Unintentional quantitative easing ended the Great Depression

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Novel analysis from Christina Romer (Economic Historian).

brookings.edu/~/media/Files/ … _romer.pdf

A second key lesson from the 1930s is that monetary expansion can help to heal an economy even when interest rates are near zero. In the same paper where I said fiscal policy was not key in the recovery from the Great Depression, I argued that monetary expansion was very useful. But, the monetary expansion took a surprising form: it was essentially a policy of quantitative easing conducted by the U.S. Treasury.

The United States was on a gold standard throughout the Depression. Part of the explanation for why the Federal Reserve did so little to counter the financial panics and economic decline was that it was fighting to defend the gold standard and maintain the prevailing fixed exchange rate.13 In April 1933, Roosevelt temporarily suspended the convertibility to gold and let the dollar depreciate substantially. When we went back on gold at the new higher price, large quantities of gold flowed into the U.S. Treasury from abroad. These gold inflows serendipitously continued throughout the mid-1930s, as political tensions mounted in Europe and investors sought the safety of U.S. assets.
Under a gold standard, the Treasury could increase the money supply without going through the Federal Reserve. It was allowed to issue gold certificates, which were interchangeable with Federal Reserve notes, on the basis of the gold it held. When gold flowed in, the Treasury issued more notes. The result was that the money supply, defined narrowly as currency and reserves, grew by nearly 17% per year between 1933 and 1936.14
This monetary expansion couldn’t lower nominal interest rates because they were already near zero. What it could do was break expectations of deflation. Prices had fallen 25% between 1929 and 1933.15 People throughout the economy expected this deflation to continue. As a result, the real cost of borrowing and investing was exceedingly high. Consumers and businesses wanted to sit on any cash they had because they expected its real purchasing power to increase as prices fell. Devaluation followed by rapid monetary expansion broke this deflationary spiral. Expectations of rapid deflation were replaced by expectations of price stability or even some inflation.