The last time the US government tried to raise the price level

My research career often focused on offbeat topics that no one else seemed to be interested in.  Now it might be paying off.  One of those topics was Roosevelt’s “gold-buying program” of October-December 1933.  The only other article I’ve ever seen on this topic was published in an agricultural journal back in the 1950s.  This program was the last time (and perhaps only other time) that the US government explicitly tried to raise the price level.  Admittedly the entire April 1933-January 1934 dollar depreciation policy was aimed at reflation, but only during the gold-buying phase was the policy made explicit, and was a methodical policy followed to raise prices.

I did a long post on this in early 2009, and won’t repeat it all here.  Check out the post if you want to know more about how it was done.  Instead I’d like to discuss one very interesting aspect of the program that is relevant to what is going on right now.  (The policy involved raising the dollar price of gold to devalue the dollar.)  Here is a short passage from my Depression manuscript:

Then on November 20 and 21, the RFC price rose by a total of 20 cents and the London price of gold rose 49 cents.  On November 22 the NYT headline reported “SPRAGUE QUITS TREASURY TO ATTACK GOLD POLICY” and on page 2, “Administration, Realizing This, Vainly Tried to Persuade Him to Silence on Gold Policy”.  As with the Woodin resignation, Sprague’s resignation led to a temporary hiatus in the RFC gold price increases, this time lasting five days.

Over the next several days the controversy continued to increase in intensity.  The November 23 NYTreported “RESERVE’S ADVISORS URGE WE RETURN TO GOLD BASIS; PRESIDENT HITS AT FOES” other stories reported opposition by J.P. Warburg, and a debate between Warburg and Irving Fisher (a supporter of the plan).[1]  Another story was headlined “WARREN CALLED DICTATOR”.  The November 24 NYT headline suggested that “END OF DOLLAR UNCERTAINTY EXPECTED SOON IN CAPITAL; RFC GOLD PRICE UNCHANGED”.  Nevertheless, over the next few days the NYT headlines showed the battle raging back and forth:


“SMITH SCORES POLICY . . . Says He Is in Favor of Sound Money and Not ‘Baloney’ Dollar . . . ASKS RETURN TO GOLD . . . Critical of Professors Who ‘Turn People Into Guinea Pigs’ in Experiments” (11/25/33)

“GOLD POLICY UPHELD AND ASSAILED HERE AT RIVAL RALLIES . . . 6,000 Cheer [Father] Coughlin as He Demands Roosevelt Be ‘Stopped From Being Stopped'” (11/28/33)

[1]  Fisher regarded Roosevelt’s policy as being essentially equivalent to his Compensated Dollar Plan.  Although there were important differences, the rhetoric used by Roosevelt to justify the policy was remarkably close to the rationale behind Fisher’s plan.

The Fed better fasten its seat-belt, as the previous price level raising policy was a bit controversial.  Several FDR advisers resigned in protest.

George Warren was the FDR advisor behind the plan.  Warren was to Irving Fisher roughly what I am to Milton Friedman—similar ideology but lacking the intellectual brilliance.   Here’s a more important passage:

“It is indeed difficult to find out exactly what are Wall Street’s views with regard to the monetary question.  When former Governor Smith made public his letter and stocks were going up, there seemed to be little doubt that Wall Street wanted sound money.  But yesterday, faced with the sharpest break of the month, opinion veered toward inflation again.  As one broker expressed it, it begins to appear as if Wall Street would like to see enough inflation to double the price of stocks and commodities, but little enough so that Liberty bonds can sell at a premium.” (NYT, 11/28/33, p.33.)

One explanation for this ambiguity is that investors distinguished between once and for all changes in the price level, and changes in the rate of inflation.  During the early stages of the dollar depreciation, long term interest rates held fairly steady, and the 3 month forward discount on the dollar (against the pound) remained below 1.5 percent.  The market apparently viewed the depreciation as a one-time monetary stimulus, which would not lead to persistent inflation.  Investor confidence was shaken during November, however, when persistent administration attempts to force down the dollar were associated with falling bond prices and an increase in the forward discount on the dollar.  Consistent with this interpretation, the Dow rose 4.6 percent in mid-January 1934, following the Administration’s announcement that a decision was imminent to raise, and then fix, the price of gold.  The NYT noted that:

“The satisfaction found by stock and commodity markets in the inflationary implications of the program was nearly matched by the bond market’s enthusiasm for the fact that the government had announced limitations to dollar devaluation.” (1/16/34, p. 1).

The takeaway from all this is that markets seem to really want higher prices, but not higher inflation.  You do that by switching from inflation targeting to level targeting, when inflation has recently run below target.  Yesterday when the Fed minutes suggested the Fed was about to do that, equity markets responded strongly all over the world.  I’d guess about $500 billion dollars in wealth was created worldwide in 24 hours by 13 words from the Fed’s minutes:

. . . targeting a path for the price level rather than the rate of inflation . . .

The markets already knew QE was likely, but now the Fed seems increasingly serious about level targeting.

In 1933, the markets were surprised when the gold buying program briefly pushed long term T-bond yields higher (Liberty bonds in the quotation.)  Under the gold standard, the expected rate of inflation was generally roughly zero.  Investors were used to a liquidity effect (easy money means low rates) but not a Fisher effect (easy money raises inflation expectations, and thus interest rates.)  Even Keynes was pretty much oblivious to the Fisher effect:

“If you are held back [i.e. reluctant to buy bonds], I cannot but suspect that this may be partly due to the thought of so many people in New York being influenced, as it seems to me, by sheer intellectual error.  The opinion seems to prevail that inflation is in its essential nature injurious to fixed income securities.  If this means an extreme inflation such as is not at all likely is more advantageous to equities than to fixed charges, that is of course true.  But people seem to me to overlook the fundamental point that attempts to bring about recovery through monetary or quasi-monetary methods operate solely or almost solely through the rate of interest and they do the trick, if they do it at all, by bringing the rate of interest down.” (J.M. Keynes, Vol. 21, pp. 319-20, March 1, 1934.)

Before we judge Keynes too harshly, recall that he lived in a time of near-zero inflation expectations, with the exception of clearly anomalous situations like the German hyperinflation.  So when FDR’s policy of reflation briefly seemed to be raising long term bond yields in November 1933, bond market participants were rather shocked.  And here’s what I find so fascinating; modern security markets are only now beginning to grapple with this distinction, which turns out to be pretty hard to wrap one’s mind around.  Here’s something from today’s news:

Neil MacKinnon, global macro strategist at VTB Capital, said the worry in the markets is that the Fed’s attempt to raise inflation may not be as manageable and as controllable as it thinks.

“The bond market is alert to the potential contradiction in Fed policy of buying U.S. Treasuries to keep bond yields down and ideas such as price-level targeting that are likely to raise bond yields,” he said.

That’s the conundrum; what counts as “success,” higher nominal bond yields or lower nominal bond yields?  Everyone seems to assume the Fed is trying to lower bond yields, but if the policy is expected to produce a robust recovery and higher inflation, how can bond yields not rise?  I can’t answer these questions, but my hunch is that it has something to do with the higher inflation/higher price level distinction.  If the Fed can convince markets that they can raise the price level without changing their 2% inflation target, it is likely that all markets will react positively.  If they are seen as raising inflation in a semi-permanent way, stocks may still rise (albeit by a smaller amount), but bonds will sell off.

This is such an unusual circumstance that I don’t have much confidence in my own opinion, nor anyone else’s.  I don’t even know of anyone else who bothered to study what happened the last time Uncle Sam tried to raise the price level.  Too busy doing those VAR studies and DSGE models.

PS:  Where did the $500 billion figure come from?  I guesstimated world stock market valuation at about $50 trillion, with a 1% bump from the Fed move.  The financial press reported that all the world’s stock markets were affected by the Fed action.  I noticed that European stocks rose about 2%, and the Fed move was cited as the primary factor.  So I think $500 billion is roughly the order of magnitude, although obviously the exact figure is unknowable.  BTW, sometimes it is possible to get semi-accurate estimates, as when a huge market reaction following immediately upon a 2:15 Fed announcement and we have relevant odds from the fed funds futures markets.  And in those cases the effect is often much bigger.  I can’t wait for November 3rd.



21 Responses to “The last time the US government tried to raise the price level”

  1. Gravatar of Morgan Warstler Morgan Warstler
    13. October 2010 at 17:47

    Scoot, PLEASE pause and consider this reasoning made clear by Cochrane:

    The JOY of price level targeting (2% inflation) is NOT that right now Scott Sumner gets to see some QE.

    No sir! That’s the bad part of the deal. After all, done to soon and it might bump things along and keep us from gutting Public Employees.

    The JOY IS that EVERYONE is used to inflation running way over 2% (just like they were used to zero back then), and suddenly there is a promise that when inflation runs 2.5%, the Fed is going to start pulling money out of the system.

    It becomes a CLEAR POLICY OF INFLATION FIGHTING, even if unemployment stays at 9%, no worries! because Sumner’s Fed is going to ratchet down baby – stop buying and retire debt.

    Pissing on booms = capital formation = real cost of credit = gut the losers = liquidation of previous sins

    This policy is kinda of like the Stimulus if it ALSO INCLUDED 25% cuts in Public Employees when NGDP = 5%.

    Jesus, with that attached EVERY REPUBLICAN would have voted for the Stimulus.

    That’s what the market likes.

    Question: do you not talk about that part becuase you think the neoliberals won’t go along with it?

  2. Gravatar of Alan Rai Alan Rai
    13. October 2010 at 20:24


    When talking about which of the Fisher or liquidity effects dominate, the answer depends on the duration of the security. If the higher inflation rate is expected to be transitory, reflecting a return to a price-level path, then a liquidity effect may dominate for longer-term securities, while the Fisher effect may be more important for shorter term securities.

    The size of inflation risk premia would also play a role here: a return to a price-level path may imply greater short-run inflation volatility, than would be the case under a “memoryless” inflation target, which would tend to increase the Fisher effect for shorter-term securities.

    In the longer run, however, belief in the credibility of the Fed to stick to a price-level trajectory should reduce the risk premia on longer-term securities and reduce the longer-term yields.

  3. Gravatar of Morgan Warstler Morgan Warstler
    14. October 2010 at 00:09

    And here’s why you have to be satisfied with 2% starting in 2011…

    “[I]nflation is now on target, as far as I’m concerned. Over the last 12 months the price index for personal consumption expenditure has risen 1.5 percent, which is exactly what I’ve been recommending for the last six years. We also track a core price index that omits volatile food and energy prices, and it is sending the same message, having risen by 1.4 percent over the last 12 months. I believe that the Fed’s best contribution to our nation’s economic prosperity over time would be to keep inflation stable near the current 1.5 percent rate”

    Lacker anchors, Cochrane gives you a little play… 2%@2011 – sounds like a good compromise.

  4. Gravatar of Doug Bates Doug Bates
    14. October 2010 at 03:11

    Whether the Fed endorses an explicit, higher inflation target of 3%-4%, or what you call price level targeting, I think to the extent the market believes the Fed then inflation and economic activity will increase — which would be good for the economy and would help to reduce unemployment.

    The danger, of course, is that the market will overshoot and create an inflationary spiral like we saw during the 1970s — though I think an inflationary spiral would do a lot of good right now in helping to reduce real debt levels. An inflationary spiral would be toxic for politicians, though — the lesson from the 1970s is that Presidents don’t get any credit for real economic growth that is accompanied by spiraling inflation (real GDP grew almost exactly as fast during the 1970s as during the 1980s). We could see a series of one-term presidents for the rest of this decade 😉

    Nevertheless, as an underwater homeowner, I’m rooting for the inflationary spiral. Go Fed! Go Fed!

  5. Gravatar of Mark A. Sadowski Mark A. Sadowski
    14. October 2010 at 04:54

    Scott wrote:
    “I don’t even know of anyone else who bothered to study what happened the last time Uncle Sam tried to raise the price level. Too busy doing those VAR studies and DSGE models.”

    I think I know how you feel. The last research seminar I attended concerned the presenter’s attempt to force an RBC model into exibiting bubble-like behavior in the asset markets. I was busy controlling my impulse to laugh hysterically during much of it.

    I was gratified when two members of my dissertation committee spoke up. Laurence Seidman questioned the relevance of a supply side driven RBC model in the wake of the most serious demand driven recession in a lifetime.

    James Butkiewicz criticized the author’s policy prescription by citing the historical evidence. He pointed out that every time “bubbles” have been popped (he mentioned 1929 and 2008) they yield disasterous results that the advocates of “bubble” popping view as self justifying. It’s a curious form of circular reasoning.

    P.S. Who was the presenter? Kevin Lansing, Federal Reserve Bank of San Francisco, “Speculative Growth and the Welfare Cost of Technology Driven Bubbles.” Doesn’t do much to inspire one’s confidence in the Fed, does it?

  6. Gravatar of JTapp JTapp
    14. October 2010 at 05:21

    Scott, I don’t know if you saw this recent WSJ article (“The End of Free Trade?” by Doug Irwin (with help from Barry Eichengreen–they published a similar piece at Project Syndicate).
    It discusses how Smoot-Hawley could not have caused the “macroeconomic collapse” as is commonly thought since the imports affected were such a small part of GDP. I understand from your book chapter postings a while back that you felt differently–the stock market didn’t respond favorably to news of its coming passage.

    He then goes on to discuss the abandonment of the gold standard and its parallels to QE today for stimulus.
    “The defining moment for trade policy in the Depression era was not when President Herbert Hoover signed the ill-conceived tariff in June 1930, but when several countries abandoned the gold standard and others did not in September 1931.”

    (Just in case you hadn’t seen it, thought you might comment with how their research agrees/contradicts yours)

  7. Gravatar of Doc Merlin Doc Merlin
    14. October 2010 at 05:29

    Didn’t the tariffs caused the crash though?

  8. Gravatar of Doc Merlin Doc Merlin
    14. October 2010 at 05:30

    Sorry, the previous post was directed at JTapp.

  9. Gravatar of Sean Brown Sean Brown
    14. October 2010 at 07:22

    JTapp – What about the impact of retaliatory tariffs on U.S. exports? And what about world trade in general plummeting, partly due to these tariff systems?

  10. Gravatar of paul paul
    14. October 2010 at 07:32

    Sorry to post off topic but I can’t seem to find out the Fed’s accounting for QE2. In lecture 13 on money and banking from the Khan Academy he says that the Fed “writes a check to itself” then buys a bond from the treasury. Wikipedia says the fed creates money “out of nothing.” What does the balance sheet accounting look like for QE? Does the fed literally counterfeit money that shows up as “profit” on the feds balance sheet or is there an offsetting liability at the treasury (or somewhere else) that represents a future tax obligation?

    To me this is relevant because I’m still not sure how the fed can influence prices at all except with massive debt issuance. Any references for the answer would be greatly appreciated.

  11. Gravatar of Howard Howard
    14. October 2010 at 08:46

    And here’s what I find so fascinating; modern security markets are only now beginning to grapple with this distinction, which turns out to be pretty hard to wrap one’s mind around.

    Hard to understand with many mental models, almost common sense with a really good one.

  12. Gravatar of marcus nunes marcus nunes
    14. October 2010 at 11:26

    If markets “believe” QE, long bond yields go up and so does stocks. Just prior to QE1 on March 2009, 10 year yields averaged 2.7%. They quickly went to an average of 3.7% all the way to March 2010 when QE ended. The S&P, during the same period went from 750 to 1200!

  13. Gravatar of EGrO EGrO
    14. October 2010 at 11:27

    To add to what JTapp said, Doug Irwin was on EconTalk this week talking about the GD and the gold standard:

    Haven’t listened to it fully, so I can’t comment yet, but might lead to some interesting discussion.

  14. Gravatar of Yglesias » Real Wage Readjustments Are Best Handled Through Monetary Policy Yglesias » Real Wage Readjustments Are Best Handled Through Monetary Policy
    14. October 2010 at 12:12

    […] wages. But you could also achieve this outcome by raising the price level. The politics of this are also a bit ugly but the logistics are much better. You don’t need to say to any firm, individual, union, […]

  15. Gravatar of scott sumner scott sumner
    14. October 2010 at 18:20

    Morgan, Please stop talking about inflation targeting–we need NGDP targeting.

    Alan Rai, It certainly depends partly on maturity, and also partly on the sort of inflation we are looking at. But I still don’t think we have good models of this.

    Doug Bates, I am afraid there won’t be any 1970s-style inflationary spiral. That’s one of the few things I’m certain about.

    Mark, I know exactly how you feel.

    JTapp, The Depression had many causes, but the initial contraction was primarily an AD problem. I think I am one of the few who thinks Smoot-Hawley reduced AD. But I don’t see it as decisive, there were many other causes, including the events of 1931.

    Doc Merlin, The tariffs caused the stock crash of May-June 1930, but not the 1929 crash.

    Paul, Yes, the Fed’s a sort of counterfeiter, but they do it legally. If you did what the Fed did, you’d print $20 bills in your basement, and then go out and buy back your mortgage from the bank. The Fed prints money, and buys back the government’s debt. Too good to be true? Yes, that’s why there is no such thing as liquidity traps. Do too much and you create inflation.

    Howard, I’d say then that you have uncommonly good sense.

    marcus, I agree, but I still can’t figure out why long rates fell on the March 2009 QE announcement.

    EGrO, Yes, he has a new paper talking about French gold hoarding in the 1930s. Gold standard experts know about this, but outsiders are often surprised by how much gold the French hoarded. It was enough to single-handedly reduce world prices by around 15% to 20%, I don’t recall the exact figure. The US also hoarded gold.

  16. Gravatar of Morgan Warstler Morgan Warstler
    14. October 2010 at 18:31

    Well Scott… that’s the problem!

    At 2% inflation level targeted starting @2011, we can TOTALLY do that.

    But who knows HOW HIGH inflation would be if we targeted NGDP?


  17. Gravatar of marcus nunes marcus nunes
    14. October 2010 at 20:08

    @ Morgan
    You MUST be joking?

  18. Gravatar of Lee Kelly Lee Kelly
    15. October 2010 at 08:17

    Please stop talking about “NGDP targeting” — call it “nominal income” targeting instead, because it’s much more politically palatable that way.

  19. Gravatar of ssumner ssumner
    15. October 2010 at 16:02

    Morgan, Who cares?

    Lee Kelly, I’m too lazy to type out that many letters. 🙂

  20. Gravatar of Morgan Warstler Morgan Warstler
    15. October 2010 at 16:10

    Scott, The Fed!

  21. Gravatar of Should the Fed target the price level? | Bruegel Should the Fed target the price level? | Bruegel
    12. February 2016 at 08:03

    […] in October 2008. Remember, NGDP fell in 2009 at the fastest rate since 1938. In another post, Sumner notes that Roosevelt’s “gold-buying program” of October-December 1933 was the last […]

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