The Framework of Federal Reserve Monetary Control
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Regarding the financial crisis of the early 1930s, the Federal Reserve’s behavior may most charitably be described as passive. While scholars disagree on whether the Fed can legitimately be considered responsible for the Great Depression, they agree that it failed to take significant steps to prevent it. The Fed was asleep at the switch and failed to react appropriately to the banking panics—the runs on banks. In a remarkable lapse of memory, key Federal Reserve officials apparently forgot why the institution was created fewer than 20 years earlier—to serve as a lender of last resort to the banking system in times of panic. In large part as a result of the Fed’s failure to respond, the public’s panic and the banks’ reaction to it triggered a sharp contraction in the U.S. money supply. This in turn contributed strongly to a 25 percent decline in the U.S. price level over a period of less than four years. This enormous deflation of prices led to massive debt defaults by farmers, businesses, and homeowners, a development that took down more than 9,000 banks in a four-year period and was instrumental in the conversion of a recession into the Great Depression.
KeywordsFederal Reserve Money Supply Monetary Aggregate Reserve Requirement Federal Fund Rate
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