Why Won a Great Depression Happen Again

"Regarding the Great Depression, … we did it. Nosotros're very sorry. … We won't do it again."
—Ben Bernanke, November 8, 2002, in a oral communication given at "A Conference to Honor Milton Friedman … On the Occasion of His 90th Birthday."

In 2002, Ben Bernanke, then a member of the Federal Reserve Lath of Governors, best-selling publicly what economists have long believed. The Federal Reserve'southward mistakes contributed to the "worst economic disaster in American history" (Bernanke 2002).

Bernanke, like other economic historians, characterized the Swell Depression equally a disaster because of its length, depth, and consequences. The Depression lasted a decade, beginning in 1929 and ending during World War Two. Industrial production plummeted. Unemployment soared. Families suffered. Marriage rates fell. The contraction began in the United States and spread around the globe. The Depression was the longest and deepest downturn in the history of the U.s. and the modern industrial economy.

The Great Depression began in August 1929, when the economic expansion of the Roaring Twenties came to an end. A series of financial crises punctuated the contraction. These crises included a stock market crash in 1929, a series of regional banking panics in 1930 and 1931, and a series of national and international financial crises from 1931 through 1933. The downturn hit lesser in March 1933, when the commercial banking system collapsed and President Roosevelt declared a national banking vacation.1Sweeping reforms of the fiscal organisation accompanied the economic recovery, which was interrupted by a double-dip recession in 1937. Return to full output and employment occurred during the Second World War.

To empathize Bernanke'southward statement, i needs to know what he meant by "we," "did it," and "won't do it again."

By "we," Bernanke meant the leaders of the Federal Reserve System. At the start of the Depression, the Federal Reserve's controlling structure was decentralized and often ineffective. Each district had a governor who set policies for his district, although some decisions required approving of the Federal Reserve Board in Washington, DC. The Lath lacked the authorization and tools to act on its own and struggled to coordinate policies across districts. The governors and the Board understood the demand for coordination; frequently corresponded apropos important bug; and established procedures and programs, such as the Open up Marketplace Investment Committee, to institutionalize cooperation. When these efforts yielded consensus, budgetary policy could be swift and effective. But when the governors disagreed, districts could and sometimes did pursue independent and occasionally contradictory courses of activeness.

The governors disagreed on many issues, because at the time and for decades thereafter, experts disagreed about the best course of action and even most the correct conceptual framework for determining optimal policy. Information near the economy became available with long and variable lags. Experts inside the Federal Reserve, in the business community, and amidst policymakers in Washington, DC, had dissimilar perceptions of events and advocated different solutions to problems. Researchers debated these issues for decades. Consensus emerged gradually. The views in this essay reflect conclusions expressed in the writings of three recent chairmen, Paul Volcker, Alan Greenspan, and Ben Bernanke.

Past "did information technology," Bernanke meant that the leaders of the Federal Reserve implemented policies that they idea were in the public interest. Unintentionally, some of their decisions hurt the economy. Other policies that would have helped were not adopted.

An example of the former is the Fed's decision to heighten interest rates in 1928 and 1929. The Fed did this in an attempt to limit speculation in securities markets. This activeness slowed economic activity in the United States. Considering the international aureate standard linked involvement rates and monetary policies among participating nations, the Fed's actions triggered recessions in nations around the globe. The Fed repeated this mistake when responding to the international financial crisis in the autumn of 1931. This website explores these issues in greater depth in our entries on the stock market crash of 1929 and the fiscal crises of 1931 through 1933.

An example of the latter is the Fed's failure to deed every bit a lender of final resort during the banking panics that began in the fall of 1930 and ended with the banking holiday in the wintertime of 1933. This website explores this issue in essays on the banking panics of 1930 to 1931, the banking acts of 1932, and the banking holiday of 1933.

Men study the announcement of jobs at an employment agency during the Great Depression.
Men study the announcement of jobs at an employment bureau during the Peachy Depression. (Photograph: Bettmann/Bettmann/Getty Images)

One reason that Congress created the Federal Reserve, of course, was to act as a lender of final resort. Why did the Federal Reserve fail in this key task? The Federal Reserve's leaders disagreed about the best response to cyberbanking crises. Some governors subscribed to a doctrine similar to Bagehot's dictum, which says that during fiscal panics, central banks should loan funds to solvent financial institutions beset by runs. Other governors subscribed to a doctrine known as real bills. This doctrine indicated that fundamental banks should supply more than funds to commercial banks during economic expansions, when individuals and firms demanded boosted credit to finance product and commerce, and less during economical contractions, when demand for credit contracted. The real bills doctrine did non definitively describe what to do during banking panics, but many of its adherents considered panics to be symptoms of contractions, when central bank lending should contract. A few governors subscribed to an farthermost version of the real bills doctrine labeled "liquidationist." This doctrine indicated that during financial panics, central banks should stand aside so that troubled financial institutions would fail. This pruning of weak institutions would accelerate the evolution of a healthier economic system. Herbert Hoover's secretary of treasury, Andrew Mellon, who served on the Federal Reserve Lath, advocated this approach. These intellectual tensions and the Federal Reserve's ineffective controlling structure made it difficult, and at times impossible, for the Fed'south leaders to take effective activeness.

Amongst leaders of the Federal Reserve, differences of opinion also existed about whether to assist and how much aid to extend to financial institutions that did non vest to the Federal Reserve. Some leaders thought aid should just exist extended to commercial banks that were members of the Federal Reserve Organisation. Others thought fellow member banks should receive help substantial enough to enable them to assist their customers, including fiscal institutions that did not belong to the Federal Reserve, simply the advisability and legality of this pass-through assistance was the subject of debate. Only a handful of leaders thought the Federal Reserve (or federal regime) should directly assistance commercial banks (or other financial institutions) that did not belong to the Federal Reserve. One advocate of widespread direct assistance was Eugene Meyer, governor of the Federal Reserve Board, who was instrumental in the creation of the Reconstruction Finance Corporation.

These differences of opinion contributed to the Federal Reserve's well-nigh serious sin of omission: failure to stem the turn down in the supply of money. From the fall of 1930 through the winter of 1933, the money supply cruel past nearly thirty percentage. The declining supply of funds reduced boilerplate prices past an equivalent amount. This deflation increased debt burdens; distorted economic controlling; reduced consumption; increased unemployment; and forced banks, firms, and individuals into bankruptcy. The deflation stemmed from the collapse of the banking organization, as explained in the essay on the banking panics of 1930 and 1931.

The Federal Reserve could have prevented deflation by preventing the collapse of the cyberbanking system or past counteracting the collapse with an expansion of the budgetary base of operations, but information technology failed to do so for several reasons. The economic collapse was unforeseen and unprecedented. Decision makers lacked effective mechanisms for determining what went wrong and lacked the dominance to take deportment sufficient to cure the economy. Some decision makers misinterpreted signals almost the land of the economy, such as the nominal interest rate, because of their adherence to the real bills philosophy. Others accounted defending the gilt standard by raising interests and reducing the supply of money and credit to exist improve for the economic system than aiding ailing banks with the reverse deportment.

On several occasions, the Federal Reserve did implement policies that modern monetary scholars believe could have stemmed the contraction. In the spring of 1931, the Federal Reserve began to expand the monetary base, but the expansion was bereft to offset the deflationary effects of the banking crises. In the bound of 1932, subsequently Congress provided the Federal Reserve with the necessary authority, the Federal Reserve expanded the monetary base aggressively. The policy appeared effective initially, merely after a few months the Federal Reserve changed course. A serial of political and international shocks hitting the economy, and the contraction resumed. Overall, the Fed's efforts to finish the deflation and resuscitate the financial system, while well intentioned and based on the all-time bachelor data, appear to accept been also piffling and too tardily.

The flaws in the Federal Reserve'south structure became apparent during the initial years of the Great Depression. Congress responded by reforming the Federal Reserve and the entire fiscal system. Under the Hoover administration, congressional reforms culminated in the Reconstruction Finance Corporation Act and the Banking Act of 1932. Under the Roosevelt administration, reforms culminated in the Emergency Banking Deed of 1933, the Banking Act of 1933 (commonly called Drinking glass-Steagall), the Aureate Reserve Act of 1934, and the Banking Act of 1935. This legislation shifted some of the Federal Reserve's responsibilities to the Treasury Section and to new federal agencies such as the Reconstruction Finance Corporation and Federal Deposit Insurance Corporation. These agencies dominated monetary and banking policy until the 1950s.

The reforms of the 1930s, '40s, and '50s turned the Federal Reserve into a modern central depository financial institution. The creation of the mod intellectual framework underlying economic policy took longer and continues today. The Fed's combination of a well-designed central bank and an effective conceptual framework enabled Bernanke to state confidently that "we won't practice it again."


Bibliography

Bernanke, Ben. Essays on the Great Depression. Princeton: Princeton University Press, 2000.

Bernanke, Ben, "On Milton Friedman'due south Ninetieth Altogether," Remarks by Governor Ben S. Bernanke at the Conference to Honor Milton Friedman, University of Chicago, Chicago, IL, November 8, 2002.

Chandler, Lester V. American Monetary Policy, 1928 to 1941. New York: Harper and Row, 1971.

Chandler, Lester V. American's Greatest Depression, 1929-1941. New York: Harper Collins, 1970.

Eichengreen, Barry. "The Origins and Nature of the Great Slump Revisited." Economic History Review 45, no. 2 (May 1992): 213–239.

Friedman, Milton and Anna Schwartz. A Monetary History of the U.s.a.: 1867-1960. Princeton: Princeton University Press, 1963.

Kindleberger, Charles P. The World in Depression, 1929-1939: Revised and Enlarged Edition. Berkeley: University of California Printing, 1986.

Meltzer, Allan. A History of the Federal Reserve: Volume one, 1913 to 1951. Chicago: Academy of Chicago Printing, 2003.

Romer, Christina D. "The Nation in Low." Journal of Economic Perspectives 7, no. two (1993): xix-39.

Temin, Peter. Lessons from the Great Low (Lionel Robbins Lectures). Cambridge: MIT Press, 1989.

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Source: https://www.federalreservehistory.org/essays/great-depression

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