Economics

THE GREAT DEPRESSION

According to Alan Greensapan:

“When business in the United States underwent a mild contraction in 1927, the Federal Reserve
created more paper reserves in the hope of forestalling any possible bank reserve shortage. More
disastrous, however, was the Federal Reserve's attempt to assist Great Britain who had been losing
gold to us because the Bank of England refused to allow interest rates to rise when market forces
dictated (it was politically unpalatable). The reasoning of the authorities involved was as follows: if the
Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United
States would fall to a level comparable with those in Great Britain; this would act to stop Britain's gold
loss and avoid the political embarrassment of having to raise interest rates. The "Fed" succeeded; it
stopped the gold loss, but it nearly destroyed the economies of the world, in the process. The excess
credit which the Fed pumped into the economy spilled over into the stock market – triggering a
fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess
reserves and finally succeeded in braking the boom. But it was too late: by 1929 the speculative
imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a
consequent demoralizing of business confidence. As a result, the American economy collapsed.
Great Britain fared even worse, and rather than absorb the full consequences of her previous folly,
she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of
confidence and inducing a world-wide series of bank failures. The world economies plunged into the
Great Depression of the 1930's.”

Milton Friedman says the Fed mismanagement was responsible by effectively reducing the money
supply by a third:

"The serious fault of the Federal Reserve dates from the end of 1930, when a series of bank
failures... changed the monetary character of the contraction. Prior to that date, there was no sign of
a liquidity crisis—the ratio of currency to deposits was relatively stable or falling. From then on, the
economy was plagued by recurrent liquidity crises. A wave of bank failures would taper down for a
while, and then start up again as a few dramatic failures or other events produced a new loss of
confidence in the banking system and a new series of runs on banks.... From the end of October
1930 through July 1931, nearly 1,400 banks holding $1 billion in deposits or about 2% of all deposits
in commercial banks failed, the money stock declined by 6% in addition to the 3% decline up to
October, and deposits in commercial banks fell by 8%.... [In August 1931] the System raised discount
rates sharply....The measure was also accompanied by a spectacular increase in bank failures and
runs on banks. All told, in the six months from August 1931 through January 1932, 1,860 banks with
deposits of $1,449 million suspended operations, and total deposits in commercial banks fell by 15%"
[A Program for Monetary Stability (1960) pp 18-19].

Good Macro

"An economist
is an expert
who will know
tomorrow
why the things
he predicted
yesterday
didn't happen
today."
-- Dr. Laurence J. Peter
Author of
The Peter Principle