On black color Monday, October 28, 1929, the Dow Jones industrial Average declined practically 13 percent. Commonwealth Reserve leaders differed on just how to respond to the event and support the financial system.

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The Roaring twenties roared loudest and also longest on the new York stock Exchange. Share prices increased to unmatched heights. The Dow Jones commercial Average raised six-fold indigenous sixty-three in august 1921 come 381 in September 1929. After prices peaked, economist Irving Fisher proclaimed, “stock prices have actually reached ‘what looks like a permanently high plateau.’”1

The epos boom finished in a cataclysmic bust. On black Monday, October 28, 1929, the Dow declined practically 13 percent. ~ above the following day, black color Tuesday, the sector dropped virtually 12 percent. By mid-November, the Dow had actually lost almost half of that value. The slide ongoing through the summer that 1932, as soon as the Dow closed at 41.22, the lowest worth of the twentieth century, 89 percent listed below its peak. The Dow go not go back to its pre-crash heights until November 1954.

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graph 1: Dow Jones industrial Average Index day-to-day closing price, January 2, 1920, come December 31, 1954. Data plotted together a curve. Units space index value. Minor mite marks indicate the very first trading work of the year. As displayed in the figure, the index peaked top top September 3, 1929, closing in ~ 381.17. The index declined until July 8, 1932, as soon as it closed at $41.22. The index did no reach the 1929 high again till November 23, 1954. (Source: FRED, https://fred.stlouisfed.org (graph by: Sam Marshall, commonwealth Reserve bank of Richmond)Enlarge

The gaue won boom emerged during an era the optimism. Households prospered. Automobiles, telephones, and other new technologies proliferated. Ordinary men and also women invested cultivation sums in stocks and also bonds. A brand-new industry the brokerage houses, investment trusts, and also margin accounts enabled ordinary people to purchase corporate equities with borrowed funds. Purchasers placed down a portion of the price, frequently 10 percent, and borrowed the rest. The stocks the they bought served as collateral for the loan. Obtained money poured into equity markets, and also stock prices soared.

Skeptics existed, however. Among them was the commonwealth Reserve. The governors of numerous Federal make reservation Banks and also a majority of the federal Reserve Board thought stock-market speculation diverted sources from fertile uses, favor commerce and industry. The plank asserted the the “Federal Reserve act does not … contemplate the usage of the resources of the commonwealth Reserve banks for the production or expansion of speculative credit” (Chandler 1971, 56).2

The Board’s opinion stemmed from the text of the act. Ar 13 authorized reserve banks to expropriate as collateral because that discount loan assets that financed agricultural, commercial, and industrial task but prohibited them native accepting together collateral “notes, drafts, or receipt covering merely investments or approve or drawn for the function of transporting or commerce in stocks, binding or other investment securities, other than bonds and also notes of the government of the joined States” (Federal Reserve action 1913).

Section 14 the the act prolonged those powers and also prohibitions come purchases in the open market.3

These provisions reflected the theory of genuine bills, i m sorry had countless adherents among the authors of the federal Reserve plot in 1913 and leaders of the commonwealth Reserve mechanism in 1929. This theory shown that the main bank should problem money once production and commerce expanded, and also contract the it is provided of currency and credit when economic task contracted.

The commonwealth Reserve determined to act. The concern was how. The federal Reserve Board and the leaders of the reserve financial institutions debated this question. Come rein in the tide of contact loans, which fueled the jae won euphoria, the board favored a policy of direct action. The plank asked reserve financial institutions to deny requests for credit transaction from member banks that loaned accumulation to stock speculators.4The Board additionally warned the general public of the dangers of speculation.

The governor of the commonwealth Reserve bank of brand-new York, George Harrison, favored a different approach. He want to raise the discount lending rate. This activity would directly increase the rate that banks paid to borrow accumulation from the commonwealth Reserve and also indirectly raise prices paid by every borrowers, consisting of firms and also consumers. In 1929, brand-new York repeatedly requested to raise that is discount rate; the board denied number of of the requests. In august the Board lastly acquiesced to brand-new York’s plan of action, and new York’s discount price reached 6 percent.5

The federal Reserve’s price increase had actually unintended consequences. Because of the worldwide gold standard, the Fed’s actions compelled foreign central banks to raise their very own interest rates. Tight-money policies tipped economies around the civilization into recession. International commerce contracted, and also the international economic climate slowed (Eichengreen 1992; Friedman and Schwartz 1963; Temin 1993).

The jae won boom, however, continued. The federal Reserve watched anxiously. Commercial financial institutions continued come loan money come speculators, and other lenders invested increasing sums in loan to brokers. In September 1929, stock prices gyrated, with sudden declines and also rapid recoveries. Some financial leaders ongoing to encourage investor to purchase equities, including Charles E. Mitchell, the chairman of the nationwide City bank (now Citibank) and a manager of the federal Reserve financial institution of new York.6In October, Mitchell and also a coalition of bankers check to regain confidence through publicly purchasing blocks of shares at high prices. The initiative failed. Investors started selling madly. Share price plummeted.

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A crowd gathers external the brand-new York stock Exchange following the 1929 crash. (Photo: Bettmann/Bettmann/Getty Images)

Funds the fled the stock sector flowed into brand-new York City’s advertisement banks. These banks likewise assumed numerous dollars in stock-market loans. The sudden surges strained banks. Together deposits increased, banks’ reserve needs rose; yet banks’ reserves fell as depositors withdrew cash, financial institutions purchased loans, and checks (the principal technique of depositing funds) clearing slowly. The counterpoised operation left many financial institutions temporarily brief of reserves.

To relieve the strain, the new York Fed sprang into action. That purchased government securities on the open up market, expedited lending v its discount window, and also lowered the discount rate. The assured commercial banks that it would certainly supply the reserves they needed. These actions increased full reserves in the banking system, serene the reserve constraint confronted by financial institutions in new York City, and permitted financial establishments to remain open up for business and also satisfy their customers’ demands during the crisis. The actions likewise kept short term interest rates from increasing to disruptive levels, i beg your pardon frequently occurred during jae won crises.

At the time, the brand-new York Fed’s actions were controversial. The Board and several reserve banks complained that new York gone beyond its authority. In hindsight, however, these actions aided to save on computer the situation in the quick run. The stock market collapsed, but commercial banks near the center of the storm remained in procedure (Friedman and Schwartz 1963).

While brand-new York’s actions safeguarded commercial banks, the stock-market crash still harmed commerce and manufacturing. The crash fearful investors and also consumers. Men and women shed their life savings, feared for your jobs, and worried whether they could pay your bills. Fear and also uncertainty decreased purchases of huge ticket items, choose automobiles, that people bought with credit. Firms – favor Ford motors – saw demand decline, for this reason they slowed production and furloughed workers. Unemployment rose, and the contraction the had started in the summer of 1929 deepened (Romer 1990; calomiris 1993).7

While the crash of 1929 curtailed financial activity, its affect faded within a couple of months, and by the autumn of 1930 economic recovery appeared imminent. Then, troubles in another portion of the financial device turned what may have been a short, sharp recession right into our nation’s longest, deepest depression.

From the stock sector crash the 1929, financial experts – including the leaders of the commonwealth Reserve – learned at least two lessons.8

First, main banks – choose the federal Reserve – should be careful when exhilaration in an answer to equity markets. Detecting and also deflating financial bubbles is difficult. Using financial policy come restrain investors’ exuberance may have broad, unintended, and also undesirable consequences.9

Second, once stock market crashes occur, their damage can be consisted of by adhering to the playbook occurred by the federal Reserve financial institution of new York in the loss of 1929.

Economists and also historians questioned these worries during the years following the good Depression. Consensus coalesced around the time the the publishing of Milton Friedman and Anna Schwartz’s A Monetary history of the unified States in 1963. Your conclusions concerning these occasions are quote by plenty of economists, consisting of members of the federal Reserve plank of Governors such together Ben Bernanke, Donald Kohn and Frederic Mishkin.

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In reaction come the financial dilemm of 2008 scholars may be rethinking these conclusions. Economists have to be questioning whether main banks can and also should stop asset sector bubbles and also how concerns about financial stability should influence monetary policy. These widespread discussions hearken ago to the disputes on this issue among the leader of the federal Reserve throughout the 1920s.