In the late 1920’s we had a massive credit bubble collapse, we then loosened the money supply and increased Federal spending to help improve the situation. In the later part of this decade we had something similar.
Here is what happened in 1937.
First, the Fed tightened monetary policy. Starting in 1936 and through 1937 the Fed doubled reserve requirements (the amount of cash a bank must hold relative to its liabilities). You can see how the money supply dropped here.
Less money = less lending = less borrowing = private sector contraction = recession.
Now it is possible that if Federal government spends money it can counteract the drop in the private sector, along with an increase in exports (GDP = private consumption + private investment + government spending + net exports).
Did the Federal government spend in 1937? Nope. They also raised taxes.
So to conclude, things were starting to look better later in the 1930’s; however, the Feds tightened monetary policy and decreased spending. In my next post I will cover the fallout from that and why I think it’s dangerous to follow a similar path now.
