Question

Consider this excerpt from the textbook: “From 1929 to 1933, prior to the establishment of federal

deposit insurance, over 9,000 banks failed in the United States. Because of these bank failures, people began holding their money outside the banking system. This action contributed to a significant contraction in the money supply. . . . After peaking at $676 billion in 1931, the M2 money supply fell to just $564 billion in 1933. This drastic decline was one of the major causes of the Great Depression.” Looking back on the Great Depression, what do most economists believe the Federal Reserve should have done to try to limit the negative effects of the Depression?

Answer 1

The economists believe that the Federal Reserve should have increased the money supply in the economy either by purchasing government securities in the open market or by reducing reserve requirement and bank rate. Any of the measures would have increased the level of money supplied in the economy which would have increased aggregate demand in the economy and limited the negative effects of the Depression. The main reason of the Great Depression was the drastic fall in the aggregate demand during that time period. An increase in money supply during that time would have helped in reducing the negative impact of Great Depression.