The 1937-1938 contraction

A few months ago I was surprised to see this paper by Chris Calomiris, Joseph Mason, and David Wheelock:

In 1936-37, the Federal Reserve doubled the reserve requirements imposed on member banks. Ever since, the question of whether the doubling of reserve requirements increased reserve demand and produced a contraction of money and credit, and thereby helped to cause the recession of 1937-1938, has been a matter of controversy. Using microeconomic data to gauge the fundamental reserve demands of Fed member banks, we find that despite being doubled, reserve requirements were not binding on bank reserve demand in 1936 and 1937, and therefore could not have produced a significant contraction in the money multiplier. To the extent that increases in reserve demand occurred from 1935 to 1937, they reflected fundamental changes in the determinants of reserve demand and not changes in reserve requirements.

My view had traditionally been that of Friedman and Schwartz, Eggertsson (and here), and Krugman, but if you wish to read the other side of the story there it is.  In any case I do not see any good argument for monetary contraction today, no matter how one reads the 1937 story.  We await clarification from Scott Sumner.



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