Federal Reserve's Role in the Great Depression

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The Federal Reserve’s Role in Causing the Great Depression -------------------------------------------------
Daniel Weber
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Dr. Fadhel Kaboub
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Fall 2010
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The Federal Reserve was created in 1913 in response to several financial panics, including a particularly severe one in 1907, to serve as the central bank of the United States, and given the authority to issue legal tender. According to its founding documentation, it is enlisted with the duties of conducting the nation’s monetary policy, regulating the nation’s banking industry, and preserving the stability of the financial system. Despite the apparent prosperity during the 1920’s, there were many warning signs that the burgeoning economy was not as strong as it appeared. After the stock market crash of 1929, the Federal Reserve did little to rectify the situation, adhering to a policy of sound finance, due both to their structure and their belief of how the economy functioned. With banks failing across the country, the Federal Reserve chose not to bail them out, allowing them to go bankrupt and the public to lose faith in the strength of the economy. Today, many, including Milton Friedman, Ben Bernanke, and Anna Schwartz, blame the Federal Reserve, not for causing the Great Depression, but for allowing a recession to evolve into a full-scale depression. In this paper, it will be shown that the Federal Reserve through their actions, and sometimes lack of action (inaction?), in addressing the monetary supply issue in the economy, by using functional finance caused the United States to enter into a decade long financial crisis, rather than merely suffering through a typical business cycle recession. First, the pre-crash economy will be examined, focusing on warning signs that it was not as strong as (as who thought??) thought. Then the course of the Great Depression will be outlined, as well as (as will) the Federal Reserve’s behavior in trying to heal the economy. Finally, the actions of the Federal Reserve will be analyzed to show how they worsened the situation, and the actions that should have been taken (right now you’re saying they worsened the actions that should have been taken…do you mean you will analyze to show how they worsened it and you will describe the actions that should have been taken?), by applying monetarist theories and functional finance. -------------------------------------------------

Lead up to The Great Depression
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During the 1920s, the Federal Reserve maintained an artificially low interest rate, which encouraged consumers to borrow money and invest in the stock market on margin. This flooded the stock market with borrowed money, creating a bubble that could not be sustained. The low interest rates resulted in a large amount of privately held debt that was invested in the stock market. Between May 1928 and September 1929, the average prices of stocks rose 40 percent, with trading increasing from two million shares per day to over five million. This success further encouraged people to borrow money and invest it in an attempt to profit quickly. Many experts were unaware of the dangerous situation that was developing, but (and) instead felt optimistic that...
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