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Did the Reserve Requirement Increases of 1936–1937 Reduce Bank Lending? Evidence from a Natural Experiment

Haelim Park's picture

The recession of 1936–37 was one of the most severe recessions in economic activity in the history of the United States. This sharp but short-lived recession occurred while the U.S. economy was recovering from the Great Depression of 1929–1932. After expanding for 50 months, from March of 1933 to May 1937, real GDP fell by 11 percent from May 1937 to June 1938. Industrial production fell by a staggering 32 percent.

The recession was preceded by increases in reserve requirements for Federal Reserve member banks. In 1936–37, the Federal Reserve became worried about the large level of excess reserves in the banking system, and considered them an inflationary threat. The Federal Reserve doubled reserve requirements as an insurance policy against this threat. The first increase came on August 16, 1936. The Federal Reserve increased reserve requirements again on March 1, 1937 and a third and final time on May 1, 1937. After the third increase, reserve requirements had doubled from the levels they had been from June 21, 1917 to August 1936. Due to the timing of the two events, the recession and the reserve requirement increases, scholars have debated whether the Federal Reserve’s reserve requirement increases of 1936–37 reduced bank lending and engendered the economic recession of 1937–1938. In a new paper, Patrick Van Horn (Southwestern) and I test whether the Federal Reserve’s increases in reserve requirements reduced bank lending.