Is it 1937 again?

There are many commentaries on David Leonhardt's article today on whether we should be raising taxes and cutting government spending, as was done in 1937.  Yet I don't see anyone — at least not today — talking about monetary policy during 1936-7.  A bit earlier, David Beckworth stepped up to the plate:

Is the Federal Reserve (Fed) making a similar mistake to the one it made in 1936-1937? If you recall, the Fed during this time doubled the required reserve ratio under the mistaken belief that it would reign in what appeared to be an inordinate buildup of excess reserves. The Fed was concerned these funds could lead to excessive credit growth in the future and decided to act preemptively. What the Fed failed to consider was that the unusually large buildup of excess reserves was the result of banks insuring themselves against a replay of the 1930-1933 banking panics. So when the Fed increased the reserve requirements, the banks responded by cutting down on loans to maintain their precautionary level of excess reserves. As a result, the money multiplier dropped and the money supply growth stalled…

The second link in this post offers the critical figure.  If monetary policy is sufficiently accommodative, I do not see that we are risking a 1937-8 repeat.  In 1936-7, monetary policy was not just insufficiently expansionary, it was absolutely draconian.  Read this paper too.  Here is Scott Sumner.

As the stimulus is pulled away, there is a reasonable chance that the Fed will be more accommodative.  Remember, the monetary authority moves last.

I do not see why we are discussing this issue without placing monetary policy at the center of the analysis.


To my ear, it all just sounds like talk about how many red rubber boots the central boot making authority ought to make.

So the question is whether pulling out stimulus makes the Fed and ECB sufficiently more accommodating that pulling out is a good idea or not. Right?

Erik, more QE is one option and we may well see that. Plus the Fed could unwind its current portfolio more slowly. Coordinated Fed-Treasury action is easy enough to do, also, and while you can call it fiscal policy the real boost comes from the monetary policy angle. A helicopter drop would work as well. There are plenty of options.

Thanks for the quick response, Tyler

More QE is probably a good idea, although when you said we don't need exotic QE in your earlier post I assumed you had something else in mind for the Fed. Of course, it means buying more risky securities. That's been done a lot already and may have limits, e.g.

Unwinding more slowly is not exactly easing, though at least it's not tightening quickly.

As long as the Taylor rule suggests a rate so far below the market interest rate, we can expect the Fed to buy sufficient Treasuries to keep interest rates from rising. In that case, is a tax cut (or spending increase) different from the hypothetical "helicopter drop"? Are checks from the Treasury, however they are labeled, what you are suggesting?

Tyler, I hope your readers understand (1) that regardless some similarities, the differences in monetary systems and public sectors between the 1930s and the 2010s are too large to be ignored, and (2) that macroeconomics as a theory of national accounting (the AD and AS on which you and most macroeconomists rely to tell your stories) cannot explain what is going on today and it cannot explain what happened in the 1930s. The two points are closely linked because the theory ignores what monetary systems and public sectors do in constitutional democracies and how they work, so it cannot explain how significant changes in monetary systems and public sectors may affect the economy's performance. And to make things worse, most of the evidence from the empirical research "to validate this theory" is based on manipulating data that are hardly a proxy of the ill-defined concepts on which the theory has been built (to understand this point just look at the definitions of money and public expenditure, revenue and deficit that are used in empirical research). Yes, the empirical research provides some insights --about what macroeconomists have been doing, but not about the economy. Call me a AD&AS skeptic, but that doesn't add to our understanding of the economy and the policy alternatives.

Is it 1937 again?

Clearly not. It's 1931.

Is "stimulus" spending just part of the fog of war that obscures - and sometimes distracts from - the true, decisive, battle that is fought using monetary policy?

Agree with Erik Brynjolfsonn.

The austerity group has won because the Congress wouldn't be able to pass a stimulus program because of the concern of a deficit during, of all times, a recession. We are going to rely on monetary policy, at a time of .25% interest?

Look. You guys got what you want. No stimulus program out of concern for a deficit.

Let me predict some hypocrisy however: Next January, the deficit be damnned, some group will come forward and say: we need to cut corporate taxes, taxes on the top 2%, to "stimulate" the economy. The deficit will recede as the issue as everyone grabs for a tax cut.

Make a bet they won't change their tune?

Mario, that's team work.

Tyler, the problem is not to fly a helicopter. The problem is the WH pilot and the FED copilot (and the crew of macro experts advising them) --actually the helicopter is crowded and can harldy fly. Yes there are plenty of options, but most are as bad or worse (they rely on the same macroeconomics and are stuck in the Great Depression).

One word for Tyler: liquidity trap. Furthermore, how is he so sure that this time around "accommodating" monetary policy is going to compensate for the effects of austerity measures?

Given speeches by regional Fed presidents and the composition of the FOMC, it may well be a mistake to believe monetary authorities will do much.

Note the time and date!

Leonhardt writes: "The United States, Europe and Japan have all made promises they cannot afford. Eventually, something needs to change."

one of the dumbest pair of sentences I have seen. Seems to be arguing that for some unspecified amount of time, the US, Europe and Japan should continue making promises they can't keep.

It's not the Fed, it's the banks. Once they believe they have sufficient reserves to offset the bad loans they are carrying, then they might start to make more loans. Until then they will continue to borrow from uncle Ben at .5% and lend at 3% to their bestest customer, Barack Obama.

In 1937, the Fed tightened based on inflation fears, sorta like the cries for austerity based on fears of US government default. says
In 1937, $1.00 from 1932 is worth:
$1.05 using the Consumer Price Index
$1.10 using the GDP deflator
$1.19 using the value of consumer bundle
$1.43 using the unskilled wage
$1.41 using the Production Worker Compensation
$1.52 using the nominal GDP per capita
$1.57 using the relative share of GDP

Wages had not increased due to the minimum wage because it and other labor laws had been struck down by the courts repeatedly before 1937.

Just to hammer this home, since I am not a published counterfactual economic historian,
let me point out that while people are mocking him now, at least partly becaue we have
somehow or another not fully pulled out of this recession (and may even slip into a
double dip), in my view we were profoundly fortunate to have as Chair of the Bd of Govs
at the Fed probably the world's leading expert on the history of the financial sector
during the Great Depression. He may have been wrong, but there is no doubt whatsoever
that he saw the parallel between 1931 and late September 2008, and was therefore willing
to throw all the textbooks and rulebooks out the window to engage in extraordinary policy
measures to save the world economy. If you wish to think that was all unnecessary and some
unfortunate waste of time that may have even made things worse, be my guest. Maybe you can
even revive your late grandma to help you explain to us how that might be the case.

Barkley Rosser, is that all what you have as hard evidence of your conclusion "Thanks heavens"? It looks to me not different from what "El Vasco" Aguirre, who today resigned as coach of the Mexican soccer team, said about his team's defeat against my national team. He blames the referee for his loss, you celebrate Ben B. for his intervention.

Now let me turn to your facts from the viewpoint of my long experience in preventing and solving financial crises. Indeed there were some problems with interbank lending, but totally frozen? Even on 9/11/01 interbank lending in NYC was not totally frozen and payments were completed without major disturbances (for references check the publications of the NY Fed's Research Department). A large set of banks in Europe were in danger of collapsing? Have you ever worked in a large bank or assessed the liquidity and/or the solvency of a large bank? Do you think that any Fed or ECB employee knew which banks could collapse? If you were able to assess the liquidity and solvency of a large bank as an outsider, you'd be earning well over $,1000 per hour. Then you mention that the Fed bought $600 billion of eurojunk from them. Have you ever studied (or reviewed a study) of how the Fed and ECB have been reporting their emergency operations since September 2008 and how these operations have been accounted in their balance sheets? Do you know how hard it is to do such a study? Let me tell you that it is much harder than understanding and measuring the oil spill. You seem to be too certain about your facts, but I'm not impressed by your use of words such as "totally frozen", "collapsing", "eurojunk" --it looks like fearmongering.

Now let me turn to Ben Bernanke's research on the Great Depression from the viewpoint of a professor of financial economics for many years. His research was limited largely to explain what it's called the transmission mechanism of monetary policy, and his main idea was that the disruption of banks' credit allocation process was critical to explain the size of the Great Depression. A very good idea, well known in Argentina because in the 1960s a few economists had been working on something similar to explain the differences between measures of money and credit (BTW, my Ph.D. dissertation for U. Minn. was on The Control of Money and Credit in Argentina). His approach was largely based on the narrow (and misleading) view of money and banking in IS-LM macroeconomics. It was a contribution to macroeconomics but not to the economics of money and banking (and certainly not to financial economics as it developed in the past 25 years). I don't know whether he saw a parallel between 1931 and 2008 or just cried wolf to implement whatever he thought he had to do, but I have seen many saviors in my life (or worse the legacy of saviors, including Mao's terrible legacy) to trust anyone with such a responsibility. I know, however, that in the critical days of September 2008, Ben Bernanke (and all other government officials and politicians) could not explain clearly what was going on and provide evidence that "thanks heavens" a savior had been born at the right time in the right place.

I don't claim to know what might have happened if Ben & Co. had done nothing. I claim, however, that you don't know either and therefore you cannot conclude "thanks heavens". I don't need my late grandma to help me now --thanks heavens, when she was alive she did it and I could become an skeptic economist rather than a dogmatic.

Barkley Rosser, I'm sorry that your dogmatism blinds you.

Thanks, Tom. More than I have the right to expect from somebody I have given a hard time to here.


Just what is it that you think should have been done in Fall 2008 instead of what was done and why?
You have told us what a great expert you are and more or less implied that Bernanke and crew made
serious mistakes, but what were the alternatives? And how have I been dogmatic in reporting what
are plain facts, that the people at the top of the Fed thought we were facing 1931? Are you
claiming that I am misrepresenting what they thought, or are you simply claiming that they were
wrong because you know better, which looks pretty dogmatic to me, especially without any explanation?

BTW, I would note that one sign that things have gotten serious is that fairly recently, the swap
line that the Fed and ECB used for all those transmissions of Eurojunk back then, and which were
shut down when the Fed got that stuff off its books less than a year later, has been quietly reopened
recently. Indeed, that was a stabilizing action that helped stop the slide of the euro recently after
the Germans and others agreed to prop up Greek and other Med debt. I do not know how all that will
work out, but this particular tool is back in action again.
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Barkley Rosser, being a dogmatic you claim to know too much. Everyday, however, we learn something new about what happened in 2008 that should keep our minds open about the causes of the financial crisis and the responsibility of Bernanke and other officials and politicians and about what might have happened if they had done nothing or something else. For example, today I read this
Remember that we are still trying to determine the causes and the dynamics of the Great Depression. The case is not closed.

"As it is, I seriously doubt that in 2009 on economists view we were discussing whether or not the current situation in 2010 is more like 1931,"

You wrote in the comments I linked to, "So, as I argued, 2008 [is] more like 1931 than 1929," whereas I was arguing the contrary and saying that 1930 was like 2009. Now add a year...

"How much of this do you dispute?" Pretty much all.

Anyway, as I said, I asked you in one of our discussions in 2009, when you went on and on with your counterfactuals, to give a real scenario at which you would admit that Bernanke had failed. I believe you said that you would admit his failure if U.S. unemployment was above 8% in 3 years (so 2012). That looks pretty likely now, but I imagine you would not take that any more as a sign that Bernanke has failed. So I am giving you now an opportunity to refresh - forget the counterfactuals and say what scenario would have you admit that Bernanke failed.


2012 is two years away. Maybe it UR will still be above 8% then, maybe not.
So, since you are apparently standing by your claim that 2009 was 1930, are you
forecasting a massive wave of bank failures soon, to be followed by a 15% UR in
the US? I do not foresee that at all, not even close, although the UR might well
still be above 8% in 2012, at which time you can throw stuff at Bernanke, if you
feel like it and show up on some blog telling me that I should denounce him too.


I do think that in Fall 2008 we were in danger of reaching an UR of 15% by now,
as was the case at the end of 1931. That has definitely not happened, and I
am willing to give some credit to Bernanke and crew for that, even if neither I nor
you can prove or disprove what would have happened under one or another possible
counterfactuals, of which there are an infinite possible set.

Mentioning that 15% figure now may put me somehow in contradiction with something
I said last year (which was apparently about 2012 in any case), but that is what is
in my mind when I think of "the possibility of 1931"

...and was therefore willing
to throw all the textbooks and rulebooks out the window...

Along with the lawbooks.

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