Actions of the Federal Reserve System During the ‘Great Contraction’

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The years between 1929-1933 represented the most severe downturn in economic affairs in modern world history. Output declined at a markedly fast rate during this period and has been referred to as the “Great Contraction” and the “gloomy years”. Life was certainly gloomy, in the United States during these years. The downward spiral of the price level and shockingly high unemployment rate were unrelenting. The yearly intervals of 1929-1930, 1930-1931, 1931-1932, and 1932-1933 saw real income decline by 11 percent, 9 percent, 18 percent, and 3 percent respectively, or in totally of the four years by 36 percent. This depression was the first true test of the United States’ lender of last resort and central bank, the Federal Reserve System. Friedman and Schwartz place great blame on the Federal Reserve System for not stopping or at least mitigating the collapse of the monetary system.

During the late 1920’s, the United States’ stock market was experiencing at what could best be called a speculative fervor. The rapid increase in stock market prices led to increases in bank loans made to brokers, and it was here where conservative economists of the time claimed that credit was going to more speculative ventures than productive ones. This led to calls from the conservatives for Federal Reserve to tighten its monetary policy to curb the speculation, but their opponents argued that if the easy-money policies adhered to for most of the decade were curtailed then business would be hurt and the gold standard threatened in Europe. Bernanke also notes that commodity prices were declining, there was little to no inflation, and the economy had just recently escaped the trough of the last recession in November 1927; this is not a scenario wh...

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...nors of the Federal Reserve System (U.S.). Banking and Monetary Statistics : 1914-1941. Electronic. Washington, D.C.: Board of Governors of the Federal Reserve System, 1943.
Board of Governors of the Federal Reserve System (U.S.). Banking Studies. Electronic. Baltimore, U.S.A.: Waverly Press, 1941. http://catalog.hathitrust.org/Record/001127457.
Friedman, Milton, and Anna J. Schwartz. A Monetary History of the United States, 1867-1960. National Bureau of Economic Research. Studies in Business Cycles 12. Princeton, New Jersey: Princeton University Press, 1993.
Shiller, Robert J. Irrational Exuberance. Princeton, New Jersey: Princeton University Press, 2005.
Studenski, Paul, and Herman Edward Krooss. Financial History of the United States: Fiscal, Monetary, Banking, and Tariff, Including Financial Administration and State and Local Finance. New York: McGraw-Hill, 1963.

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