:07:10,237
during the crisis.

142
00:07:10,237 --> 00:07:14,347
The rightmost column
reports changes within the district.

143
00:07:14,347 --> 00:07:20,456
District 6 lost 14 banks,
while District 8 lost 33.

144
00:07:20,456 --> 00:07:23,973
The mathematical formula
for the treatment effect is simple.

145
00:07:24,400 --> 00:07:28,700
We subtract the change in banks
in operation, in the 8th District

146
00:07:28,900 --> 00:07:32,200
from the change in banks
in operation in the sixth.

147
00:07:32,800 --> 00:07:35,700
Hence. The name
differences in differences,

148
00:07:37,000 --> 00:07:40,900
negative 14, minus negative, 33 equals 9.

149
00:07:41,100 --> 00:07:41,600
19.

150
00:07:42,500 --> 00:07:46,800
We estimate that 19 Banks
were saved by easy money

151
00:07:47,300 --> 00:07:51,700
in practice tables and figures like
those shown here are the beginning

152
00:07:51,800 --> 00:07:54,300
rather than the end of a DD analysis,

153
00:07:55,400 --> 00:08:00,000
the problem of how to gauge the
statistical, significance of DD, estimates

154
00:08:00,100 --> 00:08:02,300
turns out to be exceedingly, tricky

155
00:08:02,400 --> 00:08:05,600
and a regression is typically
part of the solution,

156
00:08:09,200 --> 00:08:10,700
the key assumption behind a

157
00:08:11,100 --> 00:08:17,700
DD analysis is that of parallel Trends
recall, the principle of ceteris paribus,

158
00:08:17,900 --> 00:08:21,700
our ideal comparison would have
the two districts experienced,

159
00:08:21,700 --> 00:08:27,800
an identical business environment, except
for one factor easy or tight money.

160
00:08:29,200 --> 00:08:33,500
Both districts would have identical
types of customers who would go bankrupt

161
00:08:33,500 --> 00:08:35,300
at exactly the same rate.

162
00:08:35,700 --> 00:08:38,600
The skill of their employees
would be equal and so on

163
00:08:39,200 --> 00:08:43,400
perfect ceteris, paribus comparisons
would allow us to clearly see

164
00:08:43,600 --> 00:08:48,700
the causal effect of different fed
policies in this case, that's not possible.

165
00:08:49,100 --> 00:08:53,600
But the idea of parallel Trends
is based on a similar concept.

166
00:08:53,600 --> 00:08:57,900
If we see that the two regions
experienced similar Trends in the number

167
00:08:57,900 --> 00:08:58,800
of banks over.

168
00:08:59,000 --> 00:09:04,000
Time in the absence of treatment, we
can assume they are good comparisons.

169
00:09:04,400 --> 00:09:09,800
We see that the two districts move in
parallel both before the crisis. And after,

170
00:09:10,100 --> 00:09:12,400
when they have the same Fed policy,

171
00:09:13,100 --> 00:09:18,300
the only time the district's behave differently
is when the Fed policy is different.

172
00:09:19,400 --> 00:09:26,700
In view of this Fed policy is a likely
cause of diverging Trends from 1930 to 1931.

173
00:09:27,800 --> 00:09:31,800
But we should also check for other
changes unique to northern, Mississippi.

174
00:09:32,300 --> 00:09:33,200
What do you mean?

175
00:09:33,500 --> 00:09:39,100
Imagine that bad tornadoes? Hit Northern,
but not Southern. Mississippi in 1930,

176
00:09:39,600 --> 00:09:44,300
these tornadoes devastate Farms
causing Farmers to default on loans,

177
00:09:44,600 --> 00:09:46,800
which drives their Banks out of business.

178
00:09:47,400 --> 00:09:52,200
Then the sixth and eighth districts
would differ in not one, but two ways

179
00:09:52,700 --> 00:09:57,200
Fed policy, and whether and
we'd have trouble identifying

180
00:09:57,600 --> 00:10:02,500
Policy as the causal Factor behind
increased bank failures in the eighth.

181
00:10:07,200 --> 00:10:10,200
DD credibility lives or
dies with the claim that the

182
00:10:10,200 --> 00:10:13,600
only reason northern
Mississippi was special in 1930

183
00:10:13,900 --> 00:10:16,000
is differing. Regional Fed policy.

184
00:10:16,600 --> 00:10:22,100
We're in DD heaven with strong Visual
Evidence of parallel Trend in general.

185
00:10:22,200 --> 00:10:24,200
The first step in evaluating whether

186
00:10:24,200 --> 00:10:30,200
to use DD is usually this type of
visual confirmation of parallel Trends

187
00:10:30,200 --> 00:10:31,700
outside of the period.

188
00:10:31,700 --> 00:10:36,900
When we expect to see a treatment
effect, the treatment in our example,

189
00:10:37,100 --> 00:10:39,700
Easy money in the face of bank failures

190
00:10:40,500 --> 00:10:45,000
metrics Masters, use DD to
explore effects of many policies

191
00:10:45,800 --> 00:10:47,900
like the minimum, legal drinking age,

192
00:10:48,500 --> 00:10:52,200
and environmental changes
like access to clean water.

193
00:10:52,900 --> 00:10:54,200
In our next video.

194
00:10:54,500 --> 00:10:59,200
We'll see an example of how regression
is used to implement a DD approach.

195
00:11:00,800 --> 00:11:06,900
Are you a teacher click to explore ways to
use these videos in class if your learner

196
00:11:07,000 --> 00:11:11,200
Make sure this video sticks by taking
a few quick practice questions,

197
00:11:11,600 --> 00:11:14,200
or if you're ready.
Click for the next video.

198
00:11:14,600 --> 00:11:20,000
You can also check out Mr. Use website for
more courses, teacher resources and more.