Judge Glock on the Riefler-Keynes Doctrine and Monetary Policy During the Great Depression

David Beckworth: Our guest today is Judge Glock. Judge is an economic historian and a scholar at the Cicero Institute in San Francisco. Judge's research is focused on the Great Depression and has recently published a paper on an important idea shaping Fed policy during this time. The idea was the Riefler-Keynes Doctrine.

Judge joins us today to discuss this paper and the Great Depression. Judge, welcome to the show.

While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

Judge Glock: A real pleasure to be here. Long-time listener, David, so happy to be a participant too.

Beckworth: Well, thank you, and I can say this honestly that this paper was really one of the few papers I've read in a long time that really opened my eyes, really some new thinking, some ideas. It really, to me, stressed the importance of the history of economic thought, why it's important to go back and look at what people have discussed before. As we get into your paper, we'll see that some of the recent debates really aren't so new.

Before we get into all that, I want to ask you how did you get into economic history? How did you get into this topic of the Great Depression in the first place?

Glock: Well, I, of course, [had] long-time interest in it, even in undergrad when I was a history major. When I went back to grad school in the wake of the 2008 financial crisis, again, to get a Ph.D. in history, I knew I wanted to study financial crises and, of course, the Great Depression was paramount there. It helped that when I was going to grad school in Rutgers that I was right next to the economics department there, which has a quite fantastic financial history section. I think some of whom you've had on the show: Hugh Rockoff and Michael Bordo and Eugene White, who was my advisor during my time there.

So, I got a really great background in financial and monetary history, and that certainly informed my dissertation and some of the work that emerged out of it, including this paper.

Beckworth: Wow, those are some great scholars. I need to get Eugene White on the show. He's definitely a great banking scholar too.

Glock: Yeah, he knows backwards and forwards.

Beckworth: He does. He does. Fantastic. Okay, well, let's talk about the Great Depression as a way to get into your paper. Just for our listeners who don't know, who may have forgotten, remind us about the Great Depression. What are the stylized facts about it?

Glock: Yes, so one of the things I often used to discuss with my students is it's almost impossible to overemphasize the importance and impact of the Great Depression. Once you start thinking about it, the ramifications of it seem to kind of ripple outwards as far as the eye can see. From 1929 to about 1933, global industrial production dropped by a third seemingly with no supply-side cause as far as anyone could tell. No massive famines, no industrial disasters, just across the globe you saw a very sudden collapse in production GDP.

This was accompanied by a massive collapse in prices across most of the globe too, about a 33 percent decline in the price level. United States was the worst hit of all, even though it was by far the richest and most industrialized country. Its industrial production dropped by over around 45 percent in this period before recovering very quickly in the U.S. and elsewhere, as we'll discuss later when the United States and other countries got off the gold standard leading to very sudden spikes in aggregate demand and sudden increases in gross domestic production.

That sort of global economic collapse, the level of the collapse, the amount of the collapse across many different countries was unprecedented and has never happened before or since. At the same time, the political ramifications, as many people pointed out, are perhaps even more important. The most significant of which is the rise of the Nazis in Germany, which can be pretty confidentially laid at the feet of the Great Depression, which therefore, of course, caused World War II, the rise of Communism in Eastern Europe, basically, any sort of disaster you can think of in the last half of the 20th Century.

Understanding why this collapse happened has been essential to both macroeconomics, political historians, almost anyone who studies the 20th century, and people are still continuing to wrestle with it. If we don't understand this, we're not going to understand a lot about why some of the great disasters of the 20th century took place. As Ben Bernanke said, it is sort of the Holy Grail of macroeconomics too and with good reason. 

Beckworth: Yes. There's some other, what I would call, stylized facts I just wanted to highlight that you touched on, and that is how long did it last? It lasted roughly a decade. Is that correct?

Glock: Well, yes. If you look at the actual collapse in, say, the United States in gross domestic product, that basically lasted from '29 till '33.

Beckworth: Okay.

Glock: But we had unemployment rates that were continuing in the double digits, 15, 16 percent, up until around 1940, 1941. Even, you would think 10 years after the start of the Great Depression, a double-digit unemployment rate higher than even the worse of what we suffered during the recent Great Recession, seems like a continuing recession in many cases.

So, the length of the Great Depression and the slowness of the recovery over the long-term was a big part of what made it so disastrous. Then other countries had different levels of recovery at different times. As I said before, the U.S. did happen to be both the largest total collapse and the slowest to recover, so we suffered the brunt of it.

Beckworth: Yeah, there was this huge gap in the U.S. economic production, well below where we should be, for almost a decade. You mentioned this first contraction, which is, I think, is often called the Great Contraction, '29 to '33 the economy literally gets smaller and smaller.

There's another second contraction in '36, '37.

Glock: Basically, from late '37 to early '38, often called-

Beckworth: '38, okay.

Glock: ... called the Roosevelt Recession.

Beckworth: You got two outright contractions, very slow recovery, so there's still all this excess capacity, lots of unemployment for a whole decade. It's hugely consequential. There's also this story told of a real sharp recovery in 1933. Maybe we'll come back to that later after we talk about your paper, but a real sharp recovery in 1933 that's often tied to FDR going off gold.

Then, that's like a great recovery. It's kind of stalled. You don't see the real, true recovery, the standard story tells us at least, until World War II. I know there's a critique of that story as well, but the standard story is World War II is what finally got us free from that.

One of the other underlying stories is that the Federal Reserve really blew it. Milton Friedman really stressed this, and he kind of rewrote the story on how consequential money is with his famous history book of money throughout the U.S. history. One of the stories, I think, most people take for granted now is the Fed could have done more, but it didn't do more.

So, I wanted to segue into your paper, which I mentioned before is a great discussion of what the Fed was thinking during this period, and it really sheds some new light on their views on monetary policy. Before we get into it and what it means, and it's going to touch on long-term interest rates, maybe you can share what the Fed was thinking before then. What was the context leading up to this important issue, the Riefler-Keynes Doctrine? What's the stage being set before we get into the discussion of this doctrine?

Glock: Sure. Ever since basically Friedman and Schwartz's *A Monetary History of the United States* in 1962, there's been a broad consensus that the Federal Reserve was central in both causing and exacerbating the Great Depression. So, there's, of course, been a concomitant concern then what exactly was the Fed thinking? If the ramifications of the Great Depression are as severe as we pointed out they are, then this puts a lot of weight on trying to understand basically what 12 central bankers, the 12 central Federal Reserve Bank governors were thinking in this period from 1929 until 1933. Whatever they were thinking in some sense shaped the entire course of human history, and so we really need to understand what was going on in their heads.

Before Friedman and Schwartz came along, there wasn't much concern about this because most people thought the Federal Reserve had basically done everything it could do to prevent the Great Depression. People like John Maynard Keynes himself and some others said, "Look, the amount of base money in the United States increased during this period. Interest rates were very low." By that measure, we were in a liquidity trap. There was nothing much the Fed could do, and therefore, understanding what they were thinking wasn't important because the economy must have been collapsing for some other reason.

When Friedman and Schwartz showed that well, if you look at a broader definition of the money supply, M2 in their period, as they discussed it, then, clearly, the Fed was letting money supply collapse. We have to understand why they were doing that. According to Friedman and Schwartz, the main reason was a tubercle bacillus that crept into Benjamin Strong's lungs in the late 19 teens. Benjamin Strong being the governor of the New York Federal Reserve Bank and an active exponent of expansionary monetary policy.

Unfortunately, according to Friedman and Schwartz, after Benjamin Strong died, the Federal Reserve basically took a contractionary view of monetary policy. They looked too much at short-term interest rates, and they look and thought that they were being expansionary when, in fact, they were being very contractionary. On other hands, they thought that many people in the Federal Reserve actually wanted a contraction because that would supposedly liquidate some of the bad speculation out of the system. That was their sort of logic to what the Federal Reserve was thinking.

Beckworth: Judge, let me ask this question. Just to be clear, that was a reasonable take given what you hinted at earlier. There were 12 central banks effectively, 12 effectively independent, which is very different than today, right? Each regional bank could set monetary policy in its district, is that right?

Glock: That's correct. They were somewhat organized since 1923 under what later became known as the Federal Open Market Committee, but, basically, they had a fair amount of discretion in terms of the discount rates they set, how many securities they purchased. These decisions were often appealable to the Board of Governors in D.C., but, at that time, the Board of Governors was much less substantial and powerful than these 12 independent Federal Reserve Bank governors.

So, yes, these people were the real powers behind monetary policy in this period. When Friedman and Schwartz looked at, those were the people they looked at to see what their logic and thought processes were at the time.

Beckworth: Yeah, so when the most important regional bank president dies, it would seem, on the surface, at least consequential to what the Fed's going to be doing. Tell the rest of the story.

Glock: Okay, and so I guess I'll keep going on about some of the previous, yeah, the previous thoughts about what the Federal Reserve was thinking. The next major contribution to this history, and the one that kind of survives up to the present in which I'm discussing in my paper, is the Allan Meltzer and Karl Brunner argument, what they call the Riefler-Burgess Doctrine.

Now, to get into that, we need to confront two issues that were ... Our one main issue that was important in the Riefler-Burgess Doctrine and that is the Real Bills Doctrine. Should I go into that for a-

Beckworth: Yeah, tell our listeners what that is.

Glock: This idea often traced as going back to Adam Smith is that, basically, because a bank relies on short-term liabilities, its deposits, it should also rely on very short-term assets, often would describe commercial paper, usually 60 to 90-days due. Adam Smith had a famous sort of metaphor where he described a bank should be like a pond where a river is always flowing in, and a river is always flowing out of it to keep the level stable.

Many people took this view to say as long as a central bank was merely discounting short-term commercial paper, the 60, 90-day commercial paper, that meant it was only responding to "the real needs of trade," and that meant it wasn't being either expansionary or contractionary. Well, if people are offering you commercial paper, then you should accept it and discount it. If they're not, then you shouldn't worry about it.

On the other hand, this did leave an important variable unexplained, and that's the interest rate. Of course, it's a very different situation if a central bank is not being offered any paper to discount when it's offering a 15 percent discount rate versus when it's offering a one percent discount rate, basically, if it's charging more to loan its money or charging less to loan its money.

What Allan Meltzer and Karl Brunner brought to this was to say, "You look at the Federal Reserve in this period, they were obsessed with this Riefler-Burgess Doctrine." They said, Riefler-Burgess was said that they could measure the right level of interest rates by how much these banks were borrowing from the Federal Reserve and how much open market purchases the Federal Reserve was doing at the time. So, if banks weren't borrowing, they weren't borrowing too much, that meant interest rate was probably about right. If they weren't borrowing at all, that might mean it was too high or too low.

They could use open market purchases to affect the level of interest rates, the level of discounting, at the same time that they were using the discount window to also affect the amount of reserves in the system. Hopefully, that's not too complicated, but just for the sake of the program, important to remember that, at the time, the Federal Reserve had two important levers of monetary policy. One was the discounting window and the discount rate, and the other was either buying or selling government bonds, which would either put more or less money into the economy respectively.

The Riefler-Burgess Doctrine was about trying to get the right level of short-term interest rates and the right level of commercial bank borrowing from the Federal Reserve to make this Real Bills Doctrine effective.

Beckworth: Now, my understanding of the Real Bills Doctrine is that it was a terrible idea insofar as it made procyclical monetary policy. Is that a fair assessment?

Glock: Yeah, if no one's offering paper to the Federal Reserve, that could [mean] you're in a horrible recession and the interest rates are too high relative to an equilibrium rate. Therefore, the Real Bills Doctrine can exacerbate that problem.

Beckworth: Okay, so how does the Real Bills Doctrine tie into the idea that you develop in your paper, the Riefler-Keynes Doctrine?

Glock: Yes. Okay, this gets us to the innovations of, what I call, the Riefler-Keynes Doctrine, what some people at the time, actually, called the Riefler-Keynes Doctrine, which was, first of all, the first most important part was that short-term interest rates are a bad measure of the effectiveness of monetary policy. Now, not in the sense that some things we would think today such as, "Well, it's dependent on expectations of future inflation or deflation," but more so in the sense, because short-term interest rates don't have a significant impact on investment. That was the first important contribution of the Riefler-Keynes Doctrine.

People like Wesley Clair Mitchell, famous professor, Columbia teacher of Arthur Burns and who later taught Milton Friedman, said, "Look, when you look at most businesses and their balance sheet, an increase of one or two percent on short-term borrowing doesn't make a big difference. What does make a big difference is the borrowing on long-term interest rates, that an interest rate increase of one or two percent for an investment that would last for five to 10 years would make a very significant impact on the amount of borrowing, and therefore, make an impact on the amount of investment."

Therefore, since we could, as far as they could tell, this sort of long-term fixed investment tended to lead the business cycle, maybe these long-term interest rates were much more essential in terms of determining business cycle's up and downs than the previous Real Bills theorists had thought.

Beckworth: Okay, so the first key idea is what really matters is long-term interest rates for the economy. Short-term rates aren't as consequential.

Glock: Absolutely.

Beckworth: Now, the second key idea, walk us through that. I believe that is that the Fed could influence those long-term rates. Is that right?

Glock: That's correct. When people like Wesley Clair Mitchell mentioned that long-term rates were important to the business cycle, that didn't seem to offer much policy ideas for the Federal Reserve, for other central banks, because the Federal Reserve was set up, like most central banks, only to loan on short-term commercial paper. They were still, to an extent, influenced by this Real Bills Doctrine, that that's the job of a central bank to give liquidity and discounts to this short-term commercial paper.

Another theorist, Harold Moulton, at the time, later the head of the Brookings Institute, said, "Well, no there's this kind of national, unified money market," something we don't think of as that kind of surprising today, but any sort of lending on the short-term moves its way into the long-term investment market. He said, "Well, you can look at this by looking at the actual commercial banks and practices. The commercial banks just like the Federal Reserve itself. We're supposed to loan only on short-term commercial paper."

In fact, it was illegal for most of the commercial banks in the United States to do things like make mortgages or make very long-time investment loans. But he said, "In practice, these commercial banks renew these short-term loans over and over and over again, and so they function like long-time investment loans." Even if the Federal Reserve pumps excess money into the economy, just through the short-term market, this is going to migrate over into the long-term market, and that's going to affect these sort of long-term investments that Wesley Clair Mitchell talked about.

Here now, we have an opportunity for the Federal Reserve to start thinking about how its short-term interest rate policy can affect that long-term rate and therefore, the business cycle.

Beckworth: Was he thinking through a theory that's very similar to segmented markets we would say today, or is it similar to the Expectation Theory of long-term rates today? Any relation?

Glock: Well, so it wouldn't be till later that they would formulate something as clear as either a preferred habitat or, yeah, segmented markets, or Expectations Theory of the term structure of interest rates. At the same time, they were trying to think about how certain markets ... They would probably be closest to that segmented market idea, partially independent, but not totally. There was different sorts of demands for borrowing in different sorts of markets, but the sort of supply-side, the credit that went into it, could influence all the different interest rates, short to long-term.

Beckworth: Okay, so again, the first insight, or the first idea of this doctrine, is that long-term rates are more important for the economy than short-term rates in terms of monetary policy. Number two, the Fed, in theory, could influence those long-term rates, and a third key doctrine is that the Fed could make the debt more liquid, or what you call shiftable, the term they use shiftable. Explain that third point.

Glock: Yes. How we think of liquidity today is very distinct to how they used to think about liquidity around the time of the founding of the Federal Reserve, and that was a bill. Our debt is liquid if it comes due soon. If a bill comes due in 30 days or 90 days, that's a fairly liquid bill. A five-year bond or whatever else length of bond at that distance is not going to be very liquid. Today, we think of basically what began to be called in the 1920s the Shiftability Theory of Liquidity, which is, well, any debt or asset can be made potentially liquid if you can sell it to someone else, a stronger bank or another bank.

Some of the similar advocates, a lot of them coming out of what was called the Institutionalist School of Economic Thought said, "Well, we can set up commercial banks to make all of these assets shiftable," or as we would today call it just liquid. They don't have to rely just on short-term, liquid assets 60, 90-days due because if they're able to pawn off an asset to another bank, or ideally even to a central bank, every single asset on their balance sheet can be equally liquid. That's another way to get the interest rates on these long-term debts and assets down because the increased liquidity of that is going to make commercial banks more comfortable investing in them, and it's going to increase investment in these sorts of assets.

Both these measures opening up potentially the short-term discounting and amount of money going into the short-term market, and two, potentially more long-term changes through the ability of commercial banks to invest, or the ability even of the Federal Reserve to buy these sort of long-term assets can also push down the interest rate on the crucial long-term debts and assets.

Beckworth: Yeah, so the Riefler-Keynes Doctrine sounds a lot like some of the thinking today, right? Some of the thinking today is, and we saw this over the past decade, let's go out on the yield curve, let's buy up 10-year treasuries, let's try to lower the interest rate that's offered. It seems some of the same ideas we're talking about today were being discussed back then.

Glock: I think so, exactly. If you look at a lot of the language, and we'll get into this of both Federal Reserve researchers and officials at the time, it seems not too distanced from we what we think of as contemporary New Keynesian policy. It is really focused on the effect of interest rates, especially long-term interest rates on investment, fixed investment. A lot of what Ben Bernanke and Gertler and some others have said in the last 20, 30 years really emphasized this point, and this point was emphasized again in the 2008 crisis.

In this sense, I think you can find a lot more similarities between what the Federal Reserve and policymakers were thinking in 1929, and what they were also thinking in 2008.

Beckworth: Obviously, the circumstances drove it, right? They had a very sharp contraction then. We had a sharp contraction here. You get near the zero lower bound. Maybe that also motivates some of the thinking, "Let's go beyond just short-term interest rates," but it is still very stunning. Again, this is why this paper was so interesting to me, that I hadn't seen this discussion before. Again, just to stress the role of teaching the history of economic thought maybe more of us would know about this, but let's be clear, this doctrine, this Riefler-Keynes Doctrine, your article is really the first one to kind of pull it all together and to be published on this, right?

Glock: That's correct. The term Riefler-Keynes theory or Riefler-Keynes Doctrine I found at least in two different published sources in the 1930s, so this was a contemporary term unlike the Riefler-Burgess Doctrine, which Allan Meltzer admitted he kind of came up with as a combination of these previous ideas that he thought were related. People at the time were referring to both the Riefler and, as we'll get to in a second, John Maynard Keynes in the same breath and thinking that these two individuals and some of the other economists around them had similar ideas about what should be done to counteract a depression.

As I hope I show, these ideas were very prominent both in the Hoover and Roosevelt administrations and in the Federal Reserve itself.

Beckworth: Yeah, so now when professors teach history of economic thought, they can use your paper thanks to your hard work.

Glock: I hope so.

Beckworth: Again, this is just so striking how relevant this is to discussions today. Not only do we talk about large-scale asset purchases and QE of the past decade done by the Federal Reserve, Bank of England, the European Central Bank, Bank of Japan, but there's now talk about doing things such as yield curve control. Bank of Japan is doing that. They're trying to keep the 10-year treasury yield a certain value, but others have been talking about it.

This year, the Fed's having a review of its policies. One of the points that have come up is should the Fed think about yield-curve control. Then on top of this, I think makes this extra relevant, is the fact that long-term yields have been declining. They've been declining a lot, this kind of secular decline in 10-year treasuries, which are typically the benchmark interest rate all across the advanced economies. Germany's had close to zero, slightly negative. Switzerland's been very negative. U.S. is pretty low, around two percent.

I was just reading today, about some countries that now have 100-year bonds. Austria, Belgium, and Ireland have 100-year bonds. This is even more surprising. The University of California system has a 100-year bond out as well. What I think is going to happen, this is just my prediction here, if we continue to see this decline in long-term rates so that the 10-years get really low, I think we're going to start seeing governments issuing more long, long-term, 50-year bonds, 100-year bonds.

So the debates they had in the 1930s about adjusting long-term rates is going to be moving out on the yield curve possibly even farther. That's speculation, but I think this discussion's relevant because it could be possible.

Glock: Yeah, so we could go back to the 18th Century where the British government admitted its Consols, which were indefinite bonds.

Beckworth: There you go.

Glock: Until the end of time. Who knows?

Beckworth: Right. So, unless some kind of shock comes along that brings us out of this kind of secular stagnation trap, in my mind, it's not a far-fetched scenario where we do get the 10-year treasuries in the U.S. getting really, really low so the Treasury looks beyond that, or monetary policy looks beyond that.

But, let's go on with the development of this idea. You've mentioned some individuals already, but you also mentioned in your paper that in addition to these individuals who are involved in the policy world, John Maynard Keynes, he embraced this idea as well. Tell us about his participation in this debate.

Glock: Yeah, absolutely. If we look at John Maynard Keynes in the early 1920s, he sort of declared himself a dyed-in-the-wool quantity theorist which, like their later ancestors, basically looked at the quantity and supply of money, the demand and supply of money, to see the tightness and looseness of monetary policy. By the end of the 1920s, he became much more interested in the effects of interest rates, and especially of the effects of long-term interest rates.

Some of the previous researchers on Keynes, probably butchering the name, but I think it's Axel Leijonhufvud, said that, "Listen when Keynes talks about interest rates in most of his 1930s work, he's talking about long-term interest rates." This is often missed in the discussions of IS-LM curves or the interpretation of Keynes. Keynes in the *Treatise on Money* and some of his other work said very clearly, the real impact of monetary policy is through investment and long-term fixed investment, and particularly the impact of long-term interest rates on fixed investment.

If you look at the *Treatise of Money Two* in 1930, he said he quoted pages and pages of Winfield Rifler's work so both the other half of the Riefler-Keynes Doctrine and the other half of Riefler-Burgess Doctrine, to say that, "Look, here's evidence that this Winfield Riefler, then working at the Federal Reserve at the time, compiled that showed there's this very close movement between short-term and long-term rates, that short-term rates are going to affect long-term rates."

There's also evidence, going back to some of the other theorists I mentioned, that these long-term rates are the real determinant of the business cycle. So, he says already in the early 1930s, "If we want to get out of this slump, the real thing we can do is try to lower these short-term rates to hopefully have an effect on these long-term rates. That's what's going to move us out of the already burgeoning depression right now."

Winfield Riefler was also saying the same things as he was working at the research division of the Fed to some of his bosses. So we can discuss some of the policymakers in the Fed that were abiding by these same ideas.

Beckworth: Yeah, before we jump into the Fed's adoption or embracing of this idea, a little bit more on Winfield Riefler. He has a book. I believe it was kind of key, a kind of a catalyst because you mentioned Keynes extensively cited Riefler's book. But the book's title was Money Rates and the Money Markets of the United States (1930). Was this book the big bombshell, or was it just building on the shoulders of the previous individuals you mentioned like Wesley Clair Mitchell?

Glock: Yeah. To an extent, it was the empirical bombshell. To a lot of people, it seemed to give the empirical evidence the previous theoretical work lacked. There was a chart in this book that I reproduced in my paper and that John Maynard Keynes also reproduced in his book ... I think one of the few charts he's ever reproduced from someone else's work, where Keynes was, of course, not a big fan of sharing praise when he could afford it ... that seemed to show just over the past 11 years before the book was published, that short-term and long-term rates moved in almost perfect synchronicity.

This seemed to show a lot of people these previous ideas that the institutionalist had talked about maybe had some truth to them, and also provided some pretty sharp evidence on terms of how these long-term rates affected total investment in the economy. So, this book provided the evidence people needed to say, "Wait, this is the best measures we have of how monetary policy is working in the real economy," and a lot of the evidence though he was taking from Federal Reserve research information, data tables, and so on that were being used at the Federal Reserve at the exact same time.

Beckworth: Yeah, I looked at that graph with some interest. This isn't particularly relevant to our discussion, but just it struck me, writing a book in 1930 where you have these detailed graphs, it must have been a real chore back then. They don't have Excel or any kind of word processor.

But any event, the book was important. It shaped a lot of thinking. It was a culmination of thought of these institutionalist economists you mentioned already. I would just also mention a few other names: Alvin Hansen, Allyn Young. Of course, Alvin Hansen's known for his secular stagnation views at this time as well, so it made a lot of sense that he would be on board with this.

This book, okay, it arrives in 1930. Tell us how its influence seeps into the Fed and what players at the Fed are important in promoting this understanding.

Glock: Yes, so if you look at the people at some of the top positions of the Fed, they seem to be full-throated supporters of the general Riefler-Keynes Doctrine ideas, that long-term interest rates are the most important, that short-term rates effects long rates, and that you can try to increase the shiftability of long-term assets. One of the other most important [people who] believes this is Randolph Burgess, the other half of this opposed Riefler-Burgess Doctrine, who was writing articles in 1930 and 1931 about [why] credit's important primarily through its effect on the availability of long-term money and the effect of interest rates in the security market and mortgage market.

Most importantly, probably the greatest believer in it was George Harrison, who was the president after Benjamin Strong at the Federal Reserve Bank of New York, and would be for the next four or five years, would say pretty consistently in Federal Open Market Committee meetings, internal memorandum, and elsewhere that the main effect of monetary policy is by of reducing long-term interest rates and spurring fixed investment.

You see these concerns come out even in memos in late 1928 and 1929. They showed a lot of they have charts that go into the Federal Open Market Committee meetings that show pretty clearly when long-term interest rates go up, a particular fixed investment, most especially building, tended to go down. Even when they were raising interest rates in 1929 to squelch the supposed stock market boom, George Harrison, Randolph Burgess, Winfield Riefler and others were saying we're already concerned of the effect of these high, long-term interest rates on the construction industry and fixed investment.

After the collapse, when they start loosening monetary policy and lowering interest rates, they say time and again, "What we need to do is lower interest rates to spur construction, increase fixed investment, and lower long-term interest rates."

Beckworth: Yeah, it's interesting, in the article, you outline how George Harrison, which, as you said, was the president of the New York Fed, wrote a memo, I believe, in 1930, that he sent out to all the other presidents. He really needed to convince them to the understanding of this doctrine and why it was important to lower long-term yields, which again, this speaks to this challenge where you got 12 regional banks. They're effectively, at this time, setting monetary policy, and there's some effort to coordinate.

I just wonder, we're going to speculate here, but if Benjamin Strong had been alive at this time, number one, would he have bought into this doctrine, and number two, could he have convinced all the other 11 banks to join in in pushing down long-term yields?

Glock: It's hard to know, of course, and on one level, a lot of previous researchers have just kind of divided the Reserve Bank presidents or governors of the time into expansionary and contractionary camps and left it at that. But I think it is important to see why these governors thought certain policies were expansionary or contractionary and when they thought they were expansionary or contractionary.

This gets, perhaps, even to the potential problems with the Riefler-Keynes Doctrine at the time. Someone like Harrison, most of the time, was much more a believer in what we think of as expansionary monetary policy than others. The quote you mentioned he sent around as sort of round-robin letter to all the Reserve Bank presidents, and I'll read it, just at least a short passage of it.

Beckworth: Yeah, do that.

Glock: It says, "In previous business depressions, recovery has never taken place until there's been a strong bond market through which new enterprise requiring long-time capital, maybe finance. As indicated in the attached chart likely done by Winfield Riefler, whenever the Federal Reserve System embark upon a program of purchasing government securities in the short-term, the bond market has become much more active and stronger, since short-time money becomes less profitable in comparison with long-time money and this money shifts to the later market, including some […] close at the end.

This sent this around, and some people in the Federal Reserve Open Market Committee basically said this. Eugene Black later became the governor of the Federal Reserve Board said, "Believe the Federal Reserve System has a responsibility toward the bond market, towards financing new enterprise and furnishing longtime capital." In other places, like Charles Hamlin said, "Low rates for short-term borrowing will eventually help long-term borrowing," but this wasn't universal.

So, I have other quotes from George Norris of the Philadelphia Reserve Bank who says, "This is counter to everything we were taught to believe." He says, "If I understand the reasoning correctly, the policy of buying government securities is justified by some arguments such as this: we're in a period of depression characterized by falling commodity prices. This condition cannot be corrected without an increase of building activity, building activity we brought about by low rates for long-time loans. Low rates for long-time loans will only come with a strong and active bond market. Therefore, we should bring about this condition in the bond market by making short-time credit so cheap that banks' investors will be driven to the bond market to utilize their funds."

He was against it. He said, "Numerous leaps of logic in there don't make sense to me and my understanding of that," but that's one of the best descriptions we have of what he was countering to see it even then as the main impetus of thought at the Federal Reserve at the time. On the whole, I think we can say that as Allan Meltzer and others have pointed out, people like George Harrison and Winfield Riefler got their way at the Federal Reserve Open Market Committee meetings. Even though there was these divisions, they, in large part, directed the open market policies and interest rates for the next three or four years, which obviously was not quite enough to alleviate or prevent the Depression.

Beckworth: I think you can make an even stronger case, Judge, and you do this in your paper by bringing in discussion of President Hoover during this time. President Hoover and Harrison of the New York Fed were close friends, and apparently, Harrison convinced Hoover of the Riefler-Keynes Doctrine. Is that right?

Glock: That's right. If you look, Hoover, of course, is famous for some misstatements about the Great Depression. A few, I believe, even weeks after the stock market crash he famously said, "The fundamental business of America is strong and secure." Everyone quotes this as an obviously, in hindsight, ridiculous statement, but they all forget in the same speech he noted one thing that he thought was potentially destructive and that they had to worry about, and he said, "The high, long-term interest rates have inhibited construction and building activity, and these need to be corrected if we're going to begin on an upswing again."

So, George Harrison, who some people said was "the top man" in the Hoover administration, at least for a period, certainly got Hoover to believe in this theory. He gave numerous speeches over the next year and a half about the real goal was to get short-term money to move into the long-term market and eventually help construction fixed investment. He eventually too helped change the Federal Reserve Board in Washington D.C. because of this. He basically put Eugene Meyer, who is a believer in the Riefler-Keynes doctrine, and said in numerous fashions before and afterwards that these ideas were sound, to replace Roy Young and one other Federal Reserve Board governor, kind of a coup at the board that's a-

Beckworth: Yeah, I thought of Donald Trump when I was reading this. It was like, "Wow, President Hoover kind of paved the way for President Trump in terms of replacing Fed chairs, and, of course, back then, I guess the Board of Governors wasn't as powerful or as consequential at that time, right?

Glock: Exactly. It wasn't as consequential as the Reserve Bank governors, but there's been speculation ever since September 1930 that Hoover might have had something to do with this. I found some, some letters in the Hoover Library and the Charles Hamlin diaries that this was probably so … that Hoover probably engineered the then-current head of the Federal Reserve Board to leave and move into the Federal Reserve Bank of Boston and kicked out one other board member in order so he can place his own members on the board. Later on, people like Charles Hamlin complained about what he called the board's “Hooverizing.”

Beckworth: “Hooverizing,” nice.

Glock: Yeah, the increasing obsequiousness, with which the board treated Hoover's request. In that sense, Eugene Myers, the new head of the board, tried to be as operationally involved as possible. He attended the Federal Open Market Committee meetings, said very clearly ... One quote I had in the paper is that he told the committees, "The whole history of investment showed that money would go from the short-term into long-term channels," and said this was one of his main focus.

In these senses, Hoover too was trying to push the Riefler-Keynes Doctrine, and this was his, you can even argue, his main focus in the first two years of the Depression in terms of how he thought it was going to reverse it.

Beckworth: Yeah, since the Board of Governors didn't have a lot of teeth, not really powerful, all they could really do is cheerlead. He was the big cheerleader for the Riefler-Keynes Doctrine. The point I think you're making here, you're painting a picture that this doctrine was very well understood. It was cited. It was promoted by many people within the Fed. So, the question is, well, did it matter?

There are two ways it can matter. One, did they take steps to influence long-term rates, and then two, how did it affect monetary policy in the Great Depression in terms of its response to the Great Depression? Let's tackle the first one first, the first point. You do give evidence that they actually did take concrete steps to influence long-term rates, and one of the most surprising points you make on this is that the QE program they had in 1932, or it was sort of a QE program, I guess, a large-scale, asset purchase program, afterwards they went back, and they extended the average maturity of their holdings from this purchase.

Glock: Yes, absolutely. A lot of people have written about in early 1932, the Federal Reserve Board and bank governors, after a change in the law that Hoover had pushed, began purchasing hundreds of millions of dollars of government securities in the open market with the hope of flooding the banks with excess reserves, and encouraging increased lending. At the same time, they were beginning to move into this shiftability aspect of the Riefler-Keynes Doctrine.

Beginning in the late 1930s, John Maynard Keynes, Riefler, and others noticed that the long-term interest rates didn't seem to be responding as much to the changes in short-term interest rates that they had previously. All this evidence they had of an interconnected monetary market and a close connection between the two rates, it seemed to disappear in the Great Depression itself. So, they were flooding all this short-term money into the market, but long-term rates had moved down very slowly.

John Maynard Keynes says this equilibrium between short and long-term rates, as far as he could tell, was the fundamental reason for the global slump. So, Keynes, Riefler, and others said, "Well, that means we have to act directly on long-term rates." That's not just doing something like QE, that's actually making direct investment in long-term assets, which was absolutely verboten in any central bank of the period, but began to be undertaken by the Fed.

I don't think anyone else has written about the change in the Fed's maturity structure in this period, but if you look ... Michael Bordo, I think, actually has done a little bit of this in the early 1932 period, but if you look at it, before early 1932, before about May in that year, the Federal Reserve had no government securities of greater than one year until maturity. By the end of 1932, it's over 25 percent of their assets are over one-year maturity, about seven or eight percent of those are over three years maturity, and by the 1935 period, the majority of Federal Reserve Bank assets are actually in government bonds of over one-year maturity.

In a sense, they're trying to do an early Operation Twist here. They're trying not just increase the total size of their balance sheet, but also shift to focus on these long-term assets. They also created, as I mentioned, a lot of other things of what we would think of as facilities of the Federal Reserve like what they were creating in 2008. Now, the Reconstruction Finance Corporation, when it was created in February 1932, around the same time as the first beginning of the QE program, was basically there as an adjunct to the Federal Reserve.

It was run by Eugene Meyer. Their offices were housed in the Federal Reserve buildings, and they were there explicitly to buy up assets that it was illegal for the Federal Reserve itself to buy up, which basically meant these long-term, private securities. The Reconstruction Finance Corporation would buy long-term bonds, even some equities occasionally, eventually would buy mortgages. At the same time, Hoover also set up the Federal Home Loan Banks, which had a similar sort of motivation. These Federal Home Loan Banks were a way to give liquidity, as he said, to small, independent mortgages, which in that point, didn't have any liquidity, basically were on the books of small local banks.

If you look at a lot of the features that both the Federal Reserve and the Hoover administration took in the last year of the Depression, they were almost entirely focused on this creating shiftability in long-term assets. They said the short-term market has basically run its course. We've tried everything we can, but if we increase shiftability and liquidity, give people confidence that the Federal Reserve or one of its new facilities will buy up these assets, then increasingly people will invest, and hopefully, that will create the sort of fixed investment we need.

This was with the wholehearted support of John Maynard Keynes and others. John Maynard Keynes, I quoted as saying too at one point that, "I would be okay with less short-term money and deposits available if you had more long-term assets on the Federal Reserve's balance sheet." He was a full-hearted advocate of this kind of Operation Twist idea even more so in a sense than the Federal Reserve. That was a significant motivator for most of their actions in that period.

Beckworth: Yeah, if you ask most people today when was the original Operation Twist, they would say, "Oh, 1961," because we had one in 2011. In fact, people at the Fed point back, "Let's see what happened in 1961," but this is striking because the original one was the early 30s. All these steps are just ... It's very interesting, amazing that they were taking these efforts to lower long-term interest rates.

You mentioned that they were limited, so they did the Refinance Corporation Home Lending Bank, but in 1935, they made some changes so they could explicitly themselves do more long-term investing. Let me switch gears now. They were taking concrete steps. They changed the law in 1935 or helped Congress move in that direction so they could take more explicit steps, but what role did that have, or how did that affect the recovery?

Because you also argue in the paper, that despite their efforts to influence long-term rates, it also contributed some kind of complacency, that they weren't paying as close attention to other indicators in the economy that were signaling things might be worse than they think they are.

Glock: Yeah, so I should be clear that in my paper, I don't try to take a firm stance on what was the correct way to view monetary policy at the time, or which was the best way to view it. I frankly don't have the econometric chops to do that as well as many other people could, but I do think there could be a misreading of this Riefler-Keynes Doctrine and to say that, "Well, look. If we look at what the Federal Reserve was doing at this time, they were very activist. They were acting in a way we think a lot of New Keynesian policymakers say they should act. They were focused on fixed investment, long-term rates, and so on."

Clearly, if we're just looking at the effects, they are disastrous. By any measure, Federal Reserve policy was clearly a failure in this period. In a sense, whatever the Riefler-Keynes Doctrine was saying they should do and whatever its actual impacts was, they probably weren't entirely positive. So on one level, I have a couple quotes from periods like September 1930. In January 1931, where some of the major Federal Reserve policymakers are saying, "Look, because the short-term rates aren't having a long-term effect, then we don't want to loosen monetary policy anymore."

Or, at the same time when they say, "Well, look. Long-term interest rates are already quite low, and, therefore, according to our doctrine, we don't have any need for increased lending." Now, many other researchers in the Federal Reserve say, "Well, that's probably because, in many sense, short-term and long-term interest rates aren't a great measure of the efficacy of monetary policy." Milton Friedman, of course, looked at something like M2. While we wouldn't look at that today, maybe some other sort of measure of how activist or contractionary monetary policy was such as a broad measure of money or nominal gross domestic product, which I know you're a fan of, it would probably be a better indicator of whether the Federal Reserve was being activist or not in this period.

I think, in many ways, this focus on even long-term interest rates was a distraction because they weren't seeing how the collapsing price level, the collapsing credit, amount of deposits in commercial banks, all of which they had available, if you look at their Open Market Committee meetings, and elsewhere, they had all of these charts exactly like we have today pretty much that showed all these collapsing indicators, but they ignored them because they were overwhelmingly focused on these long-term interest rates, which were providing bad signals about the stance of monetary policy and were telling them either that monetary policy was ineffective, or that insofar as it changed, the long-term rate wasn't having a real effect on investment.

When compared against what was actually happening, clearly, monetary policy could have been much more expansionary.

Beckworth: Okay, so let's go back to the Real Bills Doctrine, which Allan Meltzer and a lot of others have argued was the reason the Fed was timid in its response. How do you weight these two stories? Is there any truth to the Real Bills Doctrine, and if so, how important was that view in making the Fed timid versus the view you've outlined in your paper?

Glock: I think you could find a few true blue believers in the Real Bills Doctrine. I mentioned someone like George Norris in the Philadelphia bank, John Calkins, over here in my local San Francisco Reserve Bank, and McDougal over at Chicago, but the majority of the 12 Federal Open Market Committee seem to be much closer believers in the Eugene Meyer, George Harrison belief in pushing long-term rates. As Allan Meltzer, himself said, basically when George Harrison recommended a change, the rest of the banks were very likely to listen to him.

Both ideas certainly had an impact on the Fed at this period, and I wouldn't totally exclude one or the other, but if you look again, both at what the major policymakers were thinking and doing and at what the President Hoover administration was doing, they seem to be following closest to Riefler-Keynes ideas.

Beckworth: Well, you realize, Judge, your papers overthrowing a lot of literature here, right? Because a lot of literature points to Real Bills Doctrine being very important. I expect this paper to be widely cited.

Glock: Or maybe widely cited to argue with, but that's okay too.

Beckworth: As long as they spell your name right and cite you properly.

Glock: Yeah, that's it. I'm perfectly fine with that. Yeah, I don't want to dismiss this. As Allan Meltzer and Friedman and Schwartz themselves and others have pointed out, the Real Bills Doctrines were important at the time. They existed. People believed in them, but it's interesting. If you look even to Allan Meltzer or Friedman and Schwartz's quotes to them, they'll have a lot of quotes in their works about long-term interest rates and the attention that these policymakers paid to long-term interest rates, but they won't put those together into a coherent vision of that.

I think partially because this pre-history of the Great Depression thinking on monetary policy, institutionalist, was a little bit orthogonal to the main trend of monetary thought in the period. People like Wesley Clair Mitchell and Harold Moulton and Winfield Riefler people didn't really think as huge monetary theorists. At least in this area and a few other places like their influence on John Maynard Keynes, I think you can see that they were pretty crucial.

Beckworth: Your article really paints a picture that the Riefler-Keynes Doctrine was widely understood at the time. It was very influential at the Fed. President Hoover bought into it, and he did a Trump move on the Fed because he believes it. This view was an important view at the time, so my question is, how did we forget it? Why is it only 2019 that a researcher named Judge Glock went in and found, that has published a paper on it? That seems to me a glaring hole in the literature.

Glock: Well, I think partially because I think if I had to give a main reason, I think people did not look too seriously at the institutionalist economists that I cited originally. The institutionalist, for those of your listeners not familiar with it, they tended to be much more obsessed with the sort of societal and economic structures that affected the economy than other economists. They were somewhat outside the mainstream, Marshallian ideas about they were more focused on supply and demand curves about marginal changes.

So, a lot of people tended to think they didn't have a very coherent, clear idea about monetary policy, or if they did, it wasn't that important. Even though the term institutionalist economist can be fairly capacious, I think ... A few other people, look at Perry Mehrling, the most important of which. I think you can see that they, in a lot of different ways, they had impact on economists we do think that are much more important, John Maynard Keynes, of course, but also people like Lauchlin Currie who was a major believer in this doctrine and a major economists at the Federal Reserve during the early Roosevelt administration, and Marriner Eccles, a later Federal Reserve Board Chair who basically would repeat a lot of these ideas that George Harrison did in the early years of the Roosevelt administration as well.

I think this previous background of monetary thought wasn't appreciated or was seen as sort of assumed, just like a lot of these ideas seem commonsensical to us today. They don't seem so radical as they were viewed at the period, but they clearly had an important impact, and I hope, in a sense, I can only mention a few of the quotes here, but I hope that the bulk of them and the paper shows exactly how often and clearly people were promulgating these views.

Beckworth: We will provide a link to the paper so listeners can read the paper for themselves. They can see the footnotes and explore this issue themselves.

We only have a few minutes left, Judge, and I want to ask another question to wrap this all up. We mentioned earlier that there were really two stories told for the Great Depression. One is the timid response to the Federal Reserve in the U.S. The other is the global story, which is the mechanism was the integral gold center that transmitted and made this a global phenomenon. In your view, what was more important for the U.S.? Was it the global Great Depression, or was it this adherence to the Riefler-Keynes Doctrine and the Federal Reserve's timidity that was important in creating the Great Depression?

Glock: Well, I guess I think that they're very closely related.

Beckworth: Okay.

Glock: The Federal Reserve in the United States had basically around 35 percent of the world's global gold stock at the beginning of the Great Depression, and their amount of gold actually increased over the next two years basically till the dollar came under attack after England left the gold standard and some thought the United States would be the next to fall. In a sense, not only did the U.S. have a massively disproportionate amount of gold in this period, they continued to increase it during the majority of the Great Depression.

Insofar as the Federal Reserve was being excessively tight, again, depending on how we measure or describe that tightness or we think about that tightness, and the Riefler-Keynes Doctrine contributed to that, then that was certainly contributing to the global depression. At the same time, I think there's a lot to be said for the work of Eichengreen and Scott Sumner and others who showed that places are ... Doug Irwin as well. Places like France, which was accumulating vastly more gold reserve in this period than even the United States, they went from about 70 percent to about 27 percent of the global gold reserves during this period. They must have had a major contribution to the world economic collapse.

As we mentioned before, that an important power of the Great Depression's story is that it was global. It affected countries all across the world. Insofar as the U.S. had a massive amount of the world's gold, they were going to be in a sense an important conductor of what was happening everywhere. The Riefler-Keynes Doctrine might have contributed to them being excessively tight in this period.

Beckworth: Okay, so they are complementary stories, and they-

Glock: I hope.

Beckworth: Yeah, I think so. They help us understand what's going on here domestically with broad implications globally.

Well, our time is up. Our guest today has been Judge Glock, Judge, thank you for coming on the show.

Glock: Thank you so much, David. Real pleasure.

Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. If you haven't already, please subscribe via iTunes or your favorite podcast app. While you're there, please consider rating us and leaving a review. This helps other thoughtful people like you find the podcast. Thanks for listening.

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About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.