The Roaring Twenties witnessed an unprecedented surge in the Dow Jones Industrial Average, rising sixfold from 63 in August 1921 to 381 in September 1929. Economist Irving Fisher famously declared that “stock prices have reached ‘what looks like a permanently high plateau.'” This era of optimism fueled by technological advancements and widespread investment in stocks and bonds, however, culminated 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 had lost almost half its value, eventually bottoming out at 41.22 in the summer of 1932 – an 89% decline from its peak. It took until November 1954 for the Dow Jones Industrial Average to recover to its pre-crash levels.
This financial boom was fueled by readily available credit, allowing ordinary individuals to invest heavily in the stock market using borrowed funds. A new industry of brokerage houses and margin accounts facilitated this speculative frenzy. However, skeptics, including the Federal Reserve, recognized the potential dangers of this unsustainable growth.
The Federal Reserve believed that stock market speculation diverted resources from productive sectors of the economy. The Federal Reserve Act, grounded in the “real bills” doctrine, restricted the use of Federal Reserve resources for speculative credit. This doctrine advocated for expanding credit during economic growth and contracting it during downturns.
The Federal Reserve debated how to address the escalating 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, however, preferred raising the discount rate to curb borrowing.
In August 1929, the Federal Reserve finally raised the discount rate to 6%. This move, however, had unintended global consequences. Due to the international gold standard, other central banks were forced to raise their interest rates, contributing to a worldwide economic slowdown.
Despite these efforts, the speculative bubble continued to inflate. Even as stock prices fluctuated wildly in September 1929, some financial leaders, like Charles E. Mitchell, president of National City Bank, encouraged further investment. Attempts to stabilize the market by publicly purchasing shares ultimately failed, triggering panic selling and the catastrophic crash.
Following the crash, funds flowed into New York City commercial banks, straining their resources. The Federal Reserve Bank of New York intervened by purchasing government securities, expediting lending, and lowering the discount rate. These actions helped stabilize the banking system and prevent a wider financial collapse, though they were initially controversial.
While the Federal Reserve’s actions protected banks, the stock market crash had a significant impact on the real economy. Consumer confidence plummeted, leading to decreased spending and production cuts. Unemployment rose, and the economy spiraled into the Great Depression. The crash of 1929 highlighted the interconnectedness of the stock market and the broader economy and the challenges of managing speculative bubbles. The crash also demonstrated the importance of a central bank’s role in stabilizing the financial system during times of crisis. Two key lessons emerged from the crash: the difficulty of using monetary policy to control speculative markets and the effectiveness of providing liquidity to banks during a financial crisis. These lessons continue to inform economic policy decisions today, especially in the wake of the 2008 financial crisis, prompting renewed debate about the role of central banks in preventing and managing asset bubbles.
