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

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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.

Our study utilizes a new quarterly-level dataset on all state-chartered commercial banks and trust companies in New York from 1935 through 1938. The data include state banks that were members of the Federal Reserve System, and state banks that were not members of the Federal Reserve System. When the Federal Reserve System was established in 1913, it permitted state-chartered banks to become Federal Reserve members if they met the standards of the Federal Reserve System. This unique feature allows for a treatment and a control group to test the effects of the reserve requirement increases. We analyze the effect of the changes in reserve requirements by comparing the lending behavior of member banks to that of nonmember banks. In 1936 and early 1937, when the Federal Reserve increased the required reserve ratio, the policy affected the reserves of member banks while it did not affect the reserves of nonmember banks. If member banks faced a financing constraint due to the doubling of reserve requirements, the lending behavior of member banks would differ from that of nonmember banks.

The economic structure of New York State also offers an ideal environment to examine how the increases in the reserve requirements affected the lending behavior of member banks. New York had a diverse economy with various types of banks. Banks in rural agricultural areas, which operated as unit banks, accepted small deposits which were protected by deposit insurance and provided loans to local farmers. Banks in manufacturing cities such as Buffalo and Albany served as correspondent banks for unit banks in rural areas and issued industrial loans. And finally, banks in New York City, many of which had branches within the city and its boroughs, served as the ultimate depositories of the banking systems’ reserves and lent to large, industrial clients.

Our analysis shows that member banks did not contract bank lending in response to the increase in reserve requirements. The lending behavior of member banks did not differ from that of nonmember banks. Member banks were able to mitigate the contractionary effects of the Fed’s reserve requirements by selling securities.

Our study suggests understanding how other policy changes affected the U.S. economy is important. During this period, monetary policy was tightened not only due to the Fed’s doubling of reserve requirements, but also due to the Treasury’ sterilization of gold inflows from Europe to the U.S. bled reserve requirements. Fiscal policy also became tighter as the Roosevelt administration attempted to achieve a balanced budget by reducing the growth in government spending and increasing taxes (Friedman and Schwartz, 1963; Romer, 1992; Eggertson, 2008; Velde, 2009; Irwin, 2011). Lastly, New Deal industrial and labor policies raised wages in the manufacturing sector and stunted economic recovery (Cole and Ohanian, 2001, 2009; Hausman, 2012).

Our study has an important implication for monetary policy today. Following multiple rounds of successive quantitative easing, excess reserves increased dramatically in the U.S. banking system beginning at the end of 2008. The Federal Reserve currently wants to reduce these excess reserves. While increasing reserve requirements against deposits is an available option, policy makers are worried that this will affect banks’ ability to lend. Our study shows that increases in reserve requirements can be a worthy way to control excess reserves without immediately affecting the lending behavior of banks if reserve requirements are not binding.


Calomiris, Charles W., Joseph Mason, and David Wheelock. (2011). “Did Doubling Reserve Requirements Cause the Recession of 1937–1938? A Microeconomic Approach." NBER Working Paper 16688.

Cole, Harold and Lee Ohanian. (2001). “Re-Examining the Contribution of Money and Banking Shocks to the U.S. Great Depression.” NBER Macroeconomics Annual, 2001, 183–227.

Cole, Harold and Lee Ohanian. (2004). “New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis.” Journal of Political Economy, 112(4): 779–816.

Eggertsson, Gauti B. (2008). “Great Expectations and the End of the Depression.” American Economic Review, 98(4): 1476–1516.

Friedman, Milton and Anna J. Schwartz. (1963). A Monetary History of the United States, 1867–1960. Princeton: Princeton University Press.

Hausman, Joshua. (2012). “What was Bad for GM was Bad for America: the Automobile Industry and the 1937–38 Recession.” Working paper, University of California at Berkeley.

Irwin, Douglas A. (2011). “Gold Sterilization and the Recession of 1937–38.” Financial History Review, 19(3): 249–267.

Romer, Christina. (1992). “What Ended the Great Depression?” Journal of Economic History, 52(4): 757–784.

Velde, Francois R. (2009). “The Recession of 1937 - A Cautionary Tale.” Federal Reserve Bank of Chicago Economic Perspectives, 33, 16–37.


Haelim Park

Financial Economist

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