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the failure of otherwise sound banks. In a few weeks or months, when the situation had stabilized, the suspension could be lifted, and recovery begin without monetary contraction. |
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As we have seen, one of the major reasons for establishing the Federal Reserve System was to deal with such a situation. It was given the power to create more cash if a widespread demand should arise on the part of the public for currency instead of deposits, and was given the means to make the cash available to banks on the security of the bank's assets. In this way, it was expected that any threatened panic could be averted, that there would be no need for suspension of convertibility of deposits into currency, and that the depressing effects of monetary crises could be entirely avoided. |
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The first need for these powers and hence the first test of their efficacy came in November and December of 1930 as a result of the string of bank closings already described. The Reserve System failed the test miserably. It did little or nothing to provide the banking system with liquidity, apparently regarding the bank closings as calling for no special action. It is worth emphasizing, however, that the System's failure was a failure of will, not of power. On this occasion, as on the later ones that followed, the System had ample power to provide the banks with the cash their depositors were demanding. Had this been done, the bank closings would have been cut short and the monetary debacle averted. |
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The initial wave of bank failures died down and in early 1931 there were signs of returning confidence. The Reserve System took advantage of the opportunity to reduce its own credit outstandingwhich is to say, it offset the naturally expansionary forces by engaging in mild deflationary action. Even so, there were clear signs of improvement not only in the monetary sector but also in other economic activities. The figures for the first four or five months of 1931, if examined without reference to what actually followed, have all the earmarks of the bottom of a cycle and the beginning of revival. |
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The tentative revival was however short-lived. Renewed bank failures started another series of runs and again set in train a renewed decline in the stock of money. Again, the Reserve System stood idly by. In the face of an unprecedented liquidation |
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