Monetary Policy: Targets and Rules Price target Wicksell: adjust bank rate to “natural” rate of interest  steady P Fisher: Reflate! Counter debt deflation Inflation target: Woodford…Bernanke…et.al. Taylor rule Money growth target: Milton Friedman and the Monetarists Nominal income target: n* = PY … P = n*/Y when Y deviates Koenig: offset real shocks as well as price shocks Optimally distributes risks between debtors and creditors Applied to Great Depression (citing Fisher, 1933 & Bernanke, 1994) Would have avoided “Mistake of 1937”

Finance vs. Industry Conflict Finance – Industry Bankers – Industrialists Creditors – Lenders Tilt Toward Hard Money – Easy Money Financial centers champion price stability Key currency  Global Reach – British return to gold at pre-war parity, 1925 – Fed defense of gold, 1931

Epstein and Ferguson: Monetary Policy, Loan Liquidation and Industrial Conflict Explaining Fed behavior in critical year: 1932 Inaction – Open Market Operations - Reversal – Friedman and Schwartz Real bills doctrine: plenty of money for needs of trade Congressional pressure, then recess Epstein and Ferguson – Bank profits … regulatory capture – International constraints … villain gold – Pressures from industry – Liquidationist mindset … reduce wages!

“…liquidate labor, liquidate stocks, liquidate the farmer, liquidate real estate. It will purge the rottenness out of the system…People will work harder, lead a more moral life.” Andrew Mellon Secretary of the Treasury, 1921 – 1932

Epstein & Ferguson: Explaining Inaction Liquidationist mindset Purge the system! Curb government! Reduce wages! Gold standard constraints Open market operations reduce gold cover of currency

Epstein & Ferguson: Explaining Open Market Ops Defense of gold  bank failures BUY BONDS! … Prop up P B ! … buoy bank solvency! Political pressure: Congress … Irving Fisher Glass-Steagle Act of 1932: T-bonds can back currency Epstein & Ferguson: Explaining Reversal Loan liquidation by banks – Banks reduced loans/stocked up on short-term Treasuries Low interest rates  Low bank profits Banks couldn’t reduce deposit rates, fearing withdrawals Uneven distribution of gold reserves between district banks Gold drain by France, then Britain  pressure on some districts – Chicago Fed pushed for reversal: Chicago banks held lotsa T-bills…Chicago Fed short of gold

1932 Monetary Policy Dilemma Reduce interest rate  Foreign withdrawals  Banks sell bonds to meet demands  Bond fire sale … P B down  Bank portfolio losses  Bank runs Raise interest rate  P B down  Bank portfolio losses  Bank runs Fed tilted toward tightness  Set stage for final banking crisis Alternative explanation of final banking crisis (early 1933): Fear of FDR: Devaluation? Unbalanced budget?