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MONETARY POLICY

In the United States, heterodox proposals for monetary manipulation tend to flourish in times of economic crisis. The farm lobbies, in particular, have been disposed to back such measures when seeking relief from agricultural distress. They had done so in the 1870s when supporting the Greenback movement to expand the currency issue. They did so again in the 1890s when rallying behind the Populists and then William Jennings Bryan's campaigns for "free silver."

In 1932, this tradition took on a renewed vitality. The argument for inflationary policies to pump up farm prices was now articulated in more sophisticated form. Through the research of Cornell University agricultural economist George F. Warren and his collaborator, F. A. Pearson, doctrines that could formerly be dismissed as the work of "cranks" and "amateurs" were given at least a pseudoscientific veneer. From their base at the state of New York's land grant college, Warren and Pearson enjoyed proximity and visibility to the state's political establishment. And they had won converts to their views among some who would later occupy high positions in President Franklin D. Roosevelt's administrations—most notably, Henry Morgenthau, Jr., a future secretary of the treasury.

Warren and Pearson rested their arguments on elaborate statistical investigations of the behavior of commodity prices, on the one hand, and the price of gold, on the other. Their findings suggested that there was a high positive correlation between the two. It thus seemed to follow that the answer to depressed farm prices could be found in raising the price of gold. This approach to policy, however, would be incompatible with a U. S. commitment to gold convertibility of the dollar at a fixed parity.

Another version of this line of argument was supplied by Yale University's Irving Fisher, an economist recognized for his analytic ingenuity, though one who was also regarded as a bit suspect for his eccentricities (such as his ardent advocacy of prohibition and the eugenics movement) and for his unfortunate pronouncement in September 1929 that the stock market had reached a permanently high plateau. Fisher's empirical studies in the mid-1920s had indicated that the general price level—with a lag of seven months or so—led changes in the volume of aggregate economic activity. More specifically, a rising price level stimulated the volume of trade, and a declining price level depressed it. Since 1930, the American economy had experienced severe deflation: It was thus not surprising that the Depression had deepened. By 1932, Fisher was convinced that the remedy for this condition was to be found in "reflating" the general price level back to its pre-Depression elevation. When the targeted price level had been reached, the price level should be stabilized and the economy would thereafter enjoy stability. He insisted that monetary expansion—when no longer constrained by the gold standard—could produce the needed reflation. Raising the price of gold should be one of the measures deployed for this purpose.

The state of the American financial system when Roosevelt was inaugurated in March 1933 provided a moment of opportunity when suspension of the dollar's gold convertibility was both necessary and acceptable. Between his election in November 1932 and his assumption of the presidency, the nation had experienced unprecedented runs on banks and drains on the country's gold reserves serious enough to threaten their exhaustion. In the face of this crisis, Roosevelt was obliged to declare a "bank holiday" and to suspend gold convertibility, which he did by executive order as his first substantive official act. Measures taken in the months immediately thereafter effectively nationalized the monetary gold stock by outlawing private holdings.

Rupturing the tie to gold meant that economic policymakers had a much freer hand to experiment. Congress further widened the president's range of options with the passage of an amendment to the Agricultural Adjustment Act of 1933 (known as the Thomas Amendment, in recognition of the Oklahoma senator who sponsored it). This legislation conveyed discretionary power to the president to: (1) issue up to $3 billion in greenbacks (a currency without metallic backing); (2) establish the gold content of the dollar with the restriction that it could not be reduced by more than 50 percent; and (3) fix the value of silver and provide for its unlimited coinage and establish bimetallism. It was not clear, however, which of these powers (if any) would be exercised.

GOLD AND SILVER PURCHASE PROGRAMS

On October 22, 1933, Roosevelt announced that he had ordered a government agency to buy gold "at prices determined from time to time," that "this was a policy and not an expedient," and that this action was "not to be used merely to offset a temporary fall in prices." (The presence of Warren and of James Harvey Rogers—a Yale economist who shared Fisher's views—when this initiative was launched indicated that reflation of the price level was the objective of the exercise.) On each business day in the ensuing weeks, Roosevelt met with Morgenthau to fix the day's buying price. When price-elevating bidding was terminated in January 1934, the price of gold had reached $35 per ounce, at which point it was pegged. Before the country left the gold standard, its official price had been $20.67. Despite this activity, the general price level had not risen as the advocates of the gold purchase program had predicted.

In early 1934, the Roosevelt administration was confronted with mounting political pressures—particularly from senators representing silver-mining constituencies—to do something to raise the price of silver. There was a fundamental difference between the gold purchase program mounted in the autumn of 1933 and the silver purchase program that was later adopted. The former was an instance of a deliberate policy of preference that allegedly had some analytic mooring. The latter was undertaken reluctantly in response to congressional pressures that were difficult to contain. Administration officials counted it as a success that they had at least managed to forestall enactment of legislation that would mandate purchase of prescribed quantities of silver. The agreement struck with Congress in May 1934 instead set out a general goal: Treasury purchases should aim at an accumulation in which silver amounted to one-third of the value of the gold stock. However, no timetable for this outcome was specified. Though the Department of the Treasury was slow to implement this policy, it managed to spend __BODY__.6 billion on silver acquisitions between 1934 and 1941.

Between them, gold and silver acquisitions substantially augmented the nation's monetary base and made major contributions to the swelling of excess reserves in commercial banks. By contrast, the Federal Reserve's contribution to monetary ease in 1933 and 1934 was slight. The Federal Reserve—without enthusiasm—did acquire a modest quantity of government securities between May and November 1933 and then suspended open market operations until 1937. The 1933 purchases appear to have been motivated by the Board's fear that, in the absence of some activity on its part, the administration might be provoked to issue greenbacks. The discount rate, which stood at 3.5 percent in March 1933, was reduced by seven of the twelve District Banks and, in New York, it fell to 2 percent.

RESHAPING THE FEDERAL RESERVE SYSTEM

The Federal Reserve's role began to change in 1935 with passage of a Banking Act that reorganized its structure. This legislation was largely the handiwork of Marriner Eccles, a Utah banker whose views on depression-fighting called for enlarged government spending financed through deficits, who had been recruited to Washington to serve as its chairman. The Banking Act of 1935 was designed to serve three purposes: (1) to change the composition of the governing body by displacing two ex officio members—the secretary of the treasury and the comptroller of the currency—and by restyling the Federal Reserve Board as the Board of Governors of the Federal Reserve System; (2) to restructure the Open Market Committee by placing its decisive weight with the Board of Governors in Washington by reducing the voting strength of the Federal Reserve District Banks; and (3) to increase the power of the central Board over the determination of discount rates and to widen its discretionary latitude over required reserve ratios.

Eccles did not delay long in using his new authority over required reserve ratios. It was then believed that the Board's capacity to restrain lending by commercial banks would be compromised when they held abnormally large sums in excess reserves, as appeared to be the case in 1936 and early 1937. Accordingly, the Board of Governors acted to increase its leverage by exercising its newly-conveyed power to double required reserve ratios. Board action was taken in two steps: (1) required reserve ratios were raised half the distance toward the legal maximum in August 1936; and (2) increases to the full limit allowed by law were ordered in the spring of 1937. All of this was seen as precautionary and not as a retreat from monetary ease. After all, the discount rate in New York in September 1937 was 1 percent and it was set at 1.5 percent by the other District Banks. Eccles insisted that the "supply of money to finance increased production [was] ample."

THE RECESSION OF 1937 AND 1938

The Board's decisions on this matter have been faulted on grounds that they provoked the recession of 1937 and 1938, which set in when the economy was operating well below its full employment capacity. Two latter-day commentators, Milton Friedman and Anna Jacobson Schwartz, have assigned major responsibility for this sharp downturn to the Federal Reserve's actions in doubling required reserve ratios. Their argument rests on the view that excess reserves, which the Board held to be needlessly excessive, were, in fact, desired as liquidity cushions in circumstances of depression. Hence, the Board's intervention in shrinking them led banks to constrain lending activities. A different interpretation—favored by New Deal contemporaries—held that the recession had been triggered by a turnaround in government's fiscal impact on the economy: that is, from being expansionary in 1936 to contractionary in 1937.

The administration's policy response to the recession—when announced in April 1938—emphasized fiscal stimulants in a "spend-lend program." Then, for the first time, Roosevelt embraced deficit financing as a positive good, rather than an unavoidable evil. The Federal Reserve participated by lowering required reserve ratios by one-third. Subsequently the volume of excess reserves again grew. It was not until November 1941, however, that the Board once more set required reserve ratios at the maximum level allowed by law.

See Also: BANK PANICS (1930–1933); ECCLES, MARRINER; ECONOMY, AMERICAN; FEDERAL RESERVE SYSTEM; GOLD STANDARD; MORGENTHAU, HENRY T., JR.; RECESSION OF 1937.

BIBLIOGRAPHY

Barber, William J. Designs within Disorder: Franklin D. Roosevelt, the Economists, and the Shaping of American Economic Policy, 1933–1945. 1996.

Blum, John Morton. From the Morgenthau Diaries, Vol. 1: Years of Crisis, 1928–1938; Vol. 2: Years of Urgency, 1938-1941; Vol. 3: Years of War, 1941–1945. 1959–1967.

Chandler, Lester V. America's Greatest Depression, 1929–1941. 1970.

Eccles, Marriner S. Beckoning Frontiers: Public and Personal Recollections. 1951.

Friedman, Milton, and Anna Jacobson Schwartz. A Monetary History of the United States, 1867–1960. 1963.

Johnson, G. Griffith. The Treasury and Monetary Policy, 1932–1938. 1939.

Roose, Kenneth D. The Economics of Recession and Revival: An Interpretation of 1937–38. 1954.

WILLIAM J. BARBER