2006-07 EC: The Fed's Reaction to the Great Depression: Fact or Artefact (working paper)
published: 2006 | Research publication | Working Paper - Economics
ABSTRACT: The role of stock market developments during the Great Depression is underlined by Romer (1990 1992). Meltzer provides convincing qualitative evidence linking Fed policies to the performance of the stock market. Since a notable feature of the entire period is the volatility in several key macroeconomic aggregates, this is used to econometrically identify a parameter that explains the possible reaction of the Fed to stock market developments, including some evidence based on real-time data. I find that Fed behavior did change around the time of the Great Depression. If we exclude the years of the Great Depression then the Fed generally reacted positively to changes in stock prices. Otherwise, the Fed reduced interest rates when stock returns rose as the Riefler-Burgess doctrine would suggest. I conclude that, prior to the Great Depression, a form of benign neglect influences Fed behaviour.
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revised Mar 6/07