In 1933, when Franklin Roosevelt became the President, one of the first things he did was to suspend the gold standard. He forbade banks to pay out gold or export it to other countries. He signed an executive order to ban the export of gold to settle international accounts. Furthermore, on April 5, he removed gold from commercial circulation, and by the 17th of the same month, he severed the value of dollar from the price of gold. This move away from the gold standard gave some measure of flexibility for the Fed to pursue its own monetary policy. The President further empowered the Fed with the passing of the Banking Act of 1933, known as Glass-Steagall Act.
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This Act had much effect in curbing the depression. Firstly, it created the Federal Deposit Insurance Corporation (FDIC), that prevented banks from trading securities using the clients' deposits. Also every customer was guaranteed up to a certain amount and this was $2,500 then and $250,000 now. This move was done to give some measure of confidence in the minds of customers. People were assured that banks cannot use their money for trading, so the free fall ruin of banks stopped. People began to stop pulling out their deposits, and this helped to give banks some space to gather up their money.
The Glass-Steagall Act clearly identified two kinds of financial institutions, and laid down the rules for both. If a financial institution took money from customers in the form of deposits, then they could trade only in government bonds and securities. On the other hand, if a financial institution underwrote securities or engaged in some form of market trading, then it was not allowed to take deposits from the public. The idea behind this distinction was to separate conflicts of interest . There was a general sentiment among the public that the banks were partnering with affiliates to repay its own debts. Whether this was a speculative argument or not is a different issue, but to negate it altogether, the Congress enacted this Act. Under Section 20 of this Act, banks could not be affiliated with financial institutions whose primary line of business is to trade in securities. Also, section 32 of the Act specifically barred the officers of commercial banks that are affiliated with the Federal Reserve from holding any position in companies engaged in the trading of financial securities. This separation between the two financial institutions helped to infuse some confidence in the banking system among the public.
Other than this separation, there were two other provisions of the Glass-Steagall Act that has relevance even today. Firstly, this Act created the Federal Open Market Committee (FOMC) that included members from all the federal reserves along with the President of the New York Fed. The idea behind this legislation was to help the Fed to establish target interest rates based on the economic conditions prevailing at that time. Depending on the employment and inflation rate, the Fed can increase or decrease target rates to stimulate economic growth, or cut back on the inflation.
Another important part is the Regulation Q. Under this regulation, banks were not allowed to pay interest on demand deposit accounts, which are now Checking accounts. Interest rates were also capped on savings and other deposits to limit problems such as loan sharking. Furthermore, this restriction motivated investors to move money out of their deposits into money market funds. Though this regulation was repealed later, it nevertheless had a measurable impact on the economy.
This Act got further impetus in 1933 with the passing of the Thomas Amendment. Under this Amendment, the US Congress gave the Fed authority to alter the requirements of the reserve. What this meant was the Fed could increase or decrease the minimal reserve requirements, and this impacted the money supply in the economy. Also, this Amendment gave the US President some power to make open market purchases of gold and silver as needed. This Amendment gave more powers to the Fed, and the US President to control the money supply at any given time in the economy.
While this Act set to limit further problems, the Great Depression continued to roll on. In fact, the entire decade of the 1930 was deemed as a period of Great Depression, though the period from 1935 to 1937 saw some measure of economic recovery. After 1937, a new crisis emerged and this can be attributed to the monetary policy of the Fed too. Smiley (2009) contended that the second half of the 1930s caused a premature monetary restriction by the Fed, and this led to a strong growth of wages. Also, the bargaining power of the American labor unions surged, so the businesses were further weakened by a rise in wages.
To compound the existing problems for businesses and the economy as a whole, the New Deal programs were introduced by President Roosevelt. These measures did more harm than good for the economy. In some ways, the direct control of prices, the rise in taxes, wage control and the cartelization of industries and agriculture impeded economic recovery, rather than accelerating it.
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The above discussion goes to show the role of the Fed and its resultant impact on the monetary policy that in turn, accelerated the Great Depression. Had the Fed taken better measures, the depression could have been less severe or avoided.
Now that there is a greater understanding of the policies influencing monetary area during the Great Depression, the next section will discuss the monetary policy during the Great Recession, and there will be an analysis of whether the Fed acted right this time around.
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