The 1932 Federal Reserve Open‐Market Purchases as a Precedent for Quantitative Easing

• Published date: 01 August 2023
• Author: MICHAEL D. BORDO,ARUNIMA SINHA
• Date: 01 August 2023
• DOI: http://doi.org/10.1111/jmcb.12983

DOI: 10.1111/jmcb.12983

MICHAEL D. BORDO

ARUNIMA SINHA

The 1932 Federal Reserve Open-Market Purchases

as a Precedent for Quantitative Easing

The $1 billion open-market operation conducted by the Federal Reserve, at

the height of the Great Depression, was a successful precedent to the recent

Quantitative Easing (QE) programs. The 1932 program entailed large pur-

chases of medium- and long-term securities over a 4-month period. An event

study analysis indicates that the program dramatically lowered medium- and

long-term Treasury yields. A segmented markets model is used to analyze

the effects of the open-market purchases on the economy. A signicant de-

gree of nancial market segmentation is estimated, and partly explains the

observed upturn in output growth. Had the Federal Reserve continued its

operations and used the announcement strategy used in QE1, the Great Con-

traction could have been attenuated earlier. Our historical analysis suggests

that the Federal Reserve in 2008 had a good predecessor to its actions.

JEL codes: E43, E44, E58

Keywords: Federal Reserve bond purchases, segmented markets model,

yield curve

H    -market purchases in

invigorating the economy during a severe downturn?If they have stimulatory effects,

can a credible central bank boost their impact by using forward guidance, an un-

conventional tool of monetary policy? During the nancial crisis of 2007–09 in the

We are grateful to the editor and two anonymousreferees for their comments and feedback. We thank

Annette Vissing-Jorgensenand Vasco Cúrdia for very helpful insights Wealso thank Vasco Cúrdia for pro-

viding us access to his codes. Comments from audiences at the NBER DAE meeting, Berkeley,Banque De

France, UCLA, WarwickUniversity, the London School of Economics, Bank of International Settlements,

Fed System Conference on Economic and Financial History (FRB Richmond), Conference of the Society

for Computational Economics (Bordeaux), International Association of Applied Econometrics (Milan),

Conference on Fixed Income Markets (Federal Reserve Bank of San Francisco and Bank of Canada),

Expectations in Dynamic Macroeconomic Models (Eugene), the Econometric Society World Congress

(Montreal), and European Economic Association (Mannheim) meetings are gratefully acknowledged. We

also thank Andrew Jalil, Kris Mitchener, Eugene White, and Michael Woodfordfor comments.

M B is at Department of Economics, Rutgers University (E-mail: bordo@economics.

rutgers.edu). A S is at Department of Economics, Fordham University (E-mail:as-

inha3@fordham.edu).

Received May 3, 2018; and accepted in revised form April 23, 2020.

Journal of Money, Credit and Banking, Vol. 55, No. 5 (August 2023)

© 2022 The Ohio State University.

1178 :MONEY,CREDIT AND BANKING

United States, and the continuing recessionary trends in Europe and Japan, one of

the key strategies of central banks has been to purchase specic maturities of govern-

ment debt, while at the zero lower bound (ZLB). For instance, in the rst Quantita-

tive Easing (QE) program, the Federal Reserve purchased $300 billion in long-term

Treasury securities, and this purchase program was expanded in the successive QE

programs. To examine the impact of the QE purchase programs, the most prominent

approach has been to estimate the effect of the programs on the term structure of dif-

ferent types of yields; an expanding literature has examined the effect on Treasury

yields.1However, there has been considerable debate about the effect of these pur-

chases on the economy.2There are two main challenges in estimating the effects of

the open-market purchases during the QE1 program: rst, the decline in the state of

the economy during the nancial crisis period was unprecedented, and the effects of

the monetary policy intervention were complicated by the freezing up of credit mar-

kets; and second, there were several unconventional monetary policy tools deployed

in the QE1 program: forward guidance that provided guidelines about the size and

length of the programs, the presence of the ZLB, and the payment of interest rate on

excess reserves.

In this paper, we use a new historical perspective to analyze the effectiveness of

the central bank’s targeted bond purchases during an economic crisis, by considering

the largest open-market operation conducted by the Federal Reserve during the Great

Depression of 1929 to 1933. After 3 years of severe recession, in the face of Con-

gressional pressure, the Federal Reserve undertook a signicant open-market pur-

chase operation between April and August 1932, in which it bought $1 billion of

medium-term securities ($16 billion in today’s prices). At approximately 2% of 1932

GNP, this was comparable to the open-market purchases announced during the rst

QE operation. The New York Times noted, “By entering upon a policy of controlled

credit expansion, designed to turn the deation in bank credit and to stimulate a rise in

prices, the Federal Reserve System has undertaken the boldest of all central bank ef-

forts to combat the depression.”3Although the operation has been noted by previous

studies, it has been overlooked by much of the literature commenting on monetary

policy in the Great Depression.

Our event study analysis reveals that the purchase operation had largeand substan-

tial effects of Treasury yields. This is despite the fact that the 1932 program was not

announced by the Federal Reserve,4focused only on buying medium-term Treasury

securities, and provided no indication of how long the program would last. Friedman

and Schwartz (1963) also note that during the second quarter of 1932, the economy

experienced an uptick in output growth. This was precisely the period during which

the Fed’s open-market purchases were being ramped up, and these authors posit that

1. Swanson (2011), Krishnamurthy and Vissing-Jorgensen (2011).

2. Recent work by Greenlaw et al. (2018) nds that the Long Security Asset Purchases undertaken

during the 2007 crisis had modest effects.

3. The New YorkTimes, quoted in the Commercial and Financial Chronicle, April 16, 1932, p. 2774.

4. The balance sheet of the Federal Reserve was also much smaller.

MICHAEL BORDO AND ARUNIMA SINHA :1179

if the Fed had continued with its program, the economic recovery could have been

much faster. We investigate this hypothesis using our modeling framework, which

suggests that the effects of the program on the real economy can be explained by the

large degree of nancial segmentation during the 1932 period. The main counterfac-

tual suggests that had the program lasted for longer, and been credibly communicated

to the public in advance, the decline in economic activity could have been attenuated

sooner.We posit that the structure and design of the QE1 program circumvented many

of the shortcomings of the 1932 program. The provision of forward guidance to -

nancial markets, the size of the purchase operation, and the wider scope of assets

being purchased were designed to boost real economic activity in a substantial way

in 2008.

Using the 1932 operation to inform the debate about the effectiveness of the open-

market purchases undertaken during QE1 is only valid to the extent that economic

conditions were comparable at the time of the two operations. As we show below,the

states of the economy during the 1932 operation, and the rst QE program were, in

fact, quite similar in terms of key macro-economic and nancial terms. There were

also political similarities: at the time of the 1932 operation, the Congress and the

public were desperate for active intervention by the central bank. In 2008, there was

widespread discussion among the public about the need for intervention by the Fed-

eral Reserve.5Therefore, we propose to use the 1932 operation to provide a historical

perspective for examining the effectiveness of the QE1 open-market purchases, and

the importance of using forward guidance. In this analysis, we will only consider the

rst QE program, as the successive programs were anticipated to some degree by

nancial market participants.

A brief overview of our methodology and ndings follows: we rst analyze the

effect of the operation on the cross section of Treasury yields using an event study

methodology. Since there were no announcements, we construct a narrative record

of the period preceding and during the operation. Around the dates identied from

the narrative record, there were signicant changes in the yields on Treasury securi-

ties. For instance, the maximum cumulative effect from the daily changes on Trea-

sury Bills was a decline of 90 basis points (b.p.); Certicates and Notes yields fell

by 114 b.p. and the yields on Bonds fell by 42 b.p. Therefore, even though the pur-

chase program was motivated by the economic and political conditions of a very

different era, the program had important effects on the term structure of Treasury

yields.

The event study analysis is very informative about the effectsof the purchase pro-

gram on the yield curve. In the quarter that the Fed’spurchases were being conducted,

there was also the rst uptick in output growth that the economy had seen in several

quarters; between the second and third quarters of 1932, output growth rose by 0.38%

after several quarters of negativegrowth rates. Therefore, we are interested in examin-

ing whether the Fed’s purchases could havehad the stimulative effects on output, and

5. There was comprehensive coverage in various news publications. An exampleof this: “As Credit

Crisis Spiraled, Alarm Led to Action,” New YorkTimes, October 1, 2008.