Eggertsson “ Commodity Prices and the Mistake of 1937”

1. Eggertsson“Commodity Prices and the Mistake of 1937” Vaughan / Economics 639

2. Mistake of 1937 • Fed decision to double reserve requirements in three stages from August 1936 to May 1937. • Rationale: • Unprecedented build up of “excess” reserves in banking system. • Excess reserves could lead to lending explosion and (i) inflation and (ii) another asset bubble. • Rapidly rising commodity prices were thought to show inflation was coming. • Misunderstanding about Excess Reserves: • Banks held excess reserves not just because interest rates were low and loan demand was wea, but to self-insure against “run risk.” • Result: “Roosevelt Recession” • Banks scrambled to build excess reserves back up (causing money multiplier and money stock to fall). • Serious recession ensued (May 1937 to June 1938) ↓ M2 = 2.4% (mean %Δ in post-1959 recessions = ↑7.3%) ↓ Industrial production = 31.8% (mean %Δ in post-WWII recessions = ↓8.4%) ↑ Unemployment rose to 19%

3. Commodity Prices MisleadingIncreases Driven by Supply Factors, Not Inflation

4. Inflation not a Problem

5. Fallout from “Mistake of 1937”