Crisis and Credit Allocation: The Effect of Ideology on Monetary Policy during the Great Depression and the Great Recession

Abstract

Both during the Great Depression and the Great Recession, monetary policy deviated from its normal course whereby the central bank would aim to provide credit to solvent institutions while allowing insolvent institutions to fail. In both cases, monetary policy was shaped by ideology that eschewed inflationary policy as remedy for economic contraction. During the Great Depression, the Federal Reserve Board of Governors, led by Adolph Miller engaged in a policy of direct pressure that denied credit to banks that had supported speculative investment. This was part of a more general program of monetary tightening implemented by the Board in the early years of the Great Depression. During the Great Recession, Federal Reserve Chairman Ben Bernanke engaged in a program of credit allocation, using deposit accounts at the Federal Reserve to sterilize the inflationary effects of expansion, a policy practically inscrutable to the public. Both policies were the result of beliefs that a general provision of liquidity is not an appropriate or efficacious means to correct an economic downturn. Both Miller and Bernanke left their mark on Federal Reserve policy by increasing the level of support provided by the Federal Reserve to the U.S. Treasury.