Was the U.S. Great Depression a Credit Boom Gone Wrong?

Abstract

The US Great Depression was preceded by almost a decade of credit growth. This review paper suggests that low general inflation and a slowdown in broad money growth in the 1920s masked the extent of the credit boom and a deterioration in the banking system’s balance sheet. Credit from commercial banks grew tremendously, and credit from savings institutions grew even more. While there was no general inflation, the credit boom was reflected in asset price inflations which occurred in certain parts of the economy, such as the real estate and stock markets. Broad money growth slowed in part because of a fall in the liquidity of commercial banks. And as the literature tends to show, the growth of credit and the fall in liquidity made financial institutions as well as households vulnerable to shocks. While monetary authorities managed to keep inflation in check, standard monetary policy tightening was ineffective in quelling the credit boom, and at times counter-productive. This points to macro- and micro-prudential tools as potentially more successful alternative measures to keep credit under control.