After FDR’s 1933 rectification of the monetary imbalances caused by the gold-exchange standard, which had been adopted in 1922, the U.S. economy began a brisk recovery. This recovery, however, faltered in 1937. The cause of the recession within the Depression — or The Great Depression, Part II — has been an object of consistent academic interest among economists.
One of the most interesting and rigorous analyses was prepared, with Joseph R. Mason and David C. Wheelock, by Prof. Charles W. Calomiris. Prof. Calomiris is the Henry Kaufman Professor of Financial Institutions at the Columbia University Graduate School of Business and a Professor at Columbia’s School of International and Public Affairs. His research spans several areas, including banking, corporate finance, financial history, and monetary economics.
Joseph R. Mason is the Hermann Moyse, Jr. Louisiana Bankers Association Professor of Finance at Louisiana State University; David C. Wheelock is a vice president and economist at the Federal Reserve Bank of St. Louis.
The Research Division of the Federal Reserve Bank of St. Louis published this scholarly work under the title Did Doubling Reserve Requirements Cause the Recession of 1937-1938? A Microeconomic Approach. It concludes, on page 28, that: “Other policy actions, especially reduced monetary base growth (due to the December 1936 sterilization of gold flows) and the 1936 tax rate increases, seem more likely culprits [than increasing reserve requirements] in causing the recession.”
Prof. Calomiris and his colleagues wrote (pp. 9 – 10):
One challenge to identifying the effects of the increases in reserve requirements in 1936-37 is that they coincided with another monetary policy action—the sterilization of gold inflows which began in December 1936 and continued until July 1937. Gold inflows, reflecting political and economic disruptions in Europe and Asia, were the principal cause of the rapid growth in bank reserves and the monetary base during 1934-36. Treasury officials grew increasingly concerned that gold inflows were fueling financial speculation and left the United States vulnerable to a sudden gold outflow (Meltzer, 92003, p. 504). In December 1936, President Roosevelt approved the Treasury’s plan to sterilize further inflows, thereby preventing them from increasing aggregate bank reserves.
Between December 1936 and July 1937, the Treasury sterilized some $1.3 billion of gold inflows and total member bank reserve balances rose by just $180 million (Meltzer, 2003, p. 506). The resulting decline in the growth of the monetary base is apparent in Figure 1. Hanes’ (2006) evidence suggests that the gold sterilization program, and the resulting decline in monetary base growth, was a more important cause of higher bond yields and the slowing of economic activity in 1937-38 than the hikes in reserve requirements. Friedman and Schwartz (1963, p. 510, p. 544) also conclude that the sterilization program “sharply reinforced” and “was no less important” than the hikes in reserve requirements in reducing growth of the money stock and causing the recession of 1937-38.
"In December 1936, President Roosevelt approved the Treasury’s plan to sterilize further inflows, thereby preventing them from increasing aggregate bank reserves.” Drawing “from the laboratory of history,” Lewis E. Lehrman, in The True Gold Standard (The Lehrman Institute, 2011, p. 61) observes:
If several major nations proceed together to convertibility, sterilization techniques designed to forestall necessary, desirable, and balancing effects of gold transfers among nations should be prohibited. Gold transfers are the indispensable, equilibrating, balance-of payments adjustment mechanism.” (Emphasis added.)
Monetary History Highlights
The Rueffian Synthesis