Gold Sterilization and the Recession of 1937-38.pdfVIP

Gold Sterilization and the Recession of 1937-38 Douglas A. Irwin Dartmouth College and NBER This Draft: September 9, 2011 Abstract: The Recession of 1937-38 is often cited as illustrating the dangers of withdrawing fiscal and monetary stimulus too early in a weak recovery. Yet existing studies of the recession find that changes in fiscal policy were small in comparison to the magnitude of the downturn, and that higher reserve requirements were not binding on banks. This paper focuses on a neglected change in monetary policy, the sterilization of gold inflows during 1937, and finds that it exerted a powerful contractionary force during this period. Introduction The Recession of 1937-38 was America’s third most severe economic downturn in the twentieth century, after 1929-33 and 1920-21. Real GDP contracted 11 percent and industrial production plunged 30 percent between the second quarter of 1937 and the first quarter of 1938. The civilian unemployment rate, still high in the aftermath of the Great Depression, rose from 9.2 percent to 12.5 percent. Because this sharp downturn occurred when recovery from the Depression was far from complete, it became known as the “recession within a depression.” It set back the recovery from the Depression by two years. The recession is often blamed on the tightening of fiscal and monetary policies. In terms of fiscal policy, the Roosevelt administration became concerned about large budget deficits and began reducing the growth in government spending and increasing taxes. 1 In terms of monetary policy, the Federal Reserve and Treasury became concerned about the inflationary potential of 1 Much of the reduction in spending was simply the ending of the veteran’s bonus. In 1936, over President R