Banks Should Raise Prices in a Recession

by Bob Murphy
by Bob Murphy

In working on my forthcoming book dealing with the Great Depression, I noticed something intriguing about the discount rate of the Fed. Oh wait, I should first clarify – I'm talking about the New York Federal Reserve Bank, because the Fed banks had more autonomy in the beginning, and so you couldn't talk of "the Fed's" discount rate.

What I noticed is that from the time it opened its doors in November 1914, all the way through 1931, the New York Fed charged its record-low rates at the very end of this period. The "discount rate" was the interest rate the Fed banks would charge on collateralized loans made to member banks. For the New York Fed, rates had bounced around since its founding, but they were never higher than 7 percent and never lower than 3 percent, going into 1929.

This changed after the stock-market crash. On November 1, just a few days following Black Monday and Black Tuesday – when the market dropped almost 13 percent and then almost 12 percent back to back – the New York Fed began cutting its rate. It had been charging banks 6 percent going into the Crash, and then a few days later it slashed by a full percentage point.

Then, over the next few years, the New York Fed periodically cut rates down to a record low of 1½ percent by May 1931. It held the rate there until October 1931, when it began hiking to stem a gold outflow caused by Great Britain's abandonment of the gold standard the month before. (Worldwide investors feared the United States would follow suit, so they started dumping their dollars while the American gold window was still open.)

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February 7, 2009

Bob Murphy [send him mail] runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism.

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