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Role Of Federal Reserve In Casuing The Great Depression

2546 words - 11 pages

The Great Depression is undoubtedly one of the most significant events in American and world history. It was the most widespread depression in the 20th century affecting most nations in the world and lasting for as long as a decade. However, there still remain unanswered questions regarding the cause of the great depression. One of the most debated topics regarding the Great Depression continues to be the role of the Federal Reserve (Fed) in causing and prolonging the crisis. The Federal Reserve, the central banking system of the United States, was created on December 23, 1913, with the enactment of the Federal Reserve Act, primarily in response to a series of financial panics in 1907. The Fed had being in existence for 15 years before the stock market crush in 1929. It was the most devastating market crush in the history of the United States and signaled the beginning of a decade long Great Depression that affected all Western industrialized countries .
The primary responsibility of the Federal Reserve was to act as a “lender of last resort”. Essentially, the Federal Reserve was to lend money to private banks in times of crisis. The state and federal banking regulations during this period were restrictive and hence unintentionally caused a systemic weakness in the U.S banking system therefore the need for a lender of last resort. Smaller banks were subject to crisis when depositors lost confidence that their bank had enough reserves to satisfy y all withdrawal demands at a certain time. In this situation, depositors rushed to their banks in a bid to withdraw their money ahead of other depositors before the banks limited reserves runs out. This triggered a bank run. The bank run easily resulted in other bank runs as depositors became concerned about the financial health of their banks.
The gold standard was used by most western industrialized countries in the 1920’s including the United States. The U.S. formally adopted the gold standard in 1900 with the passing of the Gold Standard Act by Congress. The United States held its reserves only in Gold. Thus, the Federal Reserve adhered to gold during this period. The gold standard regulated the quantity and growth rate of the nation’s money supply. The Federal Reserve was charged with the duty of regulating the inflow and outflow of gold by increasing or decreasing the discount rate. The discount rate is the interest rate the Fed charges depository banks that borrow reserves from it. An outflow of gold meant an increase in the money supply and this was triggered by a decrease in the discount rate. On the other hand an inflow implied an increase in the discount rate and hence a restriction of the money supply. The activities of the Federal Reserve with regard to the gold standard were to be in accordance with all other countries on the standard such as the United Kingdom in other for the system to work effectively.
On the 11th of January 1929, the Wall Street Journal published an article...

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