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: Development of Monetary Policy Chapter Authors: Milton Friedman, Anna Jacobson Schwartz Chapter URL: http://www.nber.org/chapters/c9278 Chapter pages in book: (p. 66 - 95) THE GItEAT CONTRA(:TIQN to 1931, China was hardly affected internally by the holocaustthat wa. s%eeping the gold-standard world,Tjust as inl920-21, Germans' had been insulated byher hvperinfiation and associated floatingrxchan rate." The first major country to Cut the linkwas Britain, when she left tL gold standard in 1931. The trough of the depressionin Britain and in other countries that accompanied Britain in leavinggold was reached in the third quarter of 1932. In the countriesthat remained on tile gold standard or,like Canada, that went onlypart way with Britain, the depression dragged on. In China, whosecurrency appreciated relative to the pound as a result of the sharp depreciation of tile pound relativeto gold. the depression set in for die first timein 1931. Of course, the country in tile vanguard of such an internationalmove- rnent need not stay there. France, which hadaccumulatec, s laree stock of gold as a result of returning to the goldstandard in 1928 at .' exchange rate that undervalued the franc, and therefore had much leeway, atsome point passed the United States and not only beganto add to its gold stock but also, after late 1931, to draingold from the United States The between the franc and the dollar link was cut when the United Statessus- pended gold pa)ments in March 1933,which proved to be the business cycle trough for the United States and countries closely linkedto itIn France. which stayed on gold fora further interval, the contractioi1 (Iragged on still longer. Although there was an upturn from July1932 to July 1933, the low point of theinterwar years was not reached 1935. until April 5. Development ofMonetary Policy The course of monetary policy in the difficult and criticals'ears of the contraction was greatly influencedby the struggle for Federal Reserve S'.tem, the power within tile beginnings of whichwere described in the preceding chapter. At the timeof the stock market Reserve Bank acted in the crash, the New York tradition of its earlierdominance rapidly, decisively, andon its own. The adverse r11ovifl" greatly inhibited further reaction of the Board independent measures b.New York In 1930. New York strongly favored expansio!sarVopen markct opria. tions, but after the middleof the 'car was unable to persuadeeither ti:' other Bank governors_allof whom by thi5 time the reorganizyd Open Market had become members of Policy Conferencewhich replaced die earlier Open Market InvestmentCommittee..or the ington. The samewas true in Board in Wash- 1931, except thatNew Yorkwas less 'Arthur Salter, China andSilver, New York, 15-1?. Economic Forum 1934pp 3-6 Frank D. Graham, Exchange Gerrr.any, 1920-23. Princeton Prices, and Prdu.-'inn/i psr:?,'i, Univcrsjr. Precs, 1931, 2873g THE GREAT CONTRACTION at was vigorous ill 1)iesstng for expansionary action, though it was nowsupported v had by the new governor(Eugene Meyer) of the Federal Reserve Board. :hange The reaction to Britain's departure- from gold did not provoke a flare-up of those conflicts. The measuresadopted at that time were favored by cit the almostallaffiliatedwith the System. The agreement reflectedthe and in dominant importance then attached to the preservation of thegold cached standard and the greater signiuicance attached toexternal than to ic gold internal stability, by both the System and the community atlarge. Not n, the long after, the differences withinthe System that had been submcred tive to in the fall of 1931 rc-emered,New York generally pressing for ex- uve to palisiOnalY open marketoperations, supported by the governor and some other members ofthe Board and by a few Bank governors, and 'stove- opposed by most of the Bank governors. under Con- tuck of 'Ihe open market operation of 1932 was acceded to largely change gressiona1pressure and withthe new Glass-Steagall Act ostensibly The operation some 1ermittg release of the System's expansionary powers. shortly after Congress adjourned, because so d stock was terminated in August. remained unenthusiastic about the policy and ie link many Bank governors deadlock persisted through the es sus- reluctant or unwilling to pursue it. Tue usiness rest of the contraction. tt. in THE STOCK MARKET CP.ASH OCTOBER1929 rartion the Open Market Investment 932 to At the time of the stock market crash, Committee consisted of five Bank governors with theNew York governor I April as chairman. It wasoperating under its recommendation to the Board, September 4, which had been approved by theBoard on October 1. to purchase "not to exceed $25,000,000 a week"of short-term government "for the of the securitiesif needed to supplement purchases of acceptances, purpose of avoiding any increaseand, if possible, facilitating some further in the bank discounts ......Up to in the reduction in the total volume of member Committee had not made any govern- v York the week ending October 23, the bills had been available. The Ssstem's 110 VInC inent security purchases because bill holdings had increased Board holdings had declined by $16 million, while itS by $115 million.16 had no doubt about what nera- When the crash came, the New York Bank steps should be taken andproceeded to take them. It purchased $160 er rho encouraging New York oers of million of government securities in addition to banks to discount freely. The amountpurchased was far iii excess of the 'd the Investment Committee was authorized Wash- amount that the Open Market Bank did not claim to be operating forthe less to purchase, but the New York Committee. It contended it had the right topurchase government secu- 3-6, Harrison. Open Market. Vol.I, nhLnute5, Sept. 24, 1929, and letter,dated Oct. 1, 1929, Young to Harrison. // THE GRgAT CONTRAcflON rities for its own account,as a matter of general credit policy, without the Board's approval.lt Harrison informedGovernor Young of the Federal Reserve Board that his directors hadatithori;ed him to purchasegovern. rnent Securities without limitationas to amount, and that on October 29, before the call loan rate was announced, a purchase had beenarranged Members of the Board regarded the New York Bank's fai!ureto seek the authorization of the Boardbefore taking actionas smacking of in- subordinationthough some regarded theation itself as desirable As a legal matter, the Nw York Bank seemed clearly within its rightsUnder the 1923 agreement setting up the Open MarketInvestment each Reserve Bank retained the Coniiriittc'e, right to purchase and holdgovernment securities for its ownaccount, Young and most Board edged the legal right members acknow!- vet felt that the challengeto the Board's authority was Insupportable After much discussionthe Board finally Young to tell Harrison authorized that, if New York shouldrequest approval of a reduction of its rate to 5per cent, the Board would that no further purchases consent on condition ofgovernmentsecurities be made approval of the Board except with On November i, thediscount rate at the New ork Bank wasso reduced To the New York directors it was clearthat the Svstep-i oughtto proceed immediately with "unless thisis done, after the further purchases for events of the past weeks,therc ma' be creator danger of a recession inbusmess with linemplosment which consequent depression and we should do all in ourpower to prevent" as they declaredin a resolutionthey adopted on November 7,75Under the leadership of Harrison, theOpen Market Investment Nosemnber 12, Conimirtee mPeting recommended that "thepresent limit of $?5,0000ftO week on the purchaseof per os'ernmen( securities beremoved and that the Committee be authorizedin lieuthereof to purchasenot to exceed S200,00o 000 ofgovernment securities for to participate ..," having account of such banksas care in mind also the fact"that present condi- tions may possibly developto the point where, in the interest of as an ernergencmeasure, maimstaininrr hankine and business stabilityit may be n°cessarv quickly to purchaselarge amounts of ordertoavoid Government seclirities in anyundue stringency incredit, "' "Of the $160 t1!jon Cocrnmentsecuritje endinOct30, S5 million purchased be Ntv Vorl, inthe week me t5o was transferd to Sssmt'rn eeksthe Nework Bank liouwbi account During the follow. System arcounm an addiffllnJi $25 auth00diretlfor "HamIsa, Diary, Volt 6. Oct.29 01 1929 pp 1t17 sider the purchase desirablelie siCeested 196 Miller didrot ('On. wouid not hate a reioiutio0 to the effectthat the Board approsed the purchase hadit hen Consulted usas more concerned about thestock market than mh that Ness York forcing the banksto cot-ne to the discount general credit situationthat response window would Fat'been the prs-)er For the rosol t1ofl se-c ii arriso,.\ sc eI an'.,,05 '01 Open Market Vol. 1. 1 minutes of nuretd Not- 2 l9Q THE GREAT CONTRACTION The next day,Lli Bc,aïdnotified the Committee that "the general situation was not sufficientlyclarified for the System to formulate and adopt a permanent openmarket policy at that time," but conceded that if "an emergency shouldarise with such suddenness and be so