Factors Accounting for Changes in the Stock of Money
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This PDF is a selection from a published volume from the National Bureau of Economic Research Volume Title: The Great Contraction, 1929–33 Volume Author/Editor: Milton Friedman and Anna J. Schwartz Volume Publisher: Princeton University Press Volume ISBN: 0-691-00350-5 Volume URL: http://www.nber.org/books/frie65-1 Publication Date: 1965 Chapter Title: Factors Accounting for Changes in the Stock of Money Chapter Authors: Milton Friedman, Anna Jacobson Schwartz Chapter URL: http://www.nber.org/chapters/c9275 Chapter pages in book: (p. 36 - 54) I I T}IE GREAT CONThAc'j-IQN the then exIsting gold parity.After the election,rumors spread that the new administration planned to devalue, I that Roosevelt had beenpet- suaded by George Warrento follow a policy of altering the gold of the dollar as content a means of "reflating" prices. Therumors became par- ticularly widespread in early1933 and gained credence when refused to deny them. The Roosevelt I effect of the tumors and the failureto deny them was that, for the firsttime in the course of the internal drain in part took contraction, the the form of a demand forgold coin and certificates thereby reinforcing the external drain arising fromspeculative accumulation of foreign exchange. The rumors about goldwere only one part of the general during the interregnum uncertainty about future financial andeconomic policy. Under ordinary circumstances, itwould have been doubtfulthat such rumors and such uncertainty couldbe a major factor and widespread accounting for so dramatic a financial panic. But thesewere not ordinary circum- I stances. The uncertainty came after more than threeyears of severe economic contraction and after more than two years of bankingdifficulties in which onewave of bank failures had followed banking system another and had left the in a peculiarly vulnerableposition. The Federal itself participated inthe general atmosphere Rscre started, it fed on itself. of panic. Once thepanic 2. Factors Accounting for Changes in theStock of Money The factorsaccounting for changes in the stock of money duringthe four years from 1929 to 1933are strikingly different from periods we have those in the other examined. Generally,the pattern for money has impressed itself high-powered most strongly on the totalstock of money, the behayior of the twodeposit ratios serving money stock relative to the mainly to alter the tiltof the tilt of high-posrerdmoney. That relation holds in Chart 31only for the period the first banking crisis. up tO October 1930. theonset of Thereafter, the twodeposit ratios take High-powered moneymoves in a direction command. stock of money, and opposite to that of thetotal not even most of itsshort-term impress on the stock ofmoney. movements leave an From August 1929to March 1933 powered money alone as a whole, the changein high- would have produceda rise of 17 stock of money. Thechange in the per cent in. the deposstcurrencyratio alone would Frank B. Freidel,Franklin Delano Little Brown, 1956, Roosevelt, Vol. 3, p. 351Rxey Smith and The TriumphBoto0 York, Longmans Green1939. pp. 32l-333Norman BcaSiey CarterG105, New reduce the goldcontent of the dollar underWhen Roosevelt authjjzd to to the .Agric,lturl authority of theThomas amendment important speeds Adjuatment Act of May12, 1933, Gias, on behalf of RoeyeJt who had madean vigorous attack on him its the during the electioncampaign made Senate (Smith andBea.sley pp 34935fi a TIlE GREAT CONTRACTION e CHART 31 The Stock of Money and Its Proximate Determinants, Monthly, 1- 1929March 1933 It E:Ions' E.Uons 01 dollers 50 y 45- Money stock d 40 35 30 9 High-peoeredmoney 8 Palo Ic0, I L Depostt--reserse rtiQ I er F R. bond d 8L IDeposit- currency ratio IMirthOSti 7 C 5Ioh Fit Second 8.tcn n maset boa nq bonknq iec.i crash crL%tS crttri cold d. 11111 P I I 1111II IIII iiiillititil al I99 t'301i 1931 1932 13 n SOURCE: Tobtos A-I (cot. 8) and 8-3. in the deposit-reserve II - have produced a decline of 37 per cent; the change ratio, a decline of 20 per cent:interaction between the two ratios, a rise of 10 per cent; these three converted thel714 per cent rise that high- Id powered money would have produced into a 35 per cerndecline in the stock of money.46 For a inUre detailed examinationof these changes, we ½ The trough of the money stock was reached inAprilI 933. Although the percentage decline from Aug. 1929 so Apr. 1933is only slightly larger than from Aug. 1929 to Mar. 1933 (35.7 rather than 35.2 percent), the percentage changes In produced if it alone had changed a in the money stock each determinant would have over the longer period show larger differences:13, 35, 19, and 9 per cent, in 37 '(HE GREAT CONtRAcTION consider separately each of the periods distinguishedin the precdn section and marked off on our charts. THE STOCK MARKET CRASH, OCTOtIER 1929 Before the stock market crash, all three determinantsof the money stock, and hence also the money stock itself, had beenroughly constant. The constancy in high-powered money reflecteda rough constancy in eac1 of the categories into which we have dividedthe correspondine assets of the monetary authorities: the gold stock,Federal Reserve private claims, and other physical assets and flat of themonetary authorities (see Chart 32B) However, the constancy of FederalReserve f)rivate claims concea!s a not uninteresting detail, brought out by Chart 33.which shows tie components of Federal Reserve credit outstanding.The total was roughly constant because a decline in bills discountedwas offset by a rise in hills bought. The reason for the divergentmovements was the siniultaneous rise in August 1929 of the NewYork Reserve Bank's discountrate fioj 5 to 6 per cent and the decline of its buying rate on bills (bankers'ac- ceptances) from 5% to 5% percent. We analyzed the reason for these apparently inconsistent movements in the preceding chaptersection 4) Their effect was to make it profitable for banks to get funds fromthe Reserve System by creatingacceptances and selling them to the Reserve Banks rather than by increasingtheir own indebtedness When the crash came, therewere widespread attempts by holders securities to liquidate them said of by banks and other lendersoutside New York to reduce their loans.As in all such cases, the tion of participants is different position of the collec- from that of anyone Participant. Long- term securities cannot, on net, be liquidated in a short intervalbut only the ooler shown in the text. Thereason is that the return flow of bankin5 holiday reduced high-powered curreçy alter th money substantially and also depcs -:irrery ratio from Mar.to Apr. 1933. raised the Thn,snierical values of the contributions of the determinantsduring the con- tractioii dated as ending in Mar. andin Apr. 1933, follow. Clcsngin Money Stock That Would Have Been Produced liv Indicated Determinant if ItAlone Had Changed Rate of Change Per Fear per Cent) 4sg. 1929 !Oa,ji ofTotal(hanae Aig'. .4itc. Proxvrite Detrnn:nan liar. 1933 19254- .1u. 1929- .4r. lciJ tiar1933 High-powered money 4 6 Apr 1Q3 Deposit_rers.eratio 6 2 3 2 37 0 28 Depositcun-ency ratio - 0 52 0 49 13 0 8 I 07 Interaction 2 6 0 98 2 3 - U 27 All - 9 12 1 121) 190 Detail may not add to total becauseofrounding. 38 TI-SF. GREAT CONTRACTION d transferred from one holder to another. The widespread attemptc to liquidate simply reduced prices to a level at which intended purchases matched intended sales. Loans on securities, especially call loans, are a somewhat more com- stock, plex affair. In large measure, what is involvedisalso a transfer of Tue debts from one lender to another, rather than a change in total. But, cli of irs addition, the total can be altered much more rapidly. Aside from de- ts of fault, one way is by a transfer of other assets, as most directly when a laims, borrower transfers money to a creditor and reduces his own money bal- Thart ance, or more indirecti when a borrower acquires cashby selling the secu- sceals rity serving as collateral to someone else who draws down a money bal- the ance to acquire it. Another way is by what is in effect mutualcancellation ughl of reciprocal debts. The most obvious but clearly insignificant example in- ibills volves the cancellation by two borrowers of loans they have made to one leous another. less obvious but mote important example involves a longer from chain, say, a corporation lending on call in the stock market and simul- S ac- taneously borrowing from a bank. If the bank talres over the call loan in these discharge of its loan to he corporation. the total of the two kinds of debt ,n 4). outstanding is reduced. The total can also be altered by creation of debts; the for example, if a corporation lending on call in the market is willing to t'SCFVC accept a note from a bank ormore realisticallya depositin that bank in return for the corporation's claim. In that case, the total of the two ers of kinds of debt is increased. New The essential point for our purpose is that the demand for liquida- collec- tion of security loans involves one of three arrangements: (I)finding Long- someone willing to take over the loans which, asfor securities, can be only done by a change of price, that is. a rise irs interest rates;(2) finding someone willing to acquire assets for money tobe used by the borrower to repay his loan, which can be done bylowering the price of the assess; or (Crdie i'd the (3) arranging for more or less roundabout mutual cancellation or crea- tion of debts, which involves changes in the relative pricesof the various e con- assets.