Did Raising the Reserve Requirments in 1936 and 1937 Prolong the Great Depression?

Since the publication of Milton Friedman and Anna Schwartz's A Monetary History of the United States 1867-1960, the conventional answer has been yes. Richard Timberlake has called the Fed's raising the legal reserve requirements three times during 1936 and '37 a "debacle" that ushered in monetary contraction and a second recession within the Great Depression.

In his essay "Money and Gold in the '20s and '30s" originally published in The Freeman and reprinted in the new book Money Sound and Unsound, Joseph Salerno offers a different perspective. Salerno notes that "the money supply (M2) continued to grow from June of 1936 to June of 1937, the year the policy was implemented." Hardly a deflationary contraction.

Two other articles published in the Journal of Post Keynesian Economics also argue against the notion that the 1937-38 contraction was due to higher reserve requirements. The first is L. G. Telser's "Higher member bank reserve ratios in 1936 and 1937 did not cause the relapse into depression." The abstract reads as follows:

Examination of both sides of member banks' balance sheets reveals evidence that refutes the claim that higher member bank reserve ratios imposed by the Federal Reserve Board of Governors in 1936 and 1937 caused the re- lapse of the U.S. economy into depression. Member banks responded to higher reserves by selling some of their U.S. Treasury paper and did not reduce their loans to business.

Robert Stauffer draws on Tesler's work in his article, "Another Perspective on the Reserve Requirement Increments of 1936 and 1937." The abstract is as follows:

The purpose of this analysis is to investigate three issues surround- ing the Federal Reserve's doubling of reserve requirements between August 1936 and May 1937. First of all, arguments are offered that strengthen and complement L.G. Telser's analysis of how bank lending was affected by reserve ratio increases. Second, a unique money multiplier model is utilized to mea- sure the impact of these policy changes on excess reserves and the money sup- ply. Finally, the possible relationships between Fed policy changes and the recession of 1937-1938 are discussed, including the Friedman and Schwartz perspective.

The issue of increased legal reserve requirements is important because that is one avenue, and perhaps the best one, the Fed could take to exit from the aftermath of all the quantitative easing so as to avoid actual hyper-inflation.