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  • Money Supply Theory and the Great Depression:What Did the Fed Know?
  • Elmus Wicker

A key chapter in the history of money supply theory is missing: the evolution of the role of the currency-deposit ratio as a determinant of the money stock. Lloyd Mints (1945) and Thomas Humphrey (1987) have traced the origins of our understanding of how banks create checkable deposits, given the amount of surplus reserves. However, Mints is silent on the role of the cash drain into circulation resulting from the expansion of demand deposits, while Humphrey refers to, but does not analyze, the contributions of James Harvey Rogers (1933) and James W. Angell and Karel F. Ficek (1933).

We also intend to show the significance of our lack of knowledge about the evolution of the role of the currency-deposit ratio for assessing the performance of Federal Reserve policymakers during the Great Depression. Milton Friedman and Anna Schwartz (1963) indicted Fed officials for being "inept," since they failed to offset the 35 percent decline in the money stock between 1929 and 1933. They argued that Fed decisionmakers had the power, the instruments, and the knowledge to have prevented the decrease in the money stock. Nevertheless, Friedman and Schwartz failed to supply any evidence to support their claim about what knowledge, if any, of the money stock determinants was available and to whom. [End Page 31]

We pose a set of questions that are as yet unanswered. What knowledge was available at the time of the Great Depression about the currency-deposit ratio as a determinant of the money stock? If any knowledge existed, was it readily available to Fed officials? What was the source or sources of that knowledge, and did the source or sources affect how that knowledge was diffused?

We do not underestimate the practical difficulties of finding firm answers to these questions. Some information is simply not available with which to discriminate among rival interpretations of the evidence. But we think we have been able to clarify the nature of the claim or claims being made when it is asserted that "X had the knowledge" and "X's behavior was inept"-claims that Friedman and Schwartz made.

The idea that deposit expansion is accompanied by an increased demand for currency appears in the writings of William Persons (1920), Benjamin Strong (U.S. House 1922, 1926), James Harvey Rogers (1927, 1933), J. S. Lawrence (1928), John Maynard Keynes (1930), and James W. Angell and Karel F. Ficek (1933). Of these, only Rogers and Angell and Ficek provided a rigorous analysis of how a change in the currency-deposit ratio affected deposit expansion. Following the work of Chester Phillips (1920), they began their analysis by constructing expansion equations for the single bank and the banking system as a whole, but, unlike Phillips, they introduced a cash drain into circulation. Rogers's 1927 contribution was contained in his book Stock Speculation and the Money Market-an unlikely place-and went unnoticed until he reproduced his findings in a paper delivered at the joint meetings of the Econometric Society and the American Economic Association in December 1931 and published in the first issue of Econometrica in 1933, the same year that Angell and Ficek published a pair of papers in the Journal of Political Economy.

The nature of Benjamin Strong's contribution is especially relevant. As governor of the Federal Reserve Bank of New York, he occupied a position of leadership within the system, and his views, as one might expect, were subject to careful consideration not only in New York but also throughout the country. What we know about his understanding of money stock determination is contained in a few brief pages of testimony given before the Joint Committee of Agricultural Inquiry in 1922 and at the stabilization hearings conducted by the Committee on Banking and Currency in 1926. But as we intend to show, his testimony revealed a knowledge of the cash drain associated with deposit expansion and [End Page 32] an intuitive grasp of how the cash drain constrained deposit expansion. How deeply that knowledge permeated the New York Federal Reserve bank we do not know. Nor do we know whether or not...


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pp. 31-53
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Archived 2005
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