The Federal Reserve System Of The United States And Great Depression Essay Examples

Type of paper: Essay

Topic: Economics, Government, Banking, Depression, Money, Investment, Great Depression, Market

Pages: 5

Words: 1375

Published: 2021/01/03


In its early days the main purpose of the Federal Reserve System was to help banks during banking crises and exchange fevers. Initially, the control over the level of bank credit, money supply and rates of interest was not within the purview of the Federal Reserve System. In that time the gold standard was dominated in the United States, and it was assumed that the amount of gold stored in the bowels of the US banking system is the mechanism that regulates the amount of money in circulation and bank credit. The founding fathers of the Federal Reserve System considered the Fed as the central bank, which would be able to provide elastic supply of cash and assets for commercial banks discounting (Broz, J., 1997).


The Great Depression began in August 1929, when the index of industrial production reached its peak. Follow the dynamics of both industrial production and national product as a whole was negative prior to 1934. A graph below shows the dynamics of US GNP in constant prices of 1929. It shows that GDP fell for four years and, resuming growth, reached the 1929 level only in 1937. Although the graph has a V-shape, the depth of the fall (29% from the peak) and the duration of recovery to pre-crisis levels (8 years) are talking about a very large welfare loss of many economic actors of the time.
Various economic schools focus on different assumptions of the Great Depression. One of the discussions is about the relationship of financial markets and the real sector. Some economists believe that among the causes of the crisis, have been active speculation in the stock market and real estate market, and the subsequent stock market crash led to stagnation in the economy. At the same time, many economists, such as R. Dornbusch, Fischer, S. and R. Startz, delimit the stock market collapse of 1929 and the fall of the economy, considering them to be independent events (Ellis, E., 1970).
Another area of ​​debate concerns the role of monetary factors. Proponents of the monetarist school believe that procyclical monetary policy of the Federal Reserve System was a big mistake. It led to the credit crunch and the fall in real output worsened. At the same time, neoclassical economists doubt the causal relationship between the value of the monetary aggregates and the dynamics of real output and argue in favor of an endogenous relationship between these parameters. It should be noted that the debate over the Fed's monetary policy has intensified recently. During the Depression, the discussion of the role of the government, initiated by representatives of the Keynesian school, was focused on fiscal policy of the government. Fundamentals of the theory of Keynes were laid before the Great Depression, Keynes and his followers explained the deep recession 1930 by the fall of aggregate demand. Thus, according to this theory, the decline in investment and consumption was the result of a very deep fall of private sector expectations related to the prospects of the US economy. At the same time, the administration of President E. Hoover pursued a policy of balancing the fiscal budget as well as export-import balance. For these purposes, the government cut public spending and increased import tariffs, and this additionally strengthened the decline in aggregate demand. In addition, President Hoover urged employers, even with falling demand for products not to cut nominal wages of workers. This factor in deflation selling prices led to an increase in real wages and, according to Keynes, has further exacerbated unemployment and falling real output (Galbraith, J., 1955).
In addition to disputes about the relative importance of the factors that led to the Great Depression, the subject of debate is the question of how these factors could cause economic stagnation of this magnitude over such a long period of time. For example, if Keynesian explanation is true, why the private sector has been so pessimistic and whether this factor to explain the almost 50protsentnoe decline in GDP during the Great Depression. It should also be noted that the history of the United States knew a lot of the stock market crisis, such as "Black Monday" in 1987, who celebrated the biggest daily drop in the history of the US stock market and surpassed Wall Street Crash of 1929. Nevertheless, the US economy has not fallen into depression after that. Fed's monetary policy is also often criticized, for example, during the recession of the 1970s, when it led to stagflation. In all cases, these negative factors contributed to the cyclical downturn of the US economy, but none of them was so deep and prolonged, as the Great Depression.
One of the prerequisites of the Great Depression was the monetary policy of the Fed. It should be noted that prior to the publication of the book by M. Friedman and A. Schwartz, most economists did not pay much attention to this factor, and focused on a Keynesian aggregate demand factors, or on the ideas of underconsumption, the existence of excess capacity and inventories.
The debate among economists is not only the role of the factors that led to the Great Depression, but also the reasons that contributed to the exit. Without going into a detailed analysis, we note that the main debate focused on the feasibility and effectiveness of the steps taken by the monetary authorities and the government for the resumption of economic growth. Friedman and Schwartz as adherents of the monetarist school emphasize the importance of the Fed's monetary policy not only at the stage of the fall, but also at the stage of recovery. They emphasize the positive role of the Fed's expansionary monetary policy and the US withdrawal from the gold standard in 1933. Representatives of the Keynesian school positively assess the role of reforms aimed at regulating the banking sector, the stock market and the labor market. They also point to the fact that the fiscal measures Government Roosevelt stimulated aggregate demand and contributed to economic growth. At the same time, proponents of the classical school argue for the fact that the economic recovery was due to improvements in productivity and purification of the economy uncompetitive entities, while the government's measures prevented the natural operation of the market and delayed the recovery of the equilibrium state (Garside, W., 1993).
Such a deep economic crisis, as the Great Depression, led to major institutional changes the most important sectors of the US economy, which determined the rules of the game for decades to come. In 1933 a Glass-Steagall Act was passed, which prohibits commercial banks to operate in the stock market that have defined the investment and commercial banks. There was also a ban on paying interest on current accounts and consolidated function of the Fed to regulate interest on deposits. Both measures were intended to restrict risky investment banking. One of the key innovations was the creation of the Federal Deposit and Insurance Corporation, which was to prevent a banking panic and panic among depositors.
In 1934, at the initiative of the Federal Reserve System, there was established the Securities and Exchange Commission, designed to monitor and implement legislation on the securities market. During those years a mandatory public reporting for companies whose shares are traded on the stock exchange was introduced. Unlike the banking sector investments in the capital market are not insured by the federal government. That’s why the Commission should act as the supervisory authority and prevent possible violations of the financial intermediaries. The cancelling of binding to gold reduced deflationary pressures on the banking system and allowed the Federal Reserve to pursue a more independent monetary policy. Devaluation of the dollar has also strengthened the competitiveness of US industry (Eichengreen, B., 1992).


Summing up, it should be noted that the identification of the nature of economic crises and their prerequisites is an important area of ​​economic analysis, because it should help modern politicians to avoid the mistakes made by their predecessors. During a severe economic crisis there are exacerbated many imbalances accumulated during the boom. Measures taken by the monetary and fiscal authorities to overcome the crisis are largely depending on their economic views, as well as the intellectual environment. In addition, the experience of the great depression convincingly demonstrates that in addition to monetary, financial, technological and other factors, private sector expectations regarding the success of government policies to overcome the crisis have a great influence on the dynamics of key macroeconomic indicators. Reduce of uncertainty and the increase of confidence in the actions of the government leads to a more rapid recovery of economic relations between the subjects of the economy and the resumption of economic growth.

Works Cited

Broz, J. Lawrence. The International Origins of the Federal Reserve System. Ithaca, N.Y.: Cornell UP, 1997. Print.
Eichengreen, Barry J. Golden Fetters: The Gold Standard and the Great Depression, 1919-1939. New York: Oxford UP, 1992. Print.
Ellis, Edward Robb. A Nation in Torment: The Great American Depression, 1929-1939. New York: Coward-McCann, 1970. Print.
Ferguson, Thomas. Golden Rule: The Investment Theory of Party Competition and the Logic of Money-driven Political Systems. Chicago: U of Chicago, 1995. Print.
Galbraith, John Kenneth. The Great Crash, 1929. Boston: Houghton Mifflin, 1955. Print.
Garside, W. R. Capitalism in Crisis: International Responses to the Great Depression. London: Pinter ;, 1993. Print.
Glasner, David. Business Cycles and Depressions: An Encyclopedia. New York: Garland Pub., 1997. Print.
Goldenweiser, E. A. American Monetary Policy. New York: McGraw-Hill, 1951. Print.
Mitchell, Broadus. Depression Decade; from New Era through New Deal, 1929-1941. New York: Rinehart, 1947. Print.

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