Regulatory Capture and the Monetary Contraction of 1932: A Comment on Epstein and Ferguson

Abstract

The Great Depression of the 1930s occupies a pivotal position in the history of the American economy. Historians and economists still debate the origins of the Depression and the reasons for its length and severity.' Since the Depression was associated with a 33 percent decline in the stock of money, some conclude that the monetary contraction transformed a normal cyclical downturn into the Great Depression.2 While others advance different explanations, few suggest that the monetary history was unimportant. In any event, students of this episode continue to puzzle over why the Federal Reserve System permitted the contraction. Some recent attempts to explain Federal Reserve behavior draw on the theory of regulatory capture and focus on the relationship between the Fed and its member banks.3 The theory suggests that during the 1930s the Federal Reserve system ignored its broader responsibilities to the public, instead tailoring its policies to benefit the banking industry.4 This comment challenges the notion that the monetary history of 1932 is explained by the regulatory capture hypothesis as suggested by Gerald Epstein and Thomas Ferguson in a 1984 issue of this JOURNAL.' Epstein and Ferguson contended that the Fed initiated and then abandoned an attempt to reverse the Great Contraction because the attempt was perceived to be damaging to the interests of member banks. They pointed out that a program for