Sunday, September 11, 2011

Maybe FDR Should Get More Blame

I have mentioned many times here how the decision of FDR and his Treasury to devalue the dollar and not sterilize gold inflows sparked a robust recovery from 1933-1936.  This development can be called the original QE program and it worked wonders despite the fact that the private sector was still deleveraging through at least 1935.  

The recovery fell apart when the recession of 1937-1936 hit.  The standard story for this recession has been that some fiscal policy tightening and a lot of monetary policy tightening caused it.  On the latter point, the conventional view is that monetary policy tightened when the Fed raised reserve requirements on banks.  Douglass Irwin, however, has a new paper that calls into question this conventional wisdom.  He says it was largely a tightening of monetary policy that caused the recession, but it was not because the Fed raised reserve requirements.  Rather, it was because the Treasury started sterilizing gold inflows.  Here is Irwin:
The severity of the Recession of 1937-38 was not due to contractionary fiscal policy or higher reserve requirements. By contrast, the policy tightening associated with gold sterilisation was not modest – it did not simply reduce the growth of the monetary base by a few percentage points, it stopped its growth altogether. While the Federal Reserve is often blamed for its poor policy choices during the Great Depression, the Treasury Department was responsible for this particular policy error.
This is amazing.  One of the key decisions that drove the 1933-1936 recovery in the first place--choosing not to sterilize gold inflows--was reversed by FDR's Treasury.  It was FDR, then, who cut short the robust recovery he started.  Throw in some of the market distortions caused by his other New Deal programs (e.g. NRA) and FDR's record is looking rather checkered.  Still, I credit FDR with being bold enough to try what effectively turned out to be a robust QE program anchored by a price level target.  He showed us it can work. 

Update:  This started me thinking about the big debate that intermittently raged in the blogosphere over the 2007-2009 period about the legacy of the New Deal.  I did a post back in early 2009 where I created the figure below to summarize this lively debate.  Enjoy!



  1. There's one smallish thing I don't understand about this. Why was it the *Treasury*, rather than the *Fed*, that was responsible for sterilising gold inflows?

  2. It all depends on your "vantage point".
    Like Nick, how could the Treasury "sterilize" the gold inflow? They bought the gold flowing in and sold Treasuries to offset. But for that to mean sterilization Irwin is implicitly assuming the Fed was "coniving" with the Treasury. After all they are the ones that have the final "say". In early 1937 the Fed decided to increase required reserves. Only natural that they would also not buy from the public the Treasury bond issues. I recall that in April 1938 FDR asked the Fed to revert the reserve requirement decision. The Fed acquiesced, so they probably also stopped "sterilizing" gold inflows.

  3. The Treasury sterilized gold inflows in 1907 which created the original demand for the creation of the Fed. Ironic that didn't solve the problem.

  4. TIME magazine reported this in 1937:
    "The Secretary of the Treasury, after conferring with the Board of Governors of the Federal Reserve System, announces that he proposes, whenever it is deemed advisable in the public interest to do so, to take appropriate action with respect to new additional acquisitions or releases of gold by the Treasury Department."

    I'm with Nick Rowe-- I think it still falls back on the FED for not informing Treasury of the impact of their actions.

    Read more:,9171,762357,00.html#ixzz1Xl6cr8Aj

  5. Irwin implies that the rate of growth of the monetary base and the rate of growth of M2 were related in 1937. In the presence of high levels of ER's, it is not clear why this should be true.

  6. Nick, Marcus, and Lord,

    Irwin explains the sterilization in his full paper:

    How did the sterilization policy work? The Treasury Department purchased all gold
    inflows at $35 per ounce with drafts from its balance at the Federal Reserve. Normally, it would
    print gold certificates for the equivalent amount and deposit them in a Federal Reserve account to replenish its balance. The certificate would then become part of the monetary base and could
    be used to increase bank reserves. However, with sterilization, instead of replacing its withdrawn balance with a gold certificate in equal amount, the Treasury kept the certificates in an “inactive” account where it could not be used for the expansion of credit. It paid for the gold out of its general fund, reducing its balances at the Federal Reserve, which would then have to be replenished by issuing new debt or raising tax revenue.

    Yes, the Fed could have offset this. But remember, all along they had been tight. It was FDR's treasury that caused the monetary expansion in 1933 and now it was the Treasury that was returning the stance of monetary policy to the default Fed position.

  7. David, FDR was evil. I sure did the right thing leave gold in 1933, but NIRA was terrible and surely prolonged the Great Depression by years (I think Scott Sumner think NIRA prolonged the Great Depression by 6-7 years).

    And no his war effort did not end the Great Depression, but you know that. (Oddly enough Bush and Krugman might have agreed on that one...both are often wrong...)

  8. David, other than my outburst against FDR I really want to add that I think Irwin have a point here.

    Generally, we - as economists - rarely look at government's money demand. As I see it what the US Treasury was basically to increase its demand for money. Normally the monetary story is told with a focus on central banks' supply of money and private agents demand for money. However, the government can via its debt and cash management policies increase or decrease the demand for money and hence indirectly conduct monetary policy.

    It is not only private agents who react to fears and increase their cash balances - most governments do the same thing. I have not looked at the data, but I would not be surprised if most governments have tried to increase their cash balances during the Great Recession. This is deflationary and hence likely have made the crisis worse.

  9. Shall we then say the Fed does not always act last?