Monetary policy after the Great Depression

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The following paper investigates the Federal Reserve's fiscal policy after the Great Depression. It concludes that during the economic downturn, monetary policies such as low-interest rates and encouraging commercial banks to hold surplus reserves were implemented.

Monetary policies are the decisions taken by a country's central bank or some other administrative committee and board to decide the volume and distribution of money supply in the economy, which influences interest rates. Central banks or the Federal Reserve maintains monetary policies through actions that may involve the modification of interest rates, selling or buying of government bonds, and changing the deposit amounts or bank reserves which banks should have in their vaults.

Economists during the great depression such as Irvin Fisher applied the Quantity Theory of money to help overcome the great depression. This theory holds that changes in the amount of money supply lead to changes in levels of prices and this can directly influence economic activities in the short term. It was argued that the Federal Reserve should increase the amount of money supply in the economy so that they could prevent economic deflation. However, proponents of liquidations theories held that having excessively easy money during the 1920s led to economic depression and that any artificial easing in response to this was a mistake. One of the primary implications of this theory is that increased amount of money supply in recessionary periods may be counterproductive. It was because of this that a mini-recession which occurred in 1927, the Federal Reserve made significant purchases in open market and significantly reduced discount rate. However, this action was regarded as one of the costly errors that further worsened the great depression (Robbins, 2011). The liquidationist proponents continued to argue against the efforts by the federal government to increase the supply of money as they held that do so would reignite speculation but would not promote an increase in the real output.

The emergence of the Keynesian explanations, however, sharply differed with those held by the liquidationists as he dismissed monetary forces as the causes of the depression (Wheelock, 1992). Instead, Keynes argued that the economic activities had reduced due to the declining household consumption and business investment which together reduced aggregate demand.

Most Federal Reserve officials believed that during the great depression measures were taken to ease the supply of money in the economy. For example, following the stock market crash in 1929, short-term rates of interest sharply fell and remain low throughout the early 1930s (Schularick & Taylor, 2012). Most economists viewed the decline in the short-term rates as implying that there was monetary ease. However, the long-term rates of interests sharply declined while yields on risk bonds including the Baa-rated bonds increased during the first three years of great depression. However, many have economists have concluded that the exceptionally low yields of short-term securities meant that the supply of money in the economy during the great depression was in abundance.

The fact that relatively few banks went to borrow reserves from the Federal Reserve also means that one of the monetary policies employed by the Federal Reserve included actions which left the commercial banks to hold as much as bank reserves as they could manage. Many banks during the great depression had excess reserves as the great depression unfolded (Wheelock, 1992). However, even the low-interest rates, as well as an apparent lack of demand for the bank reserves, persisted; many Federal Reserve policymakers concluded that tight money was not one of the causes of the great depression. Therefore, it can be concluded that during the great depression, the monetary policies which were used included actions which led to the easy supply of money in the economy, low-interest rates, and holding of excess bank reserves by the federal member banks.

References

Robbins, L. (2011). The great depression. Piscataway, NJ: Transaction Publishers.

Schularick, M., & Taylor, A. M. (2012). Credit booms gone bust: monetary policy, leverage cycles, and financial crises, 1870–2008. The American Economic Review, 102(2), 1029-1061.

Wheelock, D. C. (1992). Monetary policy in the Great Depression: What the Fed did, and why. Federal Reserve Bank of St. Louis Review, 74(2), 3-28.

November 09, 2022
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Government Life

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675

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