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

Published online by Cambridge University Press:  03 March 2009

Philip R. P. Coelho
Professors of Economics, Ball State University, Muncie, IN 47306.
G. J. Santoni
Professors of Economics, Ball State University, Muncie, IN 47306.


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Notes and Discussion
Copyright © The Economic History Association 1991

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1 For an introduction to the literature, see Friedman, Milton and Schwartz, Anna J., A Monetary History of the United States, 1867–1960 (Princeton, 1963);Google ScholarSchwartz, Anna J., “Understanding 1929–33,” in Money in Historical Perspectives (Chicago, 1987);Google ScholarKindleberger, Charles, The World in Depression. 1929–1939 (Berkeley, 1973);Google ScholarTemin, Peter, Did Monetary Forces Cause the Great Depression? (New York, 1976);Google ScholarEpstein, Gerald and Ferguson, Thomas, “Monetary Policy, Loan Liquidation, and Industrial Conflict: The Federal Reserve and the Open Market Operations of 1932,” this JOURNAL, 44 (12. 1984), pp. 957–83;Google Scholar and Wheelock, David C., “The Strategy, Effectiveness and Consistency of Federal Reserve Monetary Policy, 1924–1933,” Explorations in Economic History, 26 (10 1989). pp. 451–76.Google Scholar

2 Friedman and Schwartz, A Monetary History, p. 302.Google Scholar

3 For a discussion of regulatory capture, see Stigler, George J., “A Theory of Economic Regulation,” Bell Journal of Economics and Management Science, 2 (Spring 1971), pp. 321.CrossRefGoogle Scholar

4 For related discussion, see Anderson, Gary M., Shughart, William F., and Tollison, Robert D., “A Public Choice Theory of the Great Contraction,” Public Choice, 59 (10. 1988), pp. 323;Google ScholarToma, Mark, “Inflationary Bias of the Federal Reserve System,” Journal of Monetary Economics, 10 (09 1982), pp. 163–90;Google ScholarToma, Eugenia F. and Toma, Mark, “Research Activities and Budget Allocations Among Federal Reserve Banks,” Public Choice, 45 (No. 2, 1985), pp. 175–91;Google Scholar and Shughart, William F. and Tollison, Robert D., “Preliminary Evidence on the Use of Inputs in the Federal Reserve System,” American Economic Review, 73 (06 1983), pp. 291304. An application of this approach is found in Epstein and Ferguson, “Monetary Policy”.Google Scholar

5 Epstein and Ferguson, “Monetary Policy,” p. 957. Aside from its historical significance as an explanation for the Great Contraction, evidence that the policy decisions of the Fed are largely influenced by these considerations provides support for recent proposals to “reform” the Fed. See Res, H. J.. 409 of the 101st Congress, the Congressional Record, vol. 135, no. 106 (August. 1, 1989); and Lindley Clark Jr., “Remaking the Fed: Maybe It's Time,” Wall Street Journal, September. 18, 1989.Google Scholar

6 Epstein and Ferguson, “Monetary Policy,” p. 966.Google Scholar

7 This is a proxy for the monetary base because the sum does not include circulating coinage.Google Scholar

8 Epstein and Ferguson, “Monetary Policy,” p. 957.Google Scholar

9 Ibid., pp. 968–73.Google Scholar

13 See Fisher, Franklin M. and McGowan, John J., “On the Misuse of Accounting Rates of Return to Infer Monopoly Profits,American Economic Review, 73 (03 1983), pp. 8297.Google Scholar

14 See Samuelson, Paul A., “The Effect of Interest Rate Increases on the Banking System,American Economic Review, 35 (03 1945), pp. 1627;Google ScholarBierwag, G. O., Kaufman, G., and Toevs, A., “Duration: Its Development and Use in Bond Portfolio Management,Financial Analyst Journal, 39 (07/08 1983), pp. 1535;Google Scholar and Santoni, G. J., “Interest Rate Risk and the Stock Prices of Financial Institutions,Federal Reserve Bank of St. Louis Review, 66 (08/09 1984), pp. 1220.Google Scholar

15 See Brealey, Richard A., An Introduction to Risk and Return From Common Stocks (Cambridge, MA, 1983).Google Scholar

16 We assume the stock market is efficient. This means that stock prices reflect all currently available public information that is relevant to the determination of share prices. Current stock prices are not influenced by “old” data such as previously known policy decisions. Stock prices change only in response to new (unanticipated) information. For more on efficient markets, see Fama, Eugene F., “Efficient Capital Markets: A Review of Theory and Empirical Work,Journal of Finance, 25 (05 1970), pp. 383420;Google ScholarReilly, Frank K., Investment Analysis and Portfolio Management (Chicago, 1985);Google Scholar and Black, Fischer, “Implications of the Random Walk Hypothesis for Portfolio Management,Financial Analyst Journal, 27 (03/04 1971), pp. 1622.Google Scholar

17 See the notes to Table 1 for the method used to construct the indexes. The data used to construct the weekly indexes of bank share prices are as of the close of trading on Wednesday. These data are reported on Thursday in the financial pages of The New York Times. Data on bank reserves and notes in circulation are taken from the consolidated statements of the 12 district Federal Reserve banks. These data are reported in The New York Times on Thursday and pertain to the week ending Wednesday.Google Scholar

18 Epstein and Ferguson, “Monetary Policy,” p. 958.Google Scholar

19 See Friedman and Schwartz, A Monetary History, p. 348. For example, foreign gold flows were important in this regard.Google Scholar

20 See, for example, Wheelock, “Strategy, Effectiveness and Consistency,” p. 455: “The supply of banking system reserves is often analyzed in terms of the sources and uses of reserve funds. Federal Reserve Credit is one source of banking system reserves; the monetary gold stock and Treasury currency are other principal sources. An increase in any of them will lead to an increase in bank reserves, currency in circulation, or some other use of reserve funds. During the 1920s and early 1930s, the principal determinants of changes in the stock of bank reserves were gold and currency flows and changes in Federal Reserve Credit outstanding. Gold inflows (outflows) tended to increase (decrease) reserves. Increased currency held by the public tended to reduce bank reserves, while a reduction in currency held by the public tended to increase them. Friedman and Schwartz show that changes in the volume of FRC outstanding tended to off set gold and currency flows, and thus stabilized bank reserves. In other words, through changes in FRC outstanding, the Fed limited the effects of gold and currency flows on the money supply.” (Emphasis is added.)Google Scholar

21 A Box-Pierce test based on the estimated autocorrelations of ΔH was conducted. We cannot reject the hypothesis that the data are white noise (Q-statistic to lag 18 is equal to 5.54). As a result, ΔH can arguably be viewed as unexpected. This is important because the efficient market hypothesis implies that only new (unexpected) information will affect stock prices.Google Scholar