Federal Reserve Bank of St. Louis Review, March/April 2010
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Federal RReserveE BankV of St. LIouiEs W MARCH /APRIL 2010 VOLUME 92, N UMBER 2 R E V I E W Lessons Learned? Comparing the Federal Reserve’s Responses to the Crises of 1929-1933 and 2007-2009 David C. Wheelock Institutions and Government Growth: A Comparison of the 1890s and the 1930s Thomas A. Garrett, Andrew F. Kozak, and Russell M. Rhine M A R Fiscal Multipliers in War and in Peace C H / David Andolfatto A P R I L 2 0 1 FOMC Learning and Productivity Growth (1985-2003): 0 • A Reading of the Record V O Richard G. Anderson and Kevin L. Kliesen L U M E 9 2 N U M B E R 2 89 REVIEW Lessons Learned? Comparing the Federal Reserve’s Responses to the Director of Research Christopher J. Waller Crises of 1929-1933 and 2007-2009 Senior Policy Adviser David C. Wheelock Robert H. Rasche Deputy Director of Research Cletus C. Coughlin 109 Review Editor-in-Chief Institutions and Government Growth: William T. Gavin A Comparison of the 1890s and the 1930s Research Economists Thomas A. Garrett, Andrew F. Kozak, and Richard G. Anderson Russell M. Rhine David Andolfatto Alejandro Badel Subhayu Bandyopadhyay Silvio Contessi 121 Riccardo DiCecio Thomas A. Garrett Fiscal Multipliers in War and in Peace Carlos Garriga David Andolfatto Massimo Guidolin Rubén Hernández-Murillo Luciana Juvenal Natalia A. Kolesnikova 129 Michael W. McCracken FOMC Learning and Productivity Growth Christopher J. Neely Michael T. Owyang (1985-2003): A Reading of the Record Adrian Peralta-Alva Richard G. Anderson and Kevin L. Kliesen Rajdeep Sengupta Daniel L. Thornton Howard J. Wall Yi Wen David C. Wheelock Managing Editor George E. Fortier Editors Judith A. Ahlers Lydia H. Johnson Graphic Designer Donna M. Stiller The views expressed are those of the individual authors and do not necessarily reflect official positions of the Federal Reserve Bank of St. Louis, the Federal Reserve System, or the Board of Governors. FEDERAL RESERVE BANK OF ST . LOUIS REVIEW MARCH /APRIL 2010 i Review is published six times per year by the Research Division of the Federal Reserve Bank of St. Louis and may be accessed through our website: research.stlouisfed.org/publications/review . All nonproprietary and nonconfidential data and programs for the articles written by Federal Reserve Bank of St. Louis staff and published in Review also are available to our readers on this website. These data and programs are also available through Inter-university Consortium for Political and Social Research (ICPSR) via their FTP site: www.icpsr.umich.edu/pra/index.html. Or contact the ICPSR at P.O. Box 1248, Ann Arbor, MI 48106-1248; 734-647-5000; [email protected] . Single-copy subscriptions are available free of charge. Send requests to: Federal Reserve Bank of St. Louis, Public Affairs Department, P.O. Box 442, St. Louis, MO 63166-0442, or call (314) 444- 8809. General data can be obtained through FRED (Federal Reserve Economic Data), a database providing U.S. economic and financial data and regional data for the Eighth Federal Reserve District. You may access FRED through our website: research.stlouisfed.org/fred . Articles may be reprinted, reproduced, published, distributed, displayed, and transmitted in their entirety if copyright notice, author name(s), and full citation are included. Please send a copy of any reprinted, published, or displayed materials to George Fortier, Research Division, Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, MO 63166-0442; [email protected] . Please note: Abstracts, synopses, and other derivative works may be made only with prior written permission of the Federal Reserve Bank of St. Louis. Please contact the Research Division at the above address to request permission. © 2010, Federal Reserve Bank of St. Louis. ISSN 0014-9187 ii MARCH /APRIL 2010 FEDERAL RESERVE BANK OF ST . LOUIS REVIEW Lessons Learned? Comparing the Federal Reserve’s Responses to the Crises of 1929-1933 and 2007-2009 David C. Wheelock The financial crisis of 2007-09 is widely viewed as the worst financial disruption since the Great Depression of 1929-33. However, the accompanying economic recession was mild compared with the Great Depression, though severe by postwar standards. Aggressive monetary, fiscal, and financial policies are widely credited with limiting the impact of the recent financial crisis on the broader economy. This article compares the Federal Reserve’s responses to the financial crises of 1929-33 and 2007-09, focusing on the effects of the Fed’s actions on the composition and size of the Fed balance sheet, the monetary base, and broader monetary aggregates. The Great Depression experi - ence showed that central banks should respond aggressively to financial crises to prevent a col lapse of the money stock and price level. The modern Fed appears to have learned this lesson; howev er, some critics argue that, in focusing on the allocation of credit, the Fed was too slow to increase the monetary base. The Fed’s response to the financial crisis has raised new questions about the appropriate role of a lender of last resort and the long-run implications of actions that limit financial losses for individual firms and markets. (JEL E31, E32, E52, E58, N12) Federal Reserve Bank of St. Louis Review , March/April 2010, 92 (2), pp. 89-107. he financial crisis of 2007-09 is wide ly nomic contractions by the National Bureau of viewed as the worst financial disrup - Economic Research (NBER). The recent reces sion tion since the Great Depression of began in December 2007, according to the NBER. 1929-33. The banking crises of the Great Although their Business Cycle Dating Committee TDepression involved runs on banks by deposi - has not officially identified the end of this reces - tors, whereas the crisis of 2007-09 reflected panic sion, many economists believe that it ended in in wholesale funding markets that left banks the middle of 2009; thus, the data used for this unable to roll over short-term debt. Although recession span December 2007 through June 2009. different in character, the crisis of 2007-09 was In terms of duration, decline in real gross fundamentally a banking crisis like those of the domestic product (GDP), and peak rate of unem - Great Depression and many of the earlier crises ployment, the recent recession ranks among the that preceded large declines in economic activi ty most severe of all postwar recessions. 1 However, (Gorton, 2009). Table 1 reports information about every U.S. 1 recession since the Great Depression of 1929- 33— The recession of 1945 was marked by a sharp, but short-lived decline in output as industries sharply reduced the production of more specifically, the periods designated as eco - war material at the end of World War II. David C. Wheelock is a vice president and economist at the Federal Reserve Bank of St. Louis. The author thanks Michael Bordo, Bob Hetzel, Rajdeep Sengupta, and Dan Thornton for comments on a previous version of this article, which was presented at the conference “The History of Central Banking” at the Bank of Mexico on November 23, 2009. Craig P. Aubuchon provided research assistance. © 2010, The Federal Reserve Bank of St. Louis. The views expressed in this article are those of the author(s) and do not necessarily reflect the views of the Federal Reserve System, the Board of Governors, or the regional Federal Reserve Banks. Articles may be reprinted, reproduced, published, distributed, displayed, and transmitted in their entirety if copyright notice, author name(s), and full citation are included. Abstracts, synopses, and other derivative works may be made only with prior written permission of the Federal Reserve Bank of St. Louis. FEDERAL RESERVE BANK OF ST . LOUIS REVIEW MARCH /APRIL 2010 89 Wheelock Table 1 Key Macro Performance Measures Across U.S. Recessions Real GDP: Unemployment: CPI: Decline peak Maximum value Change peak Recession Duration (months) to trough (%) during recession (%) to trough (%) 1929-33 43 –36.21 25.36 –27.17 1937-38 13 –10.04 20.00 –2.08 1945-45 8 –14.48 3.40 1.69 1948-49 11 –1.58 7.90 –2.07 1953-54 10 –2.53 5.90 0.37 1957-58 8 –3.14 7.40 2.12 1960-61 10 –0.53 6.90 1.02 1969-70 11 –0.16 5.90 5.04 1973-75 16 –3.19 8.60 14.81 1980 6 –2.23 7.80 6.30 1981-82 16 –2.64 10.80 6.99 1990-91 8 –1.36 6.80 3.53 2001 8 0.73 5.50 0.68 2007-09 20* –3.66 9.50 2.76 *The current recession end date has not yet been determined by the NBER; data are through 2009:Q2. the recent recession was mild compared with the Bernanke noted that, in contrast, monetary pol icy economic declines of 1929-33 and 1937-38. For was “largely passive” during the Great Depression. example, real GDP fell 36 percent during 1929- 33, This article summarizes the Federal Reserve’s and the unemployment rate exceeded 25 per cent. response to the financial crisis of 2007-09 and Moreover, the price level, measured by the con - compares it with the Fed’s response to financial sumer price index (CPI), fell by 27 percent. By con - shocks during the Great Depression. First, the trast, the CPI rose 2.76 percent between December article describes the Fed’s actions as the recent 2007 and June 2009. crisis evolved. Initially, the Fed focused on mak - Monetary, fiscal, and financial policies are ing funds available to banks and other financial widely credited for limiting the impact of the institutions, but used open market operations to financial crisis of 2007-09 on the broader econ omy.