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Sixty years ago the United States--indeed, most of the world--was in the midst of the Great Depression. Today, interest in the Depression's causes and the failure of government policies to prevent it continues, peaking whenever the stock market crashes or the economy enters a recession. In the 1930s, dissatisfaction with the failure of monetary policy to prevent the Depression, or to revive the economy, led to sweeping changes in the structure of the Federal Reserve System. One of the most important changes was the creation of the Federal Open Market Committee (FOMC) to direct open market policy. Recently Congress has again considered possible changes in the Federal Reserve System.(1)
This article takes a new look at Federal Reserve policy in the Great Depression. Historical analysis of Fed performance could provide insights into the effects of System organization on policy making. The article begins with a macroeconomic overview of the Depression. It then considers both contemporary and modern views of the role of monetary policy in causing the Depression and the possibility that different policies might have made it less severe.
Much of the debate centers on whether monetary conditions were "easy" or "tight" during the Depression--that is, whether money and credit were plentiful and inexpensive, or scarce and expensive. During the 1930s, many Fed officials argued that money was abundant and "cheap," even "sloppy," because market interest rates were low and few banks borrowed from the discount window. Modern researchers who agree generally believe neither that monetary forces were responsible for the Depression nor that different policies could have alleviated it. Others contend that monetary conditions were tight, noting that the supply of money and price level fell substantially. They argue that a more aggressive response would have limited the Depression.
Among those who conclude that contractionary monetary policy worsened the Depression, there has been considerable debate about why Federal Reserve officials failed to respond appropriately. Most explanations fall into two categories. One holds that Fed officials, though well-intentioned, failed to understand that more aggressive action was needed. Some researchers, like Friedman and Schwartz (1963), argue that the Fed's behavior during the Depression contrasted sharply with its behavior during the 1920s. They contend that the death of Benjamin Strong in 1928 led to a redistribution...