The 1920s, often called the Roaring Twenties, were a period of unprecedented economic boom in the United States. This era of exuberance found its loudest expression on the New York Stock Exchange, where share prices soared to dizzying heights. The Dow Jones Industrial Average, a key indicator of stock market performance, surged sixfold, climbing from 63 in August 1921 to a peak of 381 in September 1929. Amidst this relentless climb, the renowned economist Irving Fisher famously declared that stock prices had reached “what looks like a permanently high plateau,” just before the market’s dramatic reversal. 1
However, this epic boom was not destined to last. It culminated in a devastating market crash that reverberated throughout the global economy. Black Monday, October 28, 1929, marked the beginning of the sharp decline, with the Dow Jones plummeting nearly 13 percent. The following day, infamously known as Black Tuesday, saw another catastrophic drop of almost 12 percent. By mid-November, the Dow had lost nearly half of its peak value. This downward spiral continued relentlessly until the summer of 1932, when the Dow reached its nadir for the twentieth century, closing at 41.22 – a staggering 89 percent below its peak. It would take until November 1954 for the Dow to finally reclaim its pre-crash heights, highlighting the profound and long-lasting impact of the Wall Street Crash.
This financial boom was fueled by a pervasive sense of optimism that permeated American society. Families experienced growing prosperity, and new technologies like automobiles and telephones became increasingly widespread. Ordinary citizens began investing heavily in stocks and bonds, spurred by the burgeoning industry of brokerage houses, investment trusts, and margin accounts. These new financial instruments allowed individuals to purchase stocks with borrowed funds, typically putting down only 10 percent of the price and borrowing the rest. The purchased stocks themselves served as collateral for these loans. This influx of borrowed money into the equity markets further inflated stock prices, creating a speculative bubble.
Despite the widespread euphoria, some voices of caution emerged. The Federal Reserve, the central banking system of the United States, was among the skeptics. Many governors of Federal Reserve Banks and a majority of the Federal Reserve Board believed that excessive stock market speculation was diverting resources away from productive sectors of the economy, such as commerce and industry. The Board asserted that the Federal Reserve Act was not intended to support the use of Federal Reserve resources for “the creation or extension of speculative credit” (Chandler 1971, 56). 2
This stance was rooted in the Federal Reserve Act itself. Section 13 of the Act authorized reserve banks to accept assets financing agricultural, commercial, and industrial activities as collateral for discount loans. However, it explicitly prohibited accepting “notes, drafts, or bills covering merely investments or issued or drawn for the purpose of carrying or trading in stocks, bonds or other investment securities, except bonds and notes of the Government of the United States” (Federal Reserve Act 1913).
Section 14 further reinforced these limitations, extending them to open market purchases. 3
These provisions reflected the “real bills” doctrine, a prevalent theory among the architects of the Federal Reserve Act in 1913 and influential figures within the Federal Reserve System in 1929. This theory posited that a central bank should expand the money supply in response to increases in production and commerce and contract credit and currency when economic activity slowed down.
Faced with mounting speculation, the Federal Reserve decided to intervene. The crucial question was how. A debate ensued between the Federal Reserve Board and the leaders of the reserve banks. To curb the surge in call loans, which were fueling the speculative frenzy, the Board favored a policy of direct action. They requested reserve banks to reject credit applications from member banks that were channeling funds to stock speculators. 4 The Board also issued public warnings about the dangers of excessive speculation.
However, George Harrison, the governor of the Federal Reserve Bank of New York, advocated for a different approach. He preferred raising the discount lending rate, the interest rate at which commercial banks borrow money from the Federal Reserve. This action would directly increase borrowing costs for banks and indirectly raise interest rates for all borrowers, including businesses and consumers. In 1929, New York repeatedly requested to raise its discount rate, but the Board initially resisted. Finally, in August, the Board conceded to New York’s plan, and New York’s discount rate reached 6 percent. 5
The Federal Reserve’s interest rate hike had unforeseen international repercussions. Due to the prevailing international gold standard, the Fed’s actions compelled foreign central banks to raise their own interest rates to defend their gold reserves. These tight-money policies inadvertently pushed economies worldwide into recession. International trade contracted, and the global economy experienced a significant slowdown (Eichengreen 1992; Friedman and Schwartz 1963; Temin 1993).
Despite these measures, the financial boom on Wall Street continued unabated. The Federal Reserve watched with growing concern as commercial banks persisted in lending to speculators, and other lenders further increased their investments in broker loans. In September 1929, the stock market began to exhibit increased volatility, with sudden sharp declines followed by rapid recoveries. Some financial leaders, including Charles E. Mitchell, the president of the National City Bank (now Citibank) and a director of the Federal Reserve Bank of New York, continued to publicly encourage investors to buy stocks. 6 In a desperate attempt to restore confidence in October, Mitchell and a group of influential bankers joined forces to publicly purchase large blocks of shares at inflated prices. This effort, however, proved futile. Investors panicked and began selling their holdings en masse, triggering a massive stock market collapse. Share prices plummeted, marking the beginning of the Wall Street Crash.
The funds fleeing the stock market flowed into New York City’s commercial banks. These banks also found themselves burdened with millions of dollars in stock-market loans. This sudden influx of deposits and loan obligations placed immense strain on the banking system. As deposits swelled, banks’ reserve requirements increased, while their reserves dwindled as depositors withdrew cash, banks acquired distressed loans, and the check clearing process lagged. These conflicting pressures left many banks temporarily short of required reserves.
Responding swiftly to the crisis, the New York Fed intervened decisively. It purchased government securities in the open market, streamlined lending through its discount window, and lowered the discount rate. The New York Fed reassured commercial banks that it would provide the necessary reserves. These actions injected liquidity into the banking system, easing the reserve constraints faced by New York City banks and enabling financial institutions to remain operational and meet customer demands throughout the crisis. These measures also prevented short-term interest rates from spiraling out of control, a common occurrence during financial panics.
While the New York Fed’s actions were initially met with controversy, with the Board and several reserve banks questioning New York’s authority, hindsight suggests they were crucial in containing the immediate crisis. The Wall Street Crash had occurred, but the proactive measures taken by the New York Fed prevented a complete collapse of the commercial banking system in the epicenter of the storm (Friedman and Schwartz 1963).
Despite the New York Fed’s success in safeguarding commercial banks, the Wall Street Crash still inflicted significant damage on commerce and manufacturing. The market collapse instilled fear and uncertainty in investors and consumers alike. Many individuals lost their life savings, worried about job security, and struggled to meet their financial obligations. This pervasive fear and uncertainty led to a sharp decline in purchases of big-ticket items, such as automobiles, which were often bought on credit. Companies like Ford Motors experienced a drop in demand, forcing them to curtail production and lay off workers. Unemployment surged, exacerbating the economic contraction that had begun in the summer of 1929 (Romer 1990; Calomiris 1993). 7
Although the Wall Street Crash of 1929 triggered a significant economic downturn, its initial impact appeared to wane within a few months. By the fall of 1930, signs of economic recovery seemed to be emerging. However, problems in another segment of the financial system transformed what might have been a short-lived recession into the Great Depression, the most severe and prolonged economic crisis in modern history.
The Wall Street Crash of 1929 provided economists and policymakers, including leaders at the Federal Reserve, with critical lessons. 8
Firstly, central banks must exercise caution when reacting to developments in equity markets. Identifying and deflating asset bubbles is inherently complex, and using monetary policy to curb investor exuberance can have far-reaching, unintended, and undesirable consequences. 9
Secondly, when stock market crashes do occur, their damage can be mitigated by implementing the crisis management strategies pioneered by the Federal Reserve Bank of New York in the fall of 1929.
Economists and historians have extensively debated these issues in the decades following the Great Depression. A consensus began to emerge around the time of the publication of Milton Friedman and Anna Schwartz’s seminal work, A Monetary History of the United States, in 1963. Their conclusions regarding these events are widely cited by economists, including prominent members of the Federal Reserve Board of Governors such as Ben Bernanke, Donald Kohn, and Frederic Mishkin.
The financial crisis of 2008 has prompted scholars to re-examine these established conclusions. Economists are actively questioning whether central banks possess the ability and mandate to prevent asset market bubbles and how concerns about financial stability should be integrated into monetary policy decisions. These ongoing discussions echo the debates that took place among the leaders of the Federal Reserve during the tumultuous 1920s, highlighting the enduring relevance of the lessons learned from the Wall Street Crash.
1 Fisher, Irving. 1929. “The Stock Market Has Reached a Permanently High Plateau.” Syracuse Herald, October 16.
2 Chandler, Lester V. 1971. The Economics of Money and Banking. New York: Harper & Row.
3 Federal Reserve Act. 1913.
4 Board of Governors of the Federal Reserve System. 1929. Annual Report. Washington: Federal Reserve Board.
5 Friedman, Milton, and Anna J. Schwartz. 1963. A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press.
6 Galbraith, John Kenneth. 1954. The Great Crash, 1929. Boston: Houghton Mifflin.
7 Calomiris, Charles W. 1993. “Financial Factors in the Great Depression.” Journal of Economic Perspectives 7, no. 2 (Spring): 61–85.
8 Bernanke, Ben S. 2000. Essays on the Great Depression. Princeton: Princeton University Press.
9 Mishkin, Frederic S. 2011. “Monetary Policy Strategy: Lessons from the Crisis.” National Bureau of Economic Research Working Paper 16755.
