Sometimes the Horse Will Drink and Sometimes it Won't: Monetizing the Recoveries from the Great Depression and the Great Recession

Abstract

Despite the extraordinary and unprecedented actions taken by the Federal Reserve from 2008 to 2012, the economy was unable to mount a strong economic recovery because banks were not lending the $1.6 trillion in excess reserves that the Fed had created. The economy was caught in a predicament reminiscent of the 1930s. Back then, in the face of near-zero interest rates and credit-crunch conditions that rivaled or exceeded in severity those in 2008-12, the recovery was comparatively robust. What made that 1930s recovery so unique was that it was at least partly fueled by rapid money supply growth, which resulted not from bank lending but from an inflow of gold. This paper, in an effort to better understand both periods, reviews Fed policy in recent years, looks back at how money fueled the recovery in the 1930s, and examines what really caused the money supply to grow in the 1930s. It concludes that in times of near-zero interest rate conditions, it may be how and where money is injected into the economy that determines the efficacy of monetary policy and potential strength of the economic recovery.