GERALD EPSTEIN AND THOMAS FERGUSON

1. Answers to Stock Questions: Fed Targets,Stock Prices, and the Gold Standard in theGreat Depression GERALDEPSTEINANDTHOMASFERGUSON

2. Alex Macri • This article is a rebuttal to Philip Coelho’s and G.J. Santoni’s (C&S) assertion that the FED did not abandon a reflation plan in 1932 . The evidentiary pillar of this assertion rests on the steady growth of high power money during the period in question. • C&S performed 2 econometric tests in order to demonstrate that the Fed was indeed continuing the reflation program; • The 1st related weekly measures of money to the Dow Jones average and bank share prices.

3. The 2nd test correlated T-bills (a proxy for high money with the Dow Jones and the index prices for bank shares in New York and Chicago • C&S found a direct, positive correlation between high powered money and bank share prices. • Based on this finding, C&S claimed that the banks could not have possibly opposed an easy money policy. • Epstein and Ferguson counter claim to have found 3 different rationales for the Fed’s abandonment of the reflation program (easy money policy) in 1932. • The 1st was a direct contradiction of C&S’s assertion that bank share margins were positively correlated to monetary growth.

4. If anything, in Epstein and Ferguson’s view, it was precisely because the Fed was so single mindedly concerned with bank share margins that it looked askance at monetary easing because it could at least in the short run reduce them. • The 2nd and 3rd rationales were based on the amount of gold and the gold standard regime which prevailed in 1932. • Epstein and Ferguson claim to have authored a previous study which proved that the various Fed districts were acutely aware of how much each of them possessed individually and where this situated them vis a vis the other Fed districts. In other words there was a more or less unspoken competition

5. amongst the various branches whose benchmark was the accumulation of gold. • In Epstein and Ferguson’s view C&S conclusions are diametrically at odds with reality and these erroneous conclusions are the result of an “incorrect” analytical linchpin (monetarism) to support an overall framework known as rational expectations based conclusions. • Although the gold standard’s analytical constraints were still the predominant worldview, some influential “movers and shakers” were tentatively probing for alternative, worldview changing

6. solutions. • For example, well connected JP Morgan bankers were enthusiastic supporters of open market operations for explicit macroeconomic goals and were dismissive of what they regarded as the overly stringent collateral requirements the Fed imposed for the notes. • According to E&F this period was marked by chaotically acrimonious debates amongst policy makers regarding which indicators or targets could be used as policy markers. • The main reason for this tumult was that none of the indicators which had “scored” policy results in the

7. past seemed relevant to the 1932 reality. • This, according to E&F, invalidates the C&S high power money based analysis because the money indicator is as invalid as all others for the period in question. • To substantiate this conclusion, E&F point to the fact that exactly during the time series when M1 was growing by 17%, both the credit and money multipliers were falling by 25%. • Whatever the challenges to the prevailing gold standard orthodoxy, at the 06/16/1932 of the Open Market Committee Harrison refused to press for an increase in the open market program declaring

8. That the Fed’s focus should shift to maintaining member banks’ excess reserves between $250-$300 million until there was some expansion of credit. • According to E&F, C&S made a crucial misapplication of M1 money in one of their regressions by designating it as a right hand variable. This was a misapplication because neither investors nor policymakers where using M1 as a target or indicator. • Using M1 inappropriately is not the only problem with the C&S analysis according to E&F. • The latter claim that there is “substantial” evidence against the “efficient markets” theory.

9. Since E&F are strong disciples of Keynes’ “animal spirits” theory, they obviously think that the C&S supporting tests are basically at odds with reality. • C&S concluded that the stock market’s overall trajectory was negatively correlated with the Fed’s monetary ease. • E&F claim this is explainable by investors’ gold standard worldview. With the exception of the type of influential “movers and shakers” mentioned before, the majority of investors had an “irrational” fear of inflation. • These investors viewed open market purchases as

10. an abandonment of the time tested depression busters; wage reductions and an overall deflation policy. • Within this prevailing worldview, it is only natural that stock prices were negatively correlated with easy money policy. • Investors feared that their portfolio balances would be significantly eroded by monetary ease (inflation) • As some monetary easing commenced there was a significant gold drain out of the country which made monetary ease advocates at the Fed nervous. • The open market purchases stopped shortly thereafter.

11. The gold drained was reversed at least partially as a result of the cessation of monetary easing…. C&S quote the NY times which asserted that the rise in the stock market was a reflection of the country’s determination to remain on the Gold standard. • According to E&F this is why C&S’s regression shows that falling T-bill rates push the market down and this is why the reflation program was suspended.