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The Depression of 1920–1921 and the Retu...

Bruner, Robert F.

Case

The Depression of 1920–1921 and the Return to “Orthodoxy” (A)

Bruner, Robert F.

F-1890 | Published October 15, 2019 | 38 pages Case

Collection: Darden School of Business

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In March 1921, the Federal Reserve Board (FRB) wrestled with setting monetary policy during a severe economic contraction, called by many a depression. FRB members disagreed over whether to respond to the depression, and if so, how. The depression had sparked a crisis of purpose and policy within the FRB. For the past six years, FRB leaders had been trying to get the Treasury to allow the Federal Reserve (Fed) to pursue "orthodox" monetary policies; but the Treasury had demanded that the Fed implement policies that would support America's war effort. The depression also stoked intense criticism of the Fed from Progressives, Populists, labor, socialists, veterans, and farmers, who charged that the Fed caused the depression, and were now agitating for change. The FRB leaders confronted questions that seemed likely to shape the Fed for years to come. What should be the Fed's role in the American economy? How should the Fed help resolve World War I's debt burden and the resulting inflation? What reforms, if any, should the monetary authorities seek? Perhaps most importantly, was the "orthodoxy" of established practices still appropriate in the world that had emerged from the war? This case set has been taught successfully in Darden in-person and online classes.

This case was developed for the purposes of: (1) Exploring the consequences of monetary management by fiscal authorities and competition among public policy priorities. The cases give particular attention to war finance and the subsequent resolution of the postwar debt overhang. (2) Considering the Fed's role in the US economy, reasons for central bank independence, and the risks of "capture" of the central bank by political authorities. (3) Reviewing the financial crisis of 1920-21 and its causes. (4) Critically evaluating the "orthodox" principles of central banking at the time, including the real bills doctrine, the penalty rate, and adherence to the gold standard.