The Roaring Twenties saw the Dow Jones Industrial Average surge sixfold, from 63 in August 1921 to 381 in September 1929. Economist Irving Fisher famously proclaimed “stock prices have reached a permanently high plateau.” This optimism, fueled by technology and widespread investment, ended in a devastating crash.
Black Monday (October 28, 1929) and Black Tuesday (October 29, 1929) saw the Dow Jones plummet nearly 13% and 12%, respectively. By mid-November, the Dow lost almost half its value, bottoming out at 41.22 in the summer of 1932 – an 89% decline. The Dow didn’t recover until November 1954.
Easy credit fueled the boom, allowing ordinary people to invest heavily using borrowed funds. Brokerage houses and margin accounts facilitated this speculation. However, skeptics, including the Federal Reserve, recognized the dangers of this unsustainable growth.
The Federal Reserve believed speculation diverted resources from productive sectors. The Federal Reserve Act, based on the “real bills” doctrine, restricted using Federal Reserve resources for speculative credit. This doctrine advocated expanding credit during growth and contracting it during downturns.
The Federal Reserve debated how to address the speculation. The Federal Reserve Board favored direct action, urging reserve banks to deny credit to banks lending to speculators. The Federal Reserve Bank of New York preferred raising the discount rate to curb borrowing.
In August 1929, the Federal Reserve raised the discount rate to 6%. This had unintended global consequences. Due to the international gold standard, other central banks raised their rates, contributing to a global slowdown.
Despite these efforts, the bubble inflated. Even with fluctuating stock prices in September 1929, some financial leaders, like National City Bank president Charles E. Mitchell, encouraged further investment. Attempts to stabilize the market by buying shares failed, triggering panic selling and the crash.
Following the crash, funds flowed into New York City commercial banks, straining resources. The Federal Reserve Bank of New York intervened by purchasing government securities, expediting lending, and lowering the discount rate. These actions stabilized the banking system, preventing a wider collapse, though initially controversial.
While the Federal Reserve protected banks, the crash impacted the real economy. Consumer confidence plummeted, decreasing spending and production. Unemployment rose, and the economy spiraled into the Great Depression. The 1929 crash highlighted the interconnectedness of the stock market and the broader economy and the challenges of managing speculative bubbles. It also demonstrated the central bank’s role in stabilizing the financial system during crises. Two key lessons emerged: the difficulty of using monetary policy to control speculative markets and the effectiveness of providing liquidity to banks during a financial crisis. These lessons inform economic policy decisions today, especially after the 2008 financial crisis, prompting debate about central banks’ roles in preventing and managing asset bubbles.