Policy Precedents and the 1920s

Since the money supply is endogenous and the natural rate of interest is going to change over time, it's always tough to know whether you can really call a monetary policy stance "tight" or "loose". You can, of course, point to whether the Fed is buying or selling and there are of course other policies like IOR and reserve requirements that you could probably independently call "tight" or "loose". But otherwise it's tough.

Bob Murphy asks whether we can at least all agree that the Fed took unprecedented policy steps in the early days of the Depression:

"Here’s something I want to pin down. In my book on the Great Depression, I quote Lionel Robbins saying (I think in 1934) that central banks around the world had tried unprecedented measures to stimulate a recovery through cheap credit, and that this was a complete reversal of traditional central bank doctrine...

So here’s my question: Do any of today’s Keynesians deny this? Obviously you think that these measures were woefully inadequate, in light of the shortfall in Aggregate Demand in the early 1930s. But I’m asking, do you agree with Robbins, Hayek, and the random Joes writing letters to the NYT, who at the time were claiming that the central banks of the world were fighting the downturn differently from how things were handled in previous crises?

Note well, I’m speaking here in absolute terms, not in a Sumnerian view whereby the Fed–by definition–has been “tight” the last few years because NGDP is below trend. Rather, I’m asking (for example) if it’s true that central banks in the early 1930s were actively trying to ease credit (by lowering interest rates, setting up special asset purchases or loan programs, etc.) when they had never done things like this in earlier crises?"

I get what he's getting at, but I still think it's tough to get someone to commit to the idea that the Fed was "easing" credit. I looked at Friedman and Schwartz, and there was some activity in 1929, but that was pulled back. More substantial bond purchases seemed to be going on in 1931, but the policy didn't seem like it was sustained. I don't know the period particularly well, but nothing extraordinary seemed to be going on.

Were they "easing"? That's very hard for me to say yes to. Were they making bond purchases? Yes - it seems like they were sporadically, but the major action had to wait for Roosevelt in 1933.

Was this unprecedented?

That I didn't know for sure. They met the 1920-21 depression with a rate hike, not because they were Austrians but because they were anticipating Volcker. If you want to call the rate reductions in 1921 a counter-cyclical response you're free to, but I don't think that makes much sense. I think it makes more sense to say that they broke the inflation and ended their policy of high rates, not that they broke out low rates to fight unemployment. So I don't see much precedent there.

I don't know much about the rest of the decade, though, nor do I know about precedent at other banks.

The blogger "Lord Keynes" does. He has a very detailed post up demonstrating the use of open market operations during the other two recessions of the 1920s. As I noted in my RAE paper on 1920-21, this decision to rely on open market operations was in part a response to the whiplash they got from relying on the discount rate alone in 1920-21. OMOs are a smoother ride.

This all seems like Bagehot to me.

If I were Bob, this is how I would put it: before 1933, the Fed engaged in some bond purchases to address the contraction. The New York Fed was particularly energetic in the very beginning, when Wall Street was in so much toil. They did not behave like a modern central bank and were following precedent from the previous decade, but of course they were building toward a modern central banking mentality.

If anyone has anything else to add, I'm sure LK and Bob would both appreciate it.