Monetary Policy in the Great Depression: What the Fed Did, and Why

David C Wheelock

David C. Wheelock, assistant professor of economics at the University of Texas-Austin, is a visiting scholar at the Federal Reserve Bank of St Louis. David H. Kelly provided research assistance.

L IXTY YEARS AGO the United States— role of monetary policy in causing the Depression indeed, most of the world—was in the midst of and the possibility that different policies might the Great Depression. Today, interest in the have made it less severe. Depression’s causes and the failure of government policies to prevent it continues, peaking Much of the debate centers on whether mone- whenever the stock market crashes or the econ- tary conditions were “easy” or “tight” during the omy enters a recession. in the 1930s, dissatisfac- Depression—that is, whether money and credit tion with the failure of monetary policy to pre- were plentiful and inexpensive, or scarce and vent the Depression, or to revive the economy, expensive. During the 1930s, many Fed officials led to sweeping changes in the structure of the argued that money was abundant and “cheap,” Federal Reserve System. One of the most impor- even “sloppy,” because market interest rates tant changes was the creation of the Federal were low and few banks borrowed from the dis- Open Market Committee (FOMC) to direct open count window. Modern researchers who agree market policy. Recently Congress has again con- generally believe neither that monetary forces sidered possible changes in the Federal Reserve were responsible for the Depression nor that System.’ different policies could have alleviated it. Others contend that monetary conditions were tight, This article takes a new look at Federal Reserve noting that the supply of money and price level policy in the Great Depression. Historical analy- fell substantially. They argue that a more aggres- sis of Fed performance could provide insights sive response would have limited the Depression. into the effects of System organization on policy making. The article begins with a macroeconomic Among those who conclude that contraction- overview of the Depression. It then considers ary monetary policy worsened the Depression, both contemporary and modern views of the there has been considerable debate about why

“The Monetary Policy Reform Act of 1991” (S. 1611) present form of the FOMC, whose members include the would have abolished the FOMC and thereby ended the Board of Governors of the Federal Reserve System and voting on open market policy by Federal Reserve Bank the 12 Reserve Bank presidents. Five of the presidents presidents. Although hearings on the bill were held, it was vote on policy on a rotating basis. not brought to a vote before Congress adjourned at the end of 1991. The Banking Act of 1935 established the Federal Reserve officials failed to respond ap- Fed’s interest in aiding its member banks. They propriately. Most explanations fall into two cate- argue that monetary policy was designed to gories. One holds that Fed officials, though well- cause the failure of nonmember banks, which intentioned, failed to understand that more ag- would enhance the long-run profits of member gressive action was needed. Some researchers, banks and enlarge the System’s regulatory like Friedman and Schwartz (1963), argue that domain - the Fed’s behavior during the Depression con- trasted sharply with its behavior during the T 1920s. They contend that the death of Benjamin .A.N OVISIIITIE%V O.F~ .FHE G.REA.Tl7 Strong in 1928 led to a redistribution of authori- i).E~vJi1L:~iSS:lt).j.v ty within the System that caused a distinct de- terioration in Fed performance. Strong, who Analysts generally agree that the economic was Governor of the Federal Reserve Bank of collapse of the 1930s was extremely severe, if New York from the System’s founding in 1914 not the most severe in American history. To until his death, dominated Federal Reserve policy- provide a sense of the Depression, Figures 1-3 making in the years before the Depression.’ plot GNP, the price level and the unemployment These researchers argue that authority was dis- rate from 1919 to 1939. As the figures show, af- persed after his death among the other Reserve ter eight years of nearly continuous expansion, Banks, whose officials were less knowledgeable nominal (current dollar) GNP fell 48 percent and failed to recognize the need for aggressive from 1929 to 1933. Real (constant dollar) GNP policies. Other researchers, like Wicker (1966), fell 33 percent and the price level declined 25 Brunner and Meltzer (1968), and ‘I’emin (1989), percent. The unemployment rate went from un- contend that Strong’s death caused no change in der 4 percent in 1929 to 25 percent in 1933.’ Fed performance. They argue that Strong had Real GNP did not recover to its 1929 level until not developed a countercyclical policy and that 1937. The unemployment rate did not fall below he would have failed to recognize the need for 10 percent until World War H.’ vigorous action during the Depression. in their Few segments of the economy were unscathed. view, Fed errors were not due to organizational Personal and firm bankruptcies rose to unpre- flaws or changes, but simply to continued use cedented highs. In 1932 and 1933, aggregate of flawed policies. corporate profits in the United States were A second category of explanations holds that negative. Some 9,000 banks, with $6.8 billion of the Fed’s contractionary policy was deliberate. deposits, failed between 1930 and 1933 (see Epstein and Ferguson (1984) and Anderson, figure 4). Since some suspended banks eventually Shughart and Tollison (1988) contend that Fed reopened and deposits were recovered, these officials understood that monetary conditions figures overstate the extent of the banking dis- were tight. Epstein and Ferguson assert that the tress.’ Nevertheless, bank failures were numer- Fed believed a contraction was necessary and ous and their effects severe, even compared inevitable. When it did act, they argue, it was to with the 1920s, when failures were high by promote the interests of commercial banks, modern standards. rather than economic recovery. Anderson, Much of the debate about the causes of the Shughart and Tollison emphasize even more the Great Depression has focused on bank failures.

2 4 until changed by the Banking Act of 1935, the chief ex- Darby (1976) argues that the unemployment rate series ecutive officers of the Reserve Banks held the title “gover- considerably overstates the true rate after 1933 because it nor.” Today these officers are titled “president,” while takes persons employed on government relief projects as members of the Board of Governors, which replaced the unemployed. Kesselman and Savin (1978) offer an oppos- Federal Reserve Board in 1935, now hold the title ing view. Regardless of which argument is accepted, un- “governor.” employment during the 1930s was exceptionally severe, ‘The appendix provides a list of sources for the data used particularly since there were relatively few multi-income in this article. The GNP and unemployment series used households. here are standard, but Romer (1986a, 1986b) presents ‘There was no deposit insurance in these years. The Bank- new estimates of GNP and unemployment for the 1920s. ing Act of 1933 created federal deposit insurance. During Both new estimates exhibit less variability than those tradi- the 19th and early 20th centuries a number of states ex- tionally used; Romer’s estimate of the unemployment rate perimented with insurance plans for their state-chartered in 1929 is 4.6 percent, compared with 3.2 percent plotted banks, but none was still in existence by 1930. See here. Calomiris (1989) for a survey of the state systems. Figure 1 Nominal and Real Gross National Product

Billions of dollars 120

70 Nominal

50 ——— —.-—— - 1920 1925 1930 1935

Figure 2 Implicit Price Index

1929=100 125

110

105

100

1920 1925 1930 1935 0

Figure 3 Unemployment Rate

Number of banks 4000

3500

3000

2500

2000

1500

1000

500

0 1920 1925 1930 1935

Were they merely a result of falling national in- the banking panics and money supply con- come and money demand? Or were they an im- traction. portant cause of the Depression? Most contempo- raries viewed bank failures as unfortunate for those who lost deposits, but irrelevant in macro- -_ ~f7’~ ~ C~. ¶ - ¶ ¶f7~ economic significance. Keynesian explanations of the Depression agreed, including little role for Today there is considerable debate about the bank failures. Monetarists like Friedman and causes of business cycles and whether government Schwartz (1963), on the other hand, contend policies can alleviate them.” Just as there is no that banking panics caused the money supply to consensus now, contemporary observers had many different views about the causes of the fall which, in turn, caused much of the decline Great Depression and the appropriate response of in economic activity. Bernanke (1983) notes that government. A few economists, like Irving Fisher bank failures also disrupted credit markets, (1932), applied the Quantity Theory of Money, which he argues caused an increase in the cost which holds that changes in the money supply of credit intermediation that significantly cause changes in the price level and can affect the reduced national output. In these explanations, level of economic activity for short periods. These the Federal Reserve bears much of the blame economists argued that the Fed should prevent for the Depression because it failed to prevent deflation by increasing the money supply. At the

‘See Belongia and Garfinkel (forthcoming). Figure 4 Bank Suspensions

Percent 30

0 1920 1925 1930 1935 other extreme, proponents of “liquidationist” the- revival may commence again, it is essential that ories of the cycle argued that excessively easy these positions should be liquidated. -. monetary policy in the 1920s had contributed to One implication of the liquidationist theory is the Depression, and that “artificial” easing in response to it was a mistake. Liquidationists that increasing the money supply during a thought that overproduction and excessive bor- recession is likely to be counterproductive. Dur- ing a minor recession in 1927, for example, the rowing cause resource misallocation, and that depressions are the inescapable and necessary Fed had made substantial open market purchases and reduced its discount rate. Adolph means of correction: Miller, a member of the Federal Reserve Board, in the course of a boom many bad business who agreed with the liquidationist view, testified in 1931 that: commitments are undertaken. Debts are in- curred which it is impossible to repay. Stocks It lthe 1.927 action) was the greatest and boldest are produced and accumulated which it is im- operation ever undertaken by the Federal possible to sell at a profit. Loans are made Reserve System, and, in my judgment, resulted which it is impossible to recover. Both in the in one of the niost costly errors committed by sphere of finance and in the sphere of produc- it or any banking system in the last 75 years. I tion, when the boom breaks, these bad commit- am inclined to think that a different policy at ments are revealed. Now in order that that time would have left us with a different

‘Lionel Robbins, The Great Depression (1935) [quoted by Chandler (1971), p. 118]. condition at this time. -.- That was a time of it died out quickly with the Keynesian revolu- business recession. Business could not use and tion, which dominated macroeconomics for the was not asking for increased money at that next 30 years. Keynesian explanations of the time.’ Depression differed sharply from those of the Ii- quidationists. Keynesians tended to dismiss in Miller’s view, because economic activity was monetary forces as a cause of the Depression or low, the reserves created by the Fed’s actions a useful remedy. instead they argued that fueled stock market speculation, which led in- declines in business investment or household evitably to the crash and subsequent consumption had reduced aggregate demand, depression. which had caused the decline in economic activity.bO Both views, however, agreed that mone- During the Depression, proponents of the Ii- tary ease prevailed during the Depression. quidationist view argued against increasing the money supply since doing so might reignite Friedman and Schwartz renewed the debate speculation without promoting an increase in about the role of monetary policy by forcefully real output. Indeed, many argued that the Fed- restating the Quantity Theory explanation of the eral Reserve had interfered with recovery and Depression: prolonged the Depression by pursuing a policy of monetary ease. Hayek (1932), for example, The contraction is. -. a tragic testimonial to the wrote: importance of monetary forces. -- - Different and feasible actions by the monetary authorities It is a fact that the present crisis is marked by could have prevented the decline in the stock the first attempt on a large scale to revive the of money. --[This] would have reduced the con-

economy.. - by a systematic policy of lowering traction’s severity and almost as certainly its du- the interest rate accompanied by all other possi- ration (pp. 300-01). ble measures for preventing the normal process of liquidation, and that as a result the depres- Friedman and Schwartz argue that an increase in the money stock would have offset, if not sion has assumed more devastating forms and lasted longer than ever before (p. 130). prevented, banking panics, and would have led to increased lending to consumers and business Several key Fed officials shared Hayek’s views. that would have revived the economy. For example, the minutes of the June 23, 1930, Many disagree with the Friedman and Schwartz meeting of the Open Market Committee report the views of George Norris, Governor of the explanation, although some recent Keynesian explanations concede that restrictive monetary Federal Reserve Bank of Philadelphia: policy did play a role in the Depression.h1 Other He indicated that in his view the current busi- studies, such as Field (1984), Hamilton (1987), ness and price recession was to be ascribed and ‘remin (1989), conclude that contractionary largely to overproduction and excess productive monetary policy in 1928 and 1929 contributed capacity in a number of lines of business rather to the Depression. Bordo (1989) and Wicker than to financial causes, and it was his belief (1989) provide detailed surveys of the monetarist- that easier money and a better bond market Keynesian debate about the causes of the Great would not help the situation but on the con- Depression, and interested readers are referred trary might lead to further increases in produc- to them. Since most recent contributions to this tive capacity and further overproduction.’ literature emphasize the effects of monetary policy, a new look at the policies of the Federal While the liquidationist theory of the business Reserve during the Great Depression is war- cycle was commonly believed in the early 1930s, ranted.

‘U.S. Senate (1931), p. 134. IlMost criticize the Fed’s discount rate increases and failure to replace reserve losses suffered by banks in the panic ‘Quoted by Chandler (1971), pp. 136-37. De Long (1990) following Great Britain’s departure from the gold standard details the liquidationist cycle theory, and Chandler (1971), pp. 116-23, has a general discussion of prevailing busi- in late 1931. See Temin (1976), p. 170, and Kindleberger ness cycle theories and their prescriptions for monetary (1986), pp. 164-67. policy. 10 See Temin (1976) for a survey of Keynesian explanations of the Great Depression. Figure 5 Interest Rates

Percent 12

Baa 6

2 oflGfl-~-t,0n-,~

—2 1920 1925 1930 1935

Baa-rated bonds, rose during the first three years of the Depression (see figure 5)12 Never- theless, the exceptionally low yields on short- A fundamental disagreement within the Feder- term securities has suggested to many observers al Reserve System and among outside observers, an abundance of liquidity. even today, is whether monetary policy during the Depression was easy or tight. Most Fed offi- Other variables also have been interpreted as cials felt that money and credit were plentiful. indications of easy monetary conditions. Rela- Short-term market interest rates fell sharply af- tively few banks came to the Fed’s discount ter the stock market crash of 1929 and remained window to borrow reserves, for example, and at extremely low levels throughout the 1930s many banks built up substantial excess reserves (see figure 5). ‘to most observers, the decline in as the Depression progressed (see figure 8)13 To short-term rates implied monetary ease. Long- most observers, it appeared that there was little term interest rates declined less sharply, demand for credit and, since most policymakers however, and yields on risky bonds, such as saw their mission as one of accommodating

l2The short-term rate series through 1933 is the average yield in June of each year on U.S. government bonds. 3 daily yield in June of each year on three- to six-month ‘ Data on excess reserves before 1929 are not available, Treasury notes and certificates, and the yield on Treasury but they were not likely very large. bills thereafter. The long-term series is the average daily Figure 6 Borrowed and Excess Reserves of Federal Reserve Member Banks

Millions of dollars 1100

1000

900

800

700

600 Borrowed 500

400

300

200

100

0 1922 23 24 25 26 27 28 29 30 31 32 33

ing credit demand, few believed that more September 1931. -- - There was no rise in short- vigorous expansionary actions were necessary.” term interest rates in this two-year period. -- - The relevant record for the purpose of identify- Low interest rates and an apparent lack of de- ing a monetary restriction is the record of mand for reserves have led many researchers short-term interest rates (p. 169). to conclude that tight money did not cause the Depression. Temin (1976), for example, writes: There is no evidence of any effective deflation- Other indicators of monetary conditions, ary pressure from the banking system between however, suggest the opposite conclusion. Defla- the stock-market crash in October 1929 and the tion implied that the value of the dollar rose 25 British abandonment of the gold standard in percent from 1929 to 1933, which Schwartz

14 The Federal Reserve System’s founders intended that it probably continued to have considerable influence on operate according to the Real Bills Doctrine. Fed credit many Fed officials. See West (1977) or Wicker (1966) for would be extended primarily through the discount window discussion of the influence of the Real Bills Doctrine on as member banks borrowed to finance short-term agricul- policy over time. tural or business loans. A decline in economic activity would reduce discount window borrowing, causing Federal Reserve credit to decline. By 1924, System policy had evolved away from a strict Real Bills interpretation, but it —- Figure 7 Money Supply Millions of dollars 50,000

25,000

20,000

15,000 1920 1925 1930 1935 / / /

(1981) argues reflected exceptionally tight justed for changes in the price level, rose shar- money. Another indicator, the money stock, fell ply during the Depression (see figure 8).” While by one-third from 1929 to 1933 (see figure 7)13 the nominal yield on short-term government Friedman and Schwartz contend that: securities fell to an exceptionally low level, deflation implied that their real yield rose above it seems paradoxical to describe as ‘monetary 10 percent in 1930 and 1931. Thus, in contrast ease’ a policy which permitted the stock of to the apparent signal given by nominal interest

money to decline. --by a percentage exceeded rates, member bank borrowing and excess only four times in the preceding fifty-four years reserves, the falling money stock and deflation and then only during extremely severe suggest that monetary conditions were far from business-cycle contractions (p. 37a). easy.”

And finally, numerous studies point out that the Many economists now conclude that the Fed- real interest rate, that is, the interest rate ad- eral Reserve should have responded more

“Ml is the sum of coin and currency held by the public and “Yet another indicator is the real money supply, i.e., the demand deposits. M2 also includes time deposits at com- growth rate of the nominal supply of money less the ex- mercial banks. pected rate of inflation. Since the price level fell faster “See Meltzer (1976) and Hamilton (1987), for example. The the Depression, Temiri (1976) argues that real interest rate plotted in figure 8 is calculated, as the monetary conditions were not tight. The increase in real prevailing yield on short-term government s!curltles In money balances was relatively slow, however, which June of each year, less the rate of inflation in the subse- Hamilton (1987) argues was contractionary. quent year. Since actual, rather than anticipated, inflation is used to calculate the real rate, it is considered an ex post, rather than ex ante, rate. “C

Figure 8 Ex Post Real Interest Rate

Percent 25

—5

—10 1920 1925 1930 1935

vigorously tc the Depression. There is little price level stability, “and for seven years he agreement, however, about why the Fed did maintained a fairly stable price level in this not. The next sections examine alternative ex- country, and only a few of us knew what he planations for Federal Reserve behavior during was doing. His colleagues did not understand the Depression. it.”” In Fisher’s view, Strong adjusted the quantity of money to maintain a stable price level; had he lived, Fisher says, he would have .~. .f...~~.P1:kGTGE prevented the deflation of the 1930s by not al- lowing the quantity of money to decline.

Irving Fisher testified before Congress in 1935 Friedman and Schwartz agree with Fisher that that the Depression was severe because “Gover- Strong’s death caused monetary policy to nor Strong had died and his policies died with change significantly. They argue that Strong’s him. -- - I have always believed, if he had lived, aggressive open market purchases and discount ‘~‘ewould have had a different situation.” Ac- rate reductions in 1924 and 1927 had quickly al- cording to Fisher, Benjamin Strong had disco- leviated recessions, hut that his death produced vered how to use monetary policy to maintain a sharply different policy during the Depression:

ISU.5. House of Representatives (1935), p. 534. “Ibid, pp. 517-20. If Strong had still been alive and head of the fl.;ç; STRONG’S POLICY? New York Bank in the fall of 1.930, he would very likely have recognized the oncoming li- Much of Strong’s testimony before Congres- quidity crisis for what it was, would have been sional committees, as well as other speeches and prepared by experience and conviction to take writings, suggests that he had developed a poli- strenuous and appropriate nieasures to head it cy of money supply control to limit fluctuations off, and would have had the standing to carry in the price level. For example, in an unpub- the System with him (pp. 412-13). lished article dated April 1923, he wrote: “If, as is now universally admitted, prices are in- Friedman and Schwartz make a persuasive fluenced to advance or to decline by increases case. Strong was an experienced financial lead- or decreases in the total of ‘money’. -- then the er. He had served as an officer of Bankers task of the System is to maintain a reasonably Trust Company, and during the Panic of 1907 stable volume of money and credit 23 And, as head of a committee reporting to J. P. Mor- in a speech to the American Farm Bureau in gan that determined which financial institutions December 1922, he said that monetary policy: could be rescued.” He was the first governor of the Federal Reserve Bank of New York and -. should insure that there is sufficient money emerged as leader of the Federal Reserve Sys- and credit available to conduct the business of tern both because of his personality and stature the nation and to finance not only the seasonal in the financial community and because of the increases in demand but the annual or normal relative importance of New York member banks increase in volume I believe that it should in the international financial market.” He chaired he the policy of the Federal Reserve System, by a committee of Federal Reserve Bank governors the employment of the various means at its that coordinated System open market operations command, to maintain the volume of credit and and represented the System in dealings with currency in this country at such a level so that, foreign central banks and Congress.22 It is clear to the extent that the volume has any influence that, with his death, the Fed lost an experienced upon prices, it cannot possibly become the me- and forceful leader. ans for either promoting speculative advances in prices, or of a depression of prices.” Some researchers argue, however, that Strong’s death had little effect on policy. Temin These statements suggest that Strong would not (1989), for example, writes that “The death of have permitted the money supply collapse or Strong was a minor event in the history of the deflation that occurred after 1929. Great Depression” (p. 35). And Brunner and Meltzer (1968) argue that, “While there is some Other’ aspects of Strong’s testimony, speeches evidence that the death of Benjamin Strong con- and writings give different or ambiguous im- tributed to a shift in the balance of power wi- pressions of his views, however, making it thin the Federal Reserve. -- we find that a difficult to infer what policies he would have special explanation of monetary policy after advocated during the Depression. in testimony 1929 is unnecessary...” (p. 341). The disagree- before the House Banking Committee in 1926, ment between these authors and those such as Strong described the relationship between Fed Fisher, Friedman and Schwartz rests on their policy and the quantity of bank deposits, dis- views of whether Strong’s policies would have cussing in detail the multiplier relationship be- prevented the monetary collapse and Depression. tween bank reserves and deposits.” But he also

“Chandler (1958), pp. 27-28. they made it difficult to price new debt issues and a grow- 1 ‘ The Federal Reserve Act gave the individual Reserve ing understanding of the impact of open market operations Banks authority to initiate discount rate changes and open on economic activity, ted the Banks to form a “Governors market operations. The Federal Reserve Board could ap- Committee” to coordinate open market operations. This prove or disapprove these actions, but its role was primari- committee was replaced in 1923 by the Open Market In- ly supervisory, with no clear authority to determine policy. vestment Committee, which Strong headed until his death. 23 Because of this, and perhaps because it lacked forceful ”Prices and Price Control,” in Burgess (1930), pp. 229-30. leaders, the Board did not dominate policy making until af- 4 ‘ Ouoted by Chandler (1958), p. 200. ter the System was restructured by the Banking Act of 1935. See Wheelock (forthcoming) for details of this reor- “U.S. House of Representatives (1926), pp. 334-35. ganization. “Initially, each Reserve Bank determined its own open market operations. But Treasury Department complaints that testified that, “when it comes to a decline of This quotation suggests that Strong might have price level, the origin of which can not be at- found similar offsetting advantages to the defla- tributed to a credit policy, this effort that you tion that followed the stock market crash in make by a credit policy to arrest a fall of prices 1929 and might have been reluctant to expand may do more harm than good “ it is also the money supply through purchases of govern- difficult to interpret his writing that “the task of ment securities. the System is to maintain a reasonably stable These quotations illustrate the ambiguity of volume of money and credit, with due al- many of Strong’s statements and the difficulty lowances for seasonal fluctuations in demand, for of inferring what policies he would have pur- normal annual growth in the country’s develop- sued in the 1930s. To determine whether mone- ment.. and with such allowance as may be im- tary policy was changed by Strong’s death, it is posed by those great cycles of prosperity and probably more instructive to examine the poli- depression “ What sort of allowance for cies he actually implemented. fluctuations does he mean? This statement could be read as advocating an increase or a decrease Two aspects of Strong’s policies have received in money in response to a decline in economic attention from scholars studying Federal activity. The latter is suggested by the following Reserve behavior. First, beginning in the early statement: “there should be no such excessive 1920s, the System offset or “sterilized” gold or artificial supplies of money and credit as will flows and other changes in reserve funds by al- simply permit the marking up of prices when tering the volume of Fed credit outstanding.” there is no increase in business or production This policy limited fluctuations in bank reserves to warrant an increase in the volume of money and, thus, in the money supply and price level. and credit.” This sounds like the warnings by According to Friedman and Schwartz (1963), pp. some officials during the Depression that mone- 394-99, however, the Fed permitted gold out- tary expansion would be inflationary or cause flows during the Depression to reduce bank speculation because economic activity was low. reserves and the money supply and more than offset gold inflows. What had been an essential- Strong also seems to have concluded that the ly neutral policy, therefore, became a contrac- deflation from mid-1920 to 1921 had positive tionary policy after Strong’s death. effects: Miron (1988) argues that a similar change occurred in the Fed’s accommodation of seasonal The deflation which took place in the United credit and currency demands. From the Sys- States following the collapse of prices resulted in extricating the reserve system—the whole tem’s inception, Federal Reserve credit was sup- monetary system of the country—from a posi- plied to prevent seasonal demands from draining bank reserves and increasing interest tion of permanent entanglement. --and I think rates. According to Miron, the Fed was less ac- that was one of the fortunate results of the commodative after 1928, which contributed to policy. ---One of the results of this liquida- the frequency of financial crises during the tion. -.has been to put this country on as Depression.” sound or a sounder monetary basis than any other country in the world, without the in- Beyond the offsetting of gold and currency troduction of a lot of money or credit into cir- flows, a second aspect of Strong’s policies has culation, based solely upon the Government received considerable attention. In 1924 and debt to the bank of issue. I mean to explain 1927, the Fed made large open market pur- that there have been offsetting advantages to chases and discount rate reductions that were

that deflation. -- followed by increases in bank reserves and the

“Ibid, p. 577. nents, such as float. In this era, the Federal Reserve pur- “‘Prices and Price Control,” April 1923, in Burgess (1930), chased both U.S. government securities and bankers ac- p. 230 (italics added). ceptances (at fixed acceptance buying rates), and discount window lending consisted of both rediscount of eligible “From a speech to the American Farm Bureau in 1922 paper and advances to member banks at the discount [quoted by Chandler (1958), p. 200]. rate. 1 “U.S. House of Representatives (1926), p. 309. ‘ Miron does not test this claim except to show that Federal “Federal Reserve credit is supplied by Fed purchases of Reserve credit was somewhat less seasonal after 1928 securities and discount window lending (member bank bor- than before. rowing). It consists also of some miscellaneous compo- money supply. Friedman and Schwartz (1963) were. -- based upon the stock of gold and bore argue that the Fed’s purpose was to combat a constant relationship to the gold stock, and recessions and that its failure to respond as ag- the volume of bank deposits and the general gressively during the Depression reflected ‘a dis- price level were similarly related. But in recent tinct change in System behavior. Other years the relationship between gold and bank researchers, however, such as Wicker (1966) deposits is no longer as close or direct as it and Brunner and Meltzer (1968), find no incon- was, because the Federal Reserve System has sistency in Fed behavior, arguing that the com- given elasticity to the country’s bank reserves. paratively weak response to the Depression was Reserve Bank credit has become the equivalent in fact predictable from the policy strategy de- of gold in its power to serve as the basis of veloped by Strong. bank credit. .-- Hence. -- the present basis for bank credit consists of gold plus Federal i’he srei’t’in~,;3tj’C;i~ti~ohct~’~ Reserve credit. Federal Reserve bank credit is Before entering World War I, the United an elastic buffer between the country’s gold States absorbed large gold inflows that added supply and bank credit.” directly to bank reserves and caused a significant money supply increase.” Although inflows Strong credited the Federal Reserve System for ceased after America entered the war, bank preventing inflation in 1921 and 1922: reserves and the money supply continued to increase rapidly as Federal Reserve credit was ex- As the flow of gold imports was pouring into tended to help finance the war. After the war, the United States in 1921 and 1922, many gold outflows reduced the reserves of the economists abroad, and in this country as well, Reserve Banks, leading them to raise their dis- expected that this inward flow of gold would count rates and thereby restrict credit to mem- result in a huge credit expansion and a serious ber banks.3’ The resulting decline in Fed credit price inflation. That no such expansion or infla- coincided with a sharp decline in the money tion has taken place is due to the fact that the supply and deflation.’~ amount of Federal Reserve credit in use was diminished as the gold imports continued. Thus, Following the violent inflation-deflation cycle in the broad picture of financial events in this of 1917-21, the Fed began to intervene to pre- country since 1920, the presence of the Reserve vent gold flows from affecting bank reserves.” System may be said to have prevented rather In testimony before the House Committee on than fostered inflation.” Banking and Currency, Strong gave a clear explanation of this policy, presenting charts showing the relationship between gold fiovvs, Fed Figure 9 illustrates the policy of offsetting gold and currency flows during the 1920s.” credit, bank reserves and the price level.” He The shaded insert on pages 18-19 describes the explained: mechanics of this policy. Since gold is a source In the old days there was a direct relation be- of banking system reserves, gold inflows, unless tween the country’s stock of gold, bank deposits offset, add to the stock of reserves. A gold in- and the price level because bank deposits flow thus has the same effect on reserves as a

“The accompanying shaded insert discusses the sources their discount rates, and individually they began to pur- and uses of reserve funds and explains the mechanics of chase government securities. By 1923, there seems to the Fed’s sterilization policy. have been a conscious effort to offset gold flows [Fried- “The Reserve Banks were required to maintain gold man and Schwartz (1963), pp. 279-87]. reserves of 40 percent against their note issues and 35 “These charts are reproduced by Hetzel (1985), p. 7, who percent against deposits. A discount rate increase was in- examines Strong’s unwillingness to support legislation that tended to reduce discount loans and, thus, the Fed’s note would require the Fed to adopt a price level stabilization and deposit liabilities, as well as encourage gold inflows rule. as investors sought higher yields in the United States. “U.S. House of Representatives (1926), p. 470. “In January 1916, the All Commodities Price Index stood at 112.8 (1913t 100). In April 1917 (when the United States “Ibid, p.471. entered the war), it was at 172.9. At its peak in May 1920, “In practice, the Fed also offset changes in other sources the Index was at 246.7. It then fell to a low of 138.3 in and uses of reserve funds, but gold and currency flows January 1922. were the most substantial; the others can be ignored for il- lustrative purposes. “Before the war, the Fed lacked the resources to offset gold inflows, so sterilization was impossible. By the end of 1921, the Reserve Banks had sufficient reserves to reduce Figure 9 Gold and Currency Sterilization

Millions of dollars January 1924 to February 1933 3000

2500 Reserves

2000

1500

1000

500

0 ~1

‘ ,~. 1’ —500 / V ~ V

Gc’fci c\’’ •1000 V A I’ 1500 I

V —2000 I 1924 I 1925 I 1926 I 1927 I 1928 I 1929 I 1930 I 1931 I 1932 I 1933 I

Federal Reserve purchase of securities. Currency rency flows, at least until the fourth quarter of held by the public is a use of reserves: in- 1931. The money supply contraction and defla- creases in public currency holdings reflect tion during the first two years of the Depres- reserve withdrawals from banks. Thus, if not sion were not caused by a decline in bank offset, an increase in currency would correspond reserves. Instead, as figure 10 illustrates, the to a decrease in bank reserves. The difference money supply fell because the money multiplier between gold and currency is plotted in figure 9. declined.~°This was particularly true beginning It is clear that net increases (decreases) in this in the fourth quarter of 1930, when banking difference were largely offset by declines (in- panics caused marked increases in the creases) in Fed credit outstanding, so that total currency-deposit and reserve-deposit ratios.” bank reserves changed relatively little. ‘The relative stability of bank reserves ended It is also clear that Benjamin Strong’s death abruptly in September 1931. On September 21, did not interrupt the offsetting of gold and cur- Great Britain left the gold standard. Speculation

4 “The multiplier plotted in figure 10 equals (1 + k)/(r + k), ’Friedman and Schwartz (1963), pp. 340-42, conclude that where k is the ratio of currency held by the public to de- the money supply decline between August 1929 and Oc- mand deposits and r is the ratio of bank reserves to tober 1930 was caused by a decline in the monetary base. deposits. The multiplier is defined as the money supply This decline was due to a decrease in currency, not bank (here M2) divided by the monetary base, or ‘high-powered reserves. Thereafter, the base rose, but less than neces- money,” which is the sum of bank reserves and currency sary to offset the sharp decline in the multiplier. held by banks and the public. Figure 10 Money Supply and Base Multiplier

Multiplier January 1929 to February 1933 7

48.000 6.5 Multiplier

5.5

38., 000 4.5

3-5 I 1929 I 1930 I 1931 I 1932 I 1933 Monthly Data that the United States would soon follow led to Banks continued to lose reserves, however, as a large withdrawal of foreign deposits from depositors panicked and converted deposits into American banks and a consequent gold out- currency. Member banks were able to partially flow.~’In the six weeks ending October 28, offset the reserve outflows by borrowing and 1931, the gold stock declined $727 million (15 by selling acceptances to the Reserve Banks, al- percent).” The Fed raised its discount and ac- beit at the recently increased discount and acceptance buying rates, hoping that an increase ceptance buying rates. But the Fed made only in domestic interest rates would halt the gold outflow by raising the relative yield of U.S. trivial purchases of government securities, and, financial assets. This action was hailed as in all, Federal Reserve member banks suffered a demonstrating the Fed’s resolve to maintain gold $540 million (22 percent) loss of reserves be- convertibility of the dollar, and the gold outflow tween September 16, 1931, and February 24, ceased. 1932.~’

“If the United States had left the gold standard, it is likely “Non-borrowed reserves declined $1112 million (52 per- that the dollar would have depreciated against gold and cent), while discount loans (borrowed reserves) increased other currencies that remained linked to gold. This would $572 million. have meant an immediate loss of wealth in terms of gold for anyone holding dollar-denominated assets. ~‘Boardof Governors of the Federal Reserve System (1943), p. 386. The Federal Reserve Balance Sheet and Reserve Sterilization

.\ smipliied er~tonol lilt’ I ederal He~er~e

S.;tcrns balance sheet tin l)ect’riihc’r 31 - Federal Reserve System Balance Sheet

cii December 31, 1929 (billions of dollars) reserves LtrId I ed rredil outstanding. I it’ al— Assets In I’ eonsis ted of inen i her I m nk hoc l0\\ i ng Gold and ~asb reserves $3.01 (hills clkcoitnlcid. hariki’i’’~acceptances held Feceral Reservo credit 1 58

I he Resect i’ Ban ks lbills bong] ill .~ - s. Bills discounted S0.63 II’I •-got e inn ico t sect tip I iel d b~. tiin Fe erte GovenmentBills bought securities 0510 39 kinks and a rni~c.elliuwouscoinponenl. tiiadc Other 005 up pirmw iv n float. ‘11w pnncipal liabilities Other assets 087 ol I he St-stem n ire I- edera I l-k’sc’i-~eIloLen rolal assets S5 46 outsIandirig (lt’pi)sitS cit nieiiiht’r lianks ~tnil depo~aI,, of I he I .5. 1 rea%ui’v alIt! ul her’~. Liabilities and Capital Federal Reserve notes 51 91 such a~I urei~n ceni cal hank’-. Deposits 2.41 \losl M\’slc’n transactions inti.ilt I’ nenther Member oank S236 coflflfl~1ren1banks arid di cccl I’, aifecI im’uiihei- Other 005 1 Other Iiabilit;ps 069 bank rt’ser\ I~s It Liic’ I ccl makes an op o Captal accounts 045 market pui’chase ol government sc’curities Total liabilities and capital S5~6 lioni a menilier hank, I or i’~ample. it pa~ for the securit ins by ci’i’clilirig I lit’ nit’mlic’r hank de ’,o’at tt ith the Federal Re~r’i-t~tba‘econd transaction bating the opposite 3 1 a (leposil al the I ed is [tic’ principal impart on resect (!5. Fiji exanipic’, ii the led fin-ni in n hich hLtnks hold their legal sold government securities Ill he alliloillit oF resect i’s au O~WI] Iiizii’kt’l purchase iclils a gold irrI ott then’ would he 110 net change ciin’ctl’ lo hank re’~ertes. in aggregate inenihe, bank re’~erves. I he

Mant I (‘dclii Reserve transaction’- tIle ~il open market sale u caild reduce reserve.s usl itiateci ht rciiiiui,erciiil banks U hen hi’ I nil - as the gold inf!ott added Li theni lea’ rig no id StaIe~tt as on hit’ gold standqrd. 11w led 11(1 I’es(’l\ t’ cii~iuige. Siniilaiit . a bank could held substantial gold reserves, and tran’,ar— hnr’rott resect c’’~1mm its Resect e Ihir’l~10 lions in gold n crc’ coinnion. I or c’xaniple. pat Ion federal lieseite noR’s net’dc’cI to ‘~alis- suppose gold coin n as depusited bt a dos iv tvilhdran at du’niaiui’,. and lhus it oid toiiic’i’ ul a neniber bank. I lie bank could i.hau ing ciutt n its reselt ci clr’r)osih In liii’ ‘-end hit c()in Iii its I c’clc’i-al Rc’ei’t ~ I3~’~~iu~d~ case. leclc’rai Resect ci ‘ieclit hull’, di’~cotililc’clI iec(i\ t’ an incn’itst’ in ii’. c’sert 1’ clejii~~itcil ~ ouki iiic:rea’~c’in lilt’ aniotirit ol the increase 1 I hal amount he I H’, gold -Isert es and ill Federal Rc’sert e note’~otil’-laiiding, Lull member haiik cleposik t~ould ncr-ease lit the b~uikIV5~tP’, \\ 0(11(1 riot change \olc’ lhal same amount ~nppuse instead that -l nieinbc’r in lhr~ra’,e the Fed did riot iniliate liii’ oil— h,mk ‘,t as i’\pt’nend1r124 large cash tt tlidrau - sc’Uing lran~acIion. Indeed. nun holIhe

Lds intl needed e\tra ctn’renict - It could re— ‘~ieii1i7Mtk;iioI gold and ciirre.ncv llott s clw-— tluesl rnrrc’ne\ in 11w I olin ol lecic’rai jug the I 9!tis and eai’lv 1930s tt as at Lilt’ in— Re’,c’rte ilciles, irculil its Iteseit ~‘ Bank arid pa’ ituWt c’ of unn-nihei- banks although it n as lie rurreoct u jIb a iecltit’tion in its c]efinitelt the I ccl s inlent lhat stc’nihi,ution resi’I’\ r’ deposit I lenee ‘I’, lederal Ri’si’it c. oct10-. noIe,~oiitstaiidii’’ iric;r’zisc’d haiik reserves ,- h I c’deral heserve ster-W,.alion cit gold and ttinrlcl clic-liric’ lit the ~anie aiuioiirit - currency flints Iron laotian v t).~-Ito I c’hiti— 1 he I ccl could oh lsel. or ~tt’i~iIize In’ ha— zir’v I fu.L-i is ihlustr,itecl iii ligiric’ 9. \otc’ Iliat pact cif one Ii ansac’tion on hank i’esc’r’t c’s iricri’,l’,t’s cl eruc’asc’si in Federal Result c-rc-clit acc-nrnpanied declines iinc’reasesl in the months. tlierc’ tvas ‘-sri iuiei’c’a~c’ot S259 nil— net uI gold and cui’i’eucv outstanding and Iic,ri iii the nicutic’tait gold stock arid a SI 211 thus bank resect es changed c:curnparatit cIt lit— million decline ill c’urrerict in rirculalicni. The tIc’. In 193(1, fur c’xarnple member batik gold inflott antI clecliru’ in c-tn’renet’ would l’d’si’r’tes rusc’ lr’nni 5231)5 million in l)c’ct’m— have aclclc’cl 5371) million to bank i’e’.ei’t e~. her- 11129 to 52115 milliun in b)ec’c’rnher 11131). hut Fed credit clc’c-Iirit’cl by 537Q million to an increase of jnst 821.) niillion. ()vc.r the samc’ offset their unpac’t alinosl c’ntirc’lv)

~Loansto member oanks consisted & aiscounls anc ad- qal reserves. At other tines, vault cash has also vances. Many commerc’ah loans wh,ch often ‘were counted. cabled “bills were made on a oiscount basis, hence. ‘Even ‘f the rod were to purchase securities from some- wnen they were endorsed by a bank and sent lo a one other tnan a member bank, bank reserves would Reserve Banx i-i exchange for reserve balances, they still increase once ihe check issued by the Fed to pay were re-discounted oy the Rese’ve Bank al the for the securities was depos~tedin a member bank prevailing discount rate Ahternat.vely. bils we’e used Open market security sales reduce bank reserves as collate’aI to’ direct advances to member banks, since, ultimately, a member bank reserve deposit -s hence the term “bills discounteo. reduced to pay for tie securities sold by the Fed. 2 Tne terminology is confusing because bills’ •n tnis ~Tne gold inflow, decline in currency and decline in Fed- case refer to bankers acceptances riot to lhe promisso- eral Reserve credit do not sum exactly to the change r. ry notes that member banks used as collateral br dis- bank reserves because of the effect of other, small count loans, transactions affecting reserves 3 From 1917 to 1960. such deposits were the only form in whicn member banks were permitted to hold their he-

The Fed’s failure to fully offset the gold and temporarily. Epstein and Ferguson (1984), currency outflows suffered by banks permitted pp. 964-65, contend, however, that Fed officials the money supply contraction to accelerate. Fed did feel constrained by a lack of gold. Wicker officials claimed that the Reserve Banks’ lack of (1966), pp. 169-70, suggests that Fed officials reserves precluded government security pur- feared that open market purchases would chases to offset the reserve losses suffered by weaken confidence in the Fed’s determination to banks45 The Reserve Banks were required to maintain gold convertibihty and thereby renew maintain gold reserves equal to 40 percent of the gold outflow. their note issues and reserves of either gold or In any case, the Glass-Steagall Act of 1932 re- ‘eligible paper” against the remaining 60 per- moved the constraint by permitting government cent4°Since gold outflows had reduced the Sys- securities to serve as collateral for Federal tem’s reserve holdings, and since the System Reserve note issues. In March 1932, the System lacked other eligible paper, Fed officials asserted began what was then the largest open-market they could not increase Fed credit by purchas- purchase program in its history.~~Between ing government securities, which were not eligi- February 24 and July 27, 1932, the Fed bought ble collateral. $1.1 billion of government securities. Member Friedman and Schwartz (1963), pp. 399-406, bank reserves increased only $194 million in dispute the Fed’s justification for not buying these months, however, because of renewed government securities. They argue that the Sys- gold and currency outflows and a reduction in tem had sufficient gold reserves and, in any member bank borrowing. Moreover, the supply event, that the Federal Reserve Board had the of money continued to fall because of a sharp power to suspend the reserve requirements decline in the money multiplier (see figure 10).~~

45 See the Board of Governors of the Federal Reserve Sys- why purchases were not made immediately following Bri- tem. Annual Report (1932), pp. 16-19. tain’s departure from gold. Friedman and Schwartz (1963), 46 Eligible paper consisted of either bankers acceptances or pp. 384-89, argue that the Fed succumbed to pressure commercial notes acquired by direct purchase or pledged from Congress, while Epstein and Ferguson (1984) con- by member banks as collateral for discount loans. See clude that pressure from both Congress and commercial Board of Governors of the Federal Reserve System (1943), banks was important. pp. 324-29, and Friedman and Schwartz (1963), p. 400. ~During these months, both the reserve-deposit and 4T Why the Fed undertook these purchases is unclear, espe- currency-deposit ratios rose. cialby if fear of undermining the gold standard explains The Fed ended its purchase program in July 1932, largely because officials believed it had done little good.49 Bank reserves continued to The Fed’s actions in 1924 mark its first use of increase) however) as gold inflows were not off- open market operations to achieve general poli- set by a corresponding reduction in Fed credit cy objectives. In that year, the Fed purchased outstanding. Although the money supply ceased $450 million of government securities and cut to fall, it also failed to rise significantly. in early its discount rate (in three stages) from 4.5 per- 1933, large gold and currency outflows caused cent to 3 percent. In testimony before the a renewed money supply decline.~°On this oc- House Banking Committee in 1926, Benjamin casion, the crisis was stopped by Franklin U. Strong listed several reasons for these actions, Roosevelt’s decision to declare a Bank Holiday including the following: and suspend gold shipments. In essence, the 1) To accelerate the process of debt repay- Fed’s failure to insulate the banking system ment to the Federal Reserve Banks by the from gold outflows and panic currency with- member banks, so as to relieve this weaken- drawals had caused the president to act to pre- ing pressure for loan liquidation. vent further reserve losses. 2) ‘Jo give the Federal Reserve Banks an asset While failure to sterilize gold and currency which would not be automatically liquidated outflows in 1931 and 1933 was inconsistent as the result of gold imports so that later, if with previous actions, it did not represent a inflation developed from excessive gold im- fundamental change in regime. Fed officials ap- ports, it might at least be checked in part by parently believed strongly in the gold standard, selling these securities, thus forcing member and there seems to have been no discussion of banks again into debt to the Reserve Banks following Great Britain off gold. Benjamin and making the Reserve Bank discount rate Strong had been a committed advocate of the effective. gold standard, and it seems doubtful that he 3) To facilitate a change in the interest rela- would have proposed actions that might have tion between the New York and London mar-

weakened it.’” As an institution, the Federal kets. -. by establishing a somewhat lower Reserve System was willing to forego short-run level of interest rates in this country at a stability to preserve the gold standard, which it time when prices were falling generally and saw as its fundamental mission.’” when the danger of a disorganizing price advance in commodities was at a minimum and Reserve sterilization constituted one aspect of remote. System policy begun under Strong, and the Fed 4) By directing foreign borrowings to this deviated little from the policy after his death, at market to create the credits which would be least until the fourth quarter of 1931. In fact, necessary to facilitate the export of com- from the stock market crash in October 1929 to Britain’s departure from gold on September 21, modities. - 1931, the Fed did little but offset gold and cur- 5) To render what assistance was possible by rency flows. It certainly did not make large our market policy toward the recovery of open market purchases, despite the deepening sterling and the resumption of gold payment depression. On the surface, this lack of vigor by Great Britain. appears at odds with the relatively large open 6) To check the pressure on the banking situ- market purchases the Fed made during the ation in the west and northwest and the minor recessions of 1924 and 1927. resulting failures and disasters.’~ 9 ‘ Banks’ excess reserves increased substantially during the stabilize commerce, industry, agriculture, employment and months of the open market purchases, which many saw as soon, without regard to the penalties of violation of the idle balances that were unneeded and potentially inflation- gold standard, you are talking about human judgment and ary. See Friedman and Schwartz (1963), pp. 385-89. As the management of prices which I do not believe in at all.” discussed below, Epstein and Ferguson (1984) suggest lOuoted by Burgess (1930), pp. 331.1 See also Temin that pressure from commercial banks contributed to the (1989), p. 35. Fed’s decision to end the program. ‘“See Temin (1989), pp. 28-29 and 76-87, and Wheebock ~°Themoney supply fell both because of a decline in (1991). reserves and a decline in the money multiplier induced by panic deposit withdrawals. ‘“U.S. House of Representatives (1926), p. 336, 5 ’Strong testified before the House Banking Committee in 1928 that, When you are speaking of efforts simply to The Fed undertook a second large purchase impact on money markets. Accorcling to Chan- program in 1927, purchasing $300 million of dler (1958): government securities and reducing the discount rate again. Strong left no written justifica- Federal Reserve officials soon discovered. tion for these operations. Friedman and much to their amazement at first, that open Schwartz (1963) argue that they were made in market purchases and sales brought about response to a recession, and that the 1924 pur- marked changes in money market conditions chases had also been intended to bring about a even though total earning assets of the Reserve domestic recovery. Wicker (1966), pp. 77-94 and Banks remained unchanged. When the Federal 106-16, challenges this interpretation, arguing Reserve sold securities and extracted money that the actions were motivated by international fi-om bank reserves, more banks were forced to considerations. According to Wicker, the pur- hot-row from the Reserve Banks, and those al- chases in 1924 were intended to encourage the ready borrowing were forced niore deeply into flow of gold to Britain by reducing U.S. interest debt. Since banks had to pay interest on their rates relative to those in London, with the goal borrowings and did not like to remain continu- of assisting Britain’s return to the gold standard. ously in debt, they tended to lend less liberally, The 1927 purchases were intended to help Bri- which raised interest rates in the market tain through a payments crisis, again by direct- pp. 238-39). ing capital toward London; these purchases followed closely a meeting between Strong and Strong testified that “the effect of open market European central bank heads. operations is to increase or decrease the extent to which the member banks must of their own Chandler (1958), p. 199, argues that both initiative call on the Reserve Bank for domestic and international goals were important credit ~ Security purchases led to less mem- in 1924 and 1927, and Wheelock (1991), ch. 2, ber bank borrowing and lower interest rates, finds empirical support for this view. Wheelock while sales increased borrowing and rates.55 also shows that, relative to the decline in eco- Strong believed that monetary policy could nomic activity, the Fed made substantially fewer stimulate economic activity by easing money open market purchases in 1930 and 1931 than market conditions: it did during 1924 and 1927. This might reflect a significant change in System behavior between .[Wlhen we have very cheap money, corpora- the 1920s and early 1930s. But an analysis of tions and individuals borrow money in order to the Fed’s policy methods suggests that its anem- extend their businesses. That results in plant ic response in 1930-31 might also be explained construction; plant construction employs more as the consistent use of a single strategy. labor, brings in to use more materials. -.-It may cause some elevation of wages. It creates During the early 1920s, the Fed developed a more spending power; and with that start it strategy of using open market operations and will permeate through into the trades and the discount rate changes to affect the level of general price level.’~ member bank discount window borrowing. Fed officials observed that, when the System pur- Chandler (1958) and Friedman and Schwartz chased government securities, member bank (1963) conclude that under Strong’s leadership borrowing tended to decline by nearly the same the Federal Reserve System attempted to stimu- amount and, sinsilarly, that open market sales late economic activity during recessions by led to comparable increases in member bank promoting monetary ease (cheap money). This borrowing. But, while the Fed’s operations had explains why Strong listed “to accelerate the little impact on the total volume of Fed credit process of debt repayment. -.by the member outstanding, they appeared to have a significant banks” as a reason for the open market pur-

4 ~ lbid,p. 468. possible otherwise, and the effect is less dramatic and less alarming. --than if we just make advances and ‘“Presumably, discount rate changes alone could achieve reductions in our discount rate.” [U.S. House of Represen- the same impact on interest rates, but the Fed preferred to tatives (1926), p. 3331- precede discount rate changes with open market operations. Strong testified that “the foundation for rate ‘“U.S. House of Representatives (1926), pp. 578-79. changes can be more safely and better laid by these preliminary operations in the open market than would be extent of any purchases which might appear desirable, one of our best guides would be the amount of borrowing by member banks in prin-

Table 1 cipal centers. .-. Our experience has shown Fed Policy During Three Recessions that when New York City banks (dollar amounts in millions) are borrowing in the neighborhood of 100 million dollars or more, there is then some real Date AlP GS DR.DL DI4NYC) pressure for reducing loans, and money rates 1929 Jut 124 $147 5.0% $1096 $319 tend to he markedly higher than the discount Oct 118 154 60 885 74 rate. On the other hand, when borrowings of 1930 Jan 106 485 4.5 501 39 these banks are negligible, as in 1924, the Apr 104 530 35 231 17 money situation tends to be less elastic and if Jul 93 583 25 226 0 gold imports take place, there is liable to he Oct 88 602 25 196 6 1931 Jan 83 647 2.0 253 5 some credit inflation, with money rates drop- Apr 88 600 2.0 155 0 ping below our discount rate. When member Jul 82 674 15 169 0 banks are owing us about 50 million dollars or Oct 73 733 3,5 614 74 less the situations appears to be comfortable,

1923Apr 106 229 45 658 123 with no marked pressure for liquidation. .. Jul 104 97 45 834 143 Oct 99 91 45 873 121 Table 1 compares Federal Reserve actions dur- 1924 Jan 100 118 45 574 85 Apr 95 274 4.5 489 45 ing the 1924, 1927 and 1930-31 downturns. The Jul 84 467 35 315 13 Fed’s index of industrial production indicates Oct 95 585 3.0 240 28 the severity of each recession. Following the 1925 Jan 105 464 3.0 275 32 stock market crash in October 1929, the New 1926 Oct 111 306 4.0 663 84 York Fed purchased $160 million of government 1927 Jan 107 310 4.0 481 76 securities and, by the end of December, the Sys- Apr 10$ 341 40 447 78 tem had purchased an additional $150 million. Jul 106 381 4.0 454 59 But, from January 1930 to October 1931, the Oct 102 506 3.5 424 75 Fed made only modest purchases, particularly in 1928 Jan 107 512 3.5 465 94 comparison with those made in 1924 and 1927, when the declines in economic activity were Variable definitions. AlP: Index of Industrial Production (seasonallyadjusted); GS. Federal Reserve government secu- less. rity holdings, DR: discount rate of the Federal Reserve Bank of New York; DL: discount loans (member bank borrowing) The relatively small purchases in 1930 and of all Federal Reserve member banks, DL(NYC): discount 1931 appear consistent, however, with the use loans of reporting banks in New York City. of member bank borrowing as a policy guide. 1’his, according to Brunner and Meltzer (1968), explains the Fed’s failure to respond aggressive- chases in 1924. Strong used the level of mem- 58 ly to the Depression. Member bank borrowing ber bank borrowing to determine the specific fell substantially following the stock market quantity of security purchases necessary to crash in October 1929 and averaged just $241 bring about monetary ease: million from January 1930 to August 1931. Bor- Should we go into a business recession while rowing by reporting member banks in New the member- banks were continuing to borrow York City averaged just $8 million over the

directly 500 or 600 million dollars. .-we should same months. Thus, by Strong’s guidelines, consider taking steps to relieve some of the money was exceptionally easy and substantial pressure which this borrowing induces by pur- open market operations were unwarranted. chasing Government securities and thus ena- bling member banks to reduce their The Fed’s use of member bank borrowing as

indebtedness. ..- As a guide to the timing and a guide to monetary conditions could explain

t7 Presentation to the Governors’ Conference, March 1926 [quoted by Chandler (1958), pp. 239-401. ‘“Wicker (1969) agrees that, to the extent that the Fed responded to domestic conditions, it used member bank borrowing as a guide. See also Mebtzer (1976). why it permitted the money supply to decline that the Policy Conference was established to sharply during the Depression. During a reces- wrest power from the New York Bank. And sion, loan demand declines and banks have fewer they show, pp. 367-80, that New York officials profitable investment opportunities. Consequent- proposed more expansionary actions, particularly, the demand for borrowed reserves declines. ly in 1930, than were accepted by the rest of If this decline in demand is not offset, total the System. Wicker (1966) finds, however, that reserves and the money supply fall. In a minor Harrison ceased to advocate open market pur- recession, as in 1924 and 1927, member bank chases once New York banks were no longer borrowing falls little. The Fed’s guidelines would borrowing reserves. Thus, while the Federal have suggested that monetary conditions were Reserve would likely have pursued somewhat relatively tight and, in response, it would have more expansionary policies had New York offi- made large open market purchases. In a severe cials held more authority, the modest open mar- economic downturn, as in 1930-31, however, ket purchases of 1930 and 1931 were member bank borrowing may fall substantially. apparently consistent with the guidelines out- But, by Strong’s rule the Fed would have made lined by Strong. few open market purchases. Thus, ironically, In sum, during the Depression, the Federal this strategy could result in a greater contrac- Reserve continued to sterilize gold and currency tion in the supply of money, the more severe a flows and made limited open market purchases decline in economic activity.58 and discount rate reductions in response to the If, as Brunner and Meltzer (1968) argue, Sys- economic decline. Notable deviations from these tem officials followed Strong’s prescription to policies occurred, such as the incomplete sterili- use the level of bank borrowing to guide policy zation of gold outflows during the crises of during the Depression, then it seems that the 1931 and 1933. But it seems likely that mone- Fed made no fundamental change in policy after tary policy would have been somewhat more Strong’s death. responsive to the Depression, particularly in Although Friedman and Schwartz (1963), 1930, had officials of the Federal Reserve Bank of New York been able to dominate policymak- pp. 362-419, believe that Strong would have re- ing in the way Strong had before his death.8~ sponded aggressively to the Depression, they The general thrust of policy, however, appears agree that a majority of Fed officials interpreted consistent with that of Benjamin Strong. the low level of member bank borrowing in 1930 and 1931 as signaling monetary ease. They contend, however, that officials of the New IN’vERF;s9•~(~R(JtfI~•Pi11~StiLtt1 York Fed understood the flaws in using member’ ~ (J.F ~ bank borrowing as a policy guide and would have pursued appropriately expansionary poli- i3F:1•~iA’V.I.O)R cies if they had the authority.60 Until recently, most studies of Fed behavior In March 1930 the Open Market Investment have concluded that policymakers failed to per- Committee, which consisted of five Reserve ceive a need to take expansionary actions, Bank governors, was replaced by the Open Mar- despite deflation, rising unemployment and ket Policy Conference, in which representatives widespread bank failures. Some researchers of all 12 Banks participated. ‘The Investment now argue, however, that Fed officials were Committee had been led by Benjamin Strong, quite aware that their policies were contribut- and then by George Harrison, Strong’s successor ing to the contraction. These researchers con- as governor of the Federal Reserve Bank of New clude that policymakers responded to interest York. Friedman and Schwartz, p. 414, contend group pressure and their own lesire for in-

‘“Indeed, except for a brief decline in Ml in 1927, the abso- policies, particularly in 1927, had contributed to stock mar- lute quantity of money did not fall in 1924 or 1927, although ket speculation and the crash and depression that fol- its rate of increase declined. The Fed’s strategy and the lowed. See Wheelock (1991), ch. 4, for analysis of consequences of using bank borrowing as a policy guide disagreements among System officials during the are examined in greater detail in Wheelock (1991), ch. 3. Depression. ‘“See also Schwartz (1981), pp. 41-42. efl~is by no means clear that Strong could have retained this degree of influence, as many officials believed that his 26 fluence, rather than the public interest. Epstein In the view of System officials the money sup- and Ferguson (1984), for example, contend that ply in 1920 was redundant (excessive) and a combination of ideology and conflicting in- should decline to restore the ‘proper’ relation- terests explain the System’s policy. And Ander- ship between prices, credit, and volume of son, Shughart and Tollison (1988) argue that production. The term most frequently used to “the restrictive monetary policy of the Fed in describe this process was ‘liquidation,’ the the 1929-33 period was not based on myopia necessity for which was not disputed by either but instead on rational, self-interested behavior” the Board or by any other Federal Reserve offi-

(p. 4). cial including Benjamin Strong. - (p. 49). Epstein and Ferguson (1984) focus their study Most researchers argue that Strong’s views on the Federal Reserve’s $1.1 billion open mar- changed significantly after the 1920-21 episode, ket purchase program of 1932. They ask why however. Chandler (1958) writes: the Fed waited so long to begin an expansionary Like most other Federal Reserve officials, [in program, what had changed to cause the Fed to 1920-1921 Strongl believed that some deflation begin the program when it did, and what led to of bank credit was essential and that some the decision to end the program. price reduction was inevitable and desirable. To the first question, Epstein and Ferguson Within three years, Strong himself had rejected (1984) conclude that the liquidationist business many of these ideas. A much smaller business cycle theory was dominant among Fed officials. recession in 1924 led him to advocate large and Liquidationists believed that depressions were aggressive open-market purchases of govern- “vital to the long-run health of a capitalist econ- ment securities and reductions of discount rates omy. Accordingly, the task of central banking to combat deflation at home as well as to en- was to stand back and allow nature’s therapy to courage foreign lending (p. 181)65 take its course.” (p. 963). This certainly was the In rejecting the importance of Strong’s death, opinion of some key officials, such as George Epstein and Ferguson (1984) implicitly deny that Norris, who argued at the September 25, 1930, Strong sought to prevent loan liquidation during meeting of the Open Market Policy Conference: recessions by pursuing monetary ease or that We believe that the correction must come he subscribed to the countercyclical policy guide- about through reduced production, reduced in- lines he presented to the Governors Conference ventories, the gradual reduction of consumer in 1926: “Should we go into a business reces- credit, the liquidation of security loans, and the sion. -- we should consider taking steps to accumulation of savings through the exercise of relieve. --the pressure. -- by purchasing thrift. These are slow and simple remedies, but Government securities 64 just as there is no ‘royal road to knowledge,’ we Epstein and Ferguson emphasize two addition- believe there is no short cut or panacea for the al reasons for the timing and extent of Fed ac- rectification of existing conditions. -- tions during the Depression. First, in contrast to We have been putting out credit in a period of Friedman and Schwartz, they conclude that a depression, when it was not wanted and could lack of gold reserves did keep the Fed from not be used, and will have to withdraw credit making open market purchases in the fourth when it is wanted and can be used.’” quarter of 1931. They argue further that, while the Glass-Steagall Act of 1932 lessened the Norris clearly believed that monetary policy had problem for the System as a whole, some of the been too stimulative and was interfering with Reserve Banks were reluctant to continue the the natural process of liquidation and recovery. purchase program in 1932 because they lacked 65 Strong and other officials apparently held sufficient gold reserves. similar views during the recession of 1920-21. Second, Epstein and Ferguson argue that Fed According to Wicker (1966): concern with member bank profits contributed

‘“Quoted in Chandler (1971), p. 137. ‘“Each Reserve Bank was required to maintain its own ‘“See also Friedman and Schwartz (1963), pp. 249-54, Wick- reserves. Pooling was not permitted, although the Banks could lend to one another. er (1966), pp. 57-66, and West (1977), pp. 173-204. ‘“Quoted by Chandler (1958), p. 239-40. 5 to the timing and extent of open market pur- Epstein and Ferguson (1984) were the first to chases in 1932. During the first two years of explain Federal Reserve behavior during the the Depression, leading bankers generally ar- Depression as a response to pressure from com- gued for loan liquidation and lower wages. But mercial bankers. Anderson, Shughart and Tolli- the sharp increase in interest rates in the son (1988) push this view to the extreme, fourth quarter of 1931 reduced the value of arguing that the principal aim of Fed policy dur- bond portfolios and threatened the solvency of ing the Depression was to enhance the long-run many banks. Bankers then began to press the profitability of member banks by eliminating Fed to support bond prices. Epstein and Fergu- nonmember competitors. This, in turn, benefited son argue that “a major goal of the [purchases the Fed by increasing the proportion of the of 1932] was to revive railroad bond values. banking system under its regulatory control: and bond prices in general.” (p. 967). The fall in the money supply presided over by Just as constituent pressure contributed to the the monetary authority between 1929 and 1933 decision to make open market purchases, it also eliminated a large number of state-chartered seems to have caused the program’s end. Dur- and small, federally-chartered institutions from ing the Depression banks generally had shifted the commercial banking industry. The profits of their bond portfolios toward short-term maturi- those banks that survived. -- rose significantly ties. And, while the need to support bond prices as a result. Coincidentally, the monetary con- was paramount in early 1932, as the year traction expanded the proportion of the com- progressed short-term interest rates fell sharply mercial banking system within the Fed’s and bank earnings declined. The decline in bureaucratic domain. Thus, rather than earnings was especially acute in Boston and representing the leading example of bureaucratic Chicago because banks in those cities had un- ineptitude, the Great Contraction may instead usually large holdings of short-term securities. be the leading example of rational regulatory Epstein and Ferguson conclude: “That the gover- policy operating for the benefit of the regula- nors of the Boston Fed and, especially, the tors and the regulated.” Chicago Fed should be early critics of the refla- Nonmember banks made up 75 percent of the tion program is therefore no mystery.” (p. 972). banks that suspended operations between 1930 Declining interest rates and questions about and 1933. Failures were highest among small in- the willingness of the United States to maintain stitutions located in rural areas. Policymakers the dollar’s gold convertibility led to deposit typically argued that such failures were caused withdrawals by foreigners, causing commercial by bad management or transportation improve- banks to raise further doubts about the pur- ments that made many banks redundant. George chase program: “The continued loss of gold and Harrison, Governor of the New York Reserve deposits put many New York banks in an in- Bank, for example, testified before the Senate Banking Committee in 1931 that: creasingly uncomfortable position. -- - Many complained that the reflation program had -- with the automobile and improved roads, the

‘demoralized money and exchange markets’.”” smaller banks. --with nominal capital, out in Thus, pressure from member banks experienc- the small rural communities, no longer had any ing falling earnings and deposit outflows and reason really to exist. Their depositors wel- the desire of some Reserve Banks to protect comed the opportunity to get into their automo- their gold reserves caused the System to aban- biles and go to the large centers where they don its program of open market purchases.67 could put their money.°°

66 Epstein and Ferguson (1984), p. 975. “Anderson, Shughart and Tollison (1988), pp. 8-9. ‘“in a comment on Epstein and Ferguson, Coelho and San- “U.S. Senate (1931), p. 44. toni (1991) present econometric evidence suggesting that banks did not suffer reduced profits as a result of the Fed’s 1932 purchases, and they question whether pressure from commercial banks caused the Fed to end its program. Indeed, they even doubt that expansionary policy was ended since the monetary base continued to rise. Ep- stein and Ferguson (1991) present additional qualitative evidence showing that banks thought that low interest rates had reduced their earnings. 25

From the Federal Reserve’s inception, Fed offi- ular states with the tools at its disposal. The Fed cials argued that it was important that all banks cannot control the destination of reserve flows generated by open market operations, and the join the System. Benjamin Strong argued in 1915 discount window was not open to nonmember that “no reform of our banking methods in this country will be complete and satisfactory to the banks. Perhaps Fed officials could have selec- tively restricted credit to member banks that country until it includes all banks. -- in one lent to nonmember banks in particular states, comprehensive system.”°Policymakers were likely less concerned with the failure of non- but it is doubtful that such a circuitous route member banks than they were with the health would have had a large impact on losses. of member banks.” But it remains to be shown Huberman (1990) casts further- doubt on the that Federal Reserve policies were deliberately Anderson, Shughart and Tollison (1988) view. intended to cause the failure of thousands of He notes that, although 75 percent of banks nonmember institutions. that suspended during the Depression were nonmember banks, the ratio of nonmember to Anderson, Shughart and Tollison (1988) argue member bank suspensions from 1930 to 1933 that “the Great Depression... was a by-product of economically rational behavior on the part of was lower than it had been during the 1920s. Federal Reserve member banks seeking rents Nonmember banks that suspended, mom-cover, reopened twice as often as member banks. through the elimination of their nonmember rivals.” (p. 9) Member banks did not capture the Membership in the Federal Reserve System Fed directly, they argue, but rather exerted grew’ at a comparatively low rate during the pressure through members of the House and Depression. Senate Banking Committees. To test this hypoth- Santoni and Van Cott (1990) also report evi- esis, the authors regress deposits in failed non- dence contrary to the Anderson, Shughart and member banks in each state on dummy varia- Tollison hypothesis. They calculate a share price bles indicating whether a state was represented index for large New York City member banks on the House or Senate Banking Committees.” and show that, relative to both the wholesale They find that nonmember bank losses were commodity price index and the Standard and higher if a state had a representative on the Poor’s index, bank share prices declined sub- House Banking Committee. This, they argue, stantially from 1929 to 1934. They show also supports their view that the Fed deliberately that the index of bank stock prices was not af- caused nonmember bank failures to be highest fected by changes in the money supply, suggest- in states having a congressman on the Banking ing that monetary policy did not enhance the Committee, thereby enhancing the long-run fortunes of banks in their sample.~~ profits of the member banks that remained. The Fed’s payoff came in 1933 when it was freed from having to return a portion of its revenues CONCLUSION to the Treasury.” The Federal Reserve’s failure to respond This explanation of Federal Reserve policy vigorously to the Great Depression probably provokes a number of questions. Left unclear, cannot be attributed to a single cause. Each of for example, is why member banks had more the explanations discussed in this article clarifies influence over Congress than nonmember banks. certain points about Fed behavior during the Nor is it explained how the Fed was able to af- Depression. A number of contemporary observ- fect the fortunes of nonmember banks in partic- ers, both within and outside the System, attrib-

70 Quoted by Chandler (1958), p. 80. share prices of “small” member banks rose relative to those of nonmember institutions. Neither study tests “Friedman and Schwartz, pp. 358-59, also make this point. 7t whether the profits of surviving member banks were en- They include deposits in failed member banks, total bank hanced in the long run, although the former note that in deposits, and other control variables as additional 1936 the average national bank profit rate was higher than regressors. in 1925. Unfortunately, it is impossible to determine whether the increase in bank profits was caused by the “Anderson, Shughart and Tollison (1988), pp. 16-17. 74 demise of nonmember banks or by New Deal reforms, Anderson, Shughart and Tollison (1990) reply by pointing such as deposit interest rate ceilings, deposit insurance, out that member bank share prices rose dramatically rela- and increased chartering requirements, which reduced tive to those of nonmember banks during 1930. Even the competition and enhanced bank charter values. 4/

uted some of the blame to what they viewed as Board of Governors of the Federal Reserve System - Annual Report (various issues). excessively easy monetary policy during reces- ______- Banking and Monetary Statistics, 1914-1941 (1943). sions in 1924 and 1927. They argued that the ______- Federal Reserve Bulletin (various issues). Fed’s actions had promoted stock market specu- Bordo, Michael D. “The Contribution of A Monetary History lation and led inevitably to the crash and of the United States, 1867-1960 to Monetary History,” in Michael D. Bordo, ed., Money History, and International Depression. The best policy during the Depres- Finance: Essays in Honor of Anna J. Schwartz (The Univer- sion, according to these observers, was to pro- sity of Chicago Press, 1989), pp. 15-75. mote loan liquidation and wage rate reductions, Brunner, Karl, and Allan H. Meltzer. “What Did We Learn from the Monetary Experience of the United States in the to allow recovery on a “sound basis.” While Great Depression?” Canadian Journal of Economics (May those officials subscribing to the liquidationist 1968), pp. 334-48. view did not win approval of open market sales, Burgess, W. Randolph, ed. Interpretations of Federal Reserve Policy in the Speeches and Writings of Benjamin Strong they were able to prevent significant open mar- (Harper and Brothers, 1930). ket purchases until 1932. It is likely that the Calomiris, Charles W. “Deposit Insurance: Lessons from the Record,” Federal Reserve Bank of Chicago Economic Per- Fed would not have made large purchases even spectives (MaylJune 1989), pp. 10-30. then without pressure from major bankers and Chandler, Lester V. Benjamin Strong, Central Banker (Brook- Congress. ings Institution, 1958).

______American Monetary Policy 1928-1941 (Harper and The most important explanations of Federal Row, 1971). Reserve behavior during the Depression, Coelho, Philip R. P., and 0. J. Santoni. “Regulatory Capture however, appear to be the dedication of and the Monetary Contraction of 1932: A Comment on Ep- stein and Ferguson[ Journal of Economic History (March policymakers to preserving the gold standard 1991), pp. 182-89. and their attachment to policy guides that gave Darby, Michael R. “Three-and-a-Half Million U.S. Employees erroneous information about monetary condi- Have Been Mislaid: Or, an Explanation of Unemployment, 1934-1941,” Journal of Political Economy (February 1976), tions. Benjamin Strong’s death robbed the Sys- pp. 1-16. tem of an intelligent leader at a crucial time and De Long, J. Bradford. “Liquidation’ Cycles: Old-Fashioned undoubtedly imparted a contractionary bias to Real Business Cycle Theory and the Great Depression,” National Bureau of Economic Research Working Paper No. monetary policy during the Depression. It seems 3546 (December 1990). clear, however, that Strong’s death did not Department of Commerce. Historical Statistics of the United cause a fundamental change in regime. Strong States (1960). believed in the gold standard, and he would not Epstein, Gerald, and Thomas Ferguson. “Monetary Policy, Loan Liquidation, and Industrial Conflict: The Federal likely have done anything to jeopardize gold Reserve and the Open Market Operations of 1932’ Journal convertibility of the dollar. There was also little of Economic History (December 1984), pp. 957-83. deviation from either the gold sterilization or ______- “Answers to Stock Questions: Fed Targets, Stock Prices, and the Gold Standard in the Great Depression,” the countercyclical policy rules that Strong had Journal of Economic History (March 1991), pp. 190-200. developed during the 1920s—at least until the Field, Alexander J. “A New Interpretation of the Onset of the fourth quarter of 1931, when maintenance of Great Depression’ Journal of Economic History (June the gold standard became the overriding goal of 1984), pp. 489-98. Fisher, Irving. Booms and Depressions (Adelphi, 1932). policy. Thus, while leadership changes and in- Friedman, Milton, and Anna J. Schwartz. A Monetary History terest group pressure probably had some effect, of the United States, 1867-1960 (Princeton University Press, monetary policy during the Depression was not 1963). fundamentally different from that of previous Hamilton, James D. “Monetary Factors in the Great Depres- sion,” Journal of Monetary Economics (March 1987), years. Federal Reserve errors seem largely at- pp. 145-69. tributable to the continued use of flawed Hayek, Friedrich A. von. “The Fate of the Gold Standard,” in Roy McCloughry, ed., Money, Capital and Fluctuations, Ear- policies. ly Essays of Friedrich A. von Hayek (Routledge and Kegan Paul, 1984), pp. 118-35. Hetzel, Robert L. “The Rules Versus Discretion Debate Over Monetary Policy in the 1920s[ Federal Reserve Bank of Richmond Economic Review (NovemberlDecember 1985), Anderson, Gary M., William F. Shughart II, and Robert D. pp. 3-14. Tollison. “A Public Choice Theory of the Great Contrac- tion,” Public Cho/ce (October 1988), pp. 3-2a Huberman, Douglas A. “An Alternative to ‘A Public Choice Theory of the Great Contraction;” Public Choice (Decem- ______- “A Public Choice Theory of the Great Contraction: Further Evidence,” Public Choice (December 1990), pp. ber 1990), pp. 257-68. 277-83. Kesselman, Jonathan R., and N. E. Savin. “Three-and-a-Half Belongia, Michael T, and Michelle R. Garfinkel, eds. What Million Workers Never Were Lost[ Economic Inquiry (April Do We Know About Business Cycles? (Kluwer Academic 1978), pp. 205-25. Publishers, forthcoming). Kindleberger, Charles P. The World in Depression, Bernanke, Ben S. “Nonmonetary Effects of the Financial 1929-1939, 2nd ad. (University of California Press, 1986). Crises in the Propagation of the Great Depression,” Ameri- Lebergott, Stanley. Men Without Work: The Economics of can Economic Review (June 1983), pp. 257-76. Unemployment (Prentice-Hall, 1964). Meltzer, Allan H. “Monetary and Other Explanations of the U.S. House of Representatives. Stabilization. Hearings Before Start of the Great Depression,” Journal of Monetary Eco- the Committee on Banking and Currency. 69th Congress, nomics (November 1976), pp. 455.71. 1st Sess. (GPO, 1926).

Miron, Jeffrey A. “Financial Panics, the Seasonality of the _____. Banking Act of 1936. Committee on Banking and Nominal Interest Rate, and the Founding of the Fed,” Currency. 74th Congress, 1st Sess. (GPO, 1935). American Economic Review (March 1986), pp. 125-40. U.S. Senate. Operation of the National and Federal Reserve Romer, Christina. “Spurious Volatility in Historical Unemploy- Banking Systems, Committee on Banking and Currency, ment Data,” Journal of Political Economy (February 1986a), 71st Congress, 3rd Sess. (GPO, 1931). pp. 1-37. West, Robert Craig. Banking Reform and the Federal Reserve ______“New Estimates of Prewar Gross National Product and Unemployment,” Journal of Economic History (June 1863-1923 (Cornell University Press, 1977). l986b), pp. 341-52. Wheelock, David C. The Strategy and Consistency of Federal Sanloni, G. J., and T. Norman Van Cott. “The Ruthless Fed: Reserve Monetary Policy 1924-1933 (Cambridge University A Critique of the AST Hypothesis,” Public Choice (Decem- Press, 1991). ber 1990), pp. 269-75. ______. “Banking Act of 1935,” in John Eatwell, Murray Schwartz, Anna J. “Understanding 1929-1933,” in Karl Milgate, and Peter Newman, eds., The New Paigrave Dic- Brunner, ed.. The Great Depression Revisited (Kluwer- tionary of Money and Finance (Macmillan Press, forth- Nijhoff, 1981), pp. 5-48. coming). Temin, Peter. Did Monetary Forces Cause the Great Depres- Wicker, Elmus R. Federal Reserve Monetary Policy, 1917-1933 sion? (W. W. Norton, 1976). (Random House. 1966).

______Lessons from the Great Depression (The MIT ______. “Brunner and Meltzer on Federal Reserve Mone- Press, 1989). tary Policy During the Great Depression;’ Canadian Journal U.S. Bureau of Labor Statistics. Wholesale Prices 1890 to of Economics (May 1969), pp. 318-21. 1925 (GPO, 1926). ______. “What Caused the Great Depression 1929-1937? A Survey of Recent Literature;’ unpublished manuscript (Indiana University, August 1989).

I:; /4% g:~aH.t.i a:~

.hHa :i.i. ~/••~f’*~

All Commodities Price Index: Bureau of Gold stock: Board of Governors of the Federal Labor Statistics (1926), pp. 24-25. Reserve System (1943), pp. 369-77.

Bank reserves: Board of Governors of the Gross national product: Department of Coin- Federal Reserve System (1943), pp. 369-77 merce (1960), Historical Statistics of the United (member banks) and Friedman and Schwartz States, series Fl (current dollar) and F3 (cons- (1963), table A-2 (all banks). tant dollar). implicit price index: Department of Commerce Bank suspensions and deposits in suspended (1960) Historical Statistics of the United States, banks: Board of Governors of the Federal series F5. Reserve System (1943), p. 283. Index of Industrial Production: Board of Currency stock: Board of Governors of the Governors of the Federal Reserve System federal Reserve System (1943), pp. 369-77. (1937), Annual Report, pp. 175-77.

Discount rate (Federal Reserve Bank of New Interest rates: 1) Baa-rated: Board of Governors York): Board of Governors of the Federal of the Federal Reserve System (1943), pp. Reserve System (1943), pp. 440-41. 468-70; 2) long-term (daily average yield in June of each year on U.S. government Federal Reserve credit and its components: bonds): ibid, pp. 468-70; 3) short-term (daily Board of Governors of the Federal Reserve average yield in June of each year on U.S. System (1943), pp. 369-77, and ibid, ~ government three- to six-month notes and 136-44 (discount loans of reporting New York certificates (1919 to 1933), and on Treasury City member banks). bills (1934 to 1939): ibid, p. 460.

Federal Reserve System balance sheet: Board of Money supply: Friedman and Schwartz (1963), table A-i, col. 7 (MI) and col. 8 (M2). Governors of the Federal Reserve System (1943), p. 331. Unemployment rate: Lebergott (1964), p. 27.