Monetary Policy in the Great Depression and Beyond: The Sources of the Fed's Inflation Bias

Abstract

The deflationary outcome of monetary policy during the Great Depression had two fundamental causes: 1) the Federal Reserve's use of flawed operating guides, and 2) a decision to make preservation of the gold standard the overriding objective of policy. The Great Depression resulted in lasting changes in the domestic and international monetary regime that substantially weakened the gold standard, increased political control of monetary policy, and created new opportunities to monetize government debt, all of which gave monetary policy an inflation bias. Uncorrected flaws in the Federal Reserve operating strategy and the lessening of the gold standard constraint enabled a sustained inflationary monetary policy to emerge in the 1960s. Ultimately, that policy led to the collapse of the Bretton Woods System and abandonment of international linkages altogether.

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