Who did most for the US stock market? FDR or Bernanke?

My post on US stock markets and monetary disorder led to some friendly but challenging comments from Diego Espinosa. Diego rightly notes that Market Monetarists including myself praises US president Roosevelt for taking the US off the gold standard and that similar decisive actions is needed today, but at the same time is critical of Ben Bernanke’s performance of Federal Reserve governor despite the fact that US share prices have performed fairly well over the last four years.

Diego’s point is basically that the Federal Reserve under the leadership of chairman Bernanke has indeed acted decisively and that that is visible if one look at the stock market performance. Diego is certainly right in the sense that the US stock market sometime ago broken through the pre-crisis peak levels and the stock market performance in 2009 by any measure was impressive. It might be worth noticing that the US stock market in general has done much better than the European markets.

However, it is a matter of fact that the stock market response to FDR’s decision to take the US off the gold standard was much more powerful than the Fed’s actions of 2008/9. I take a closer look at that below.

Monetary policy can have a powerful effect on share prices

To illustrate my point I have looked at the Dow Jones Industrial Average (DJIA) for the period from early 2008 and until today and compared that with the period from 1933 to 1937. Other stock market indices could also have been used, but I believe that it is not too important which of the major US market indices is used to the comparison.

The graph below compares the two episodes. “Month zero” is February 1933 and March 2009. These are the months where DJIA reaches the bottom during the crisis. Neither of the months are coincident as they coincide with monetary easing being implemented. In April 1933 FDR basically initiated the process that would take the US off the gold standard (in June 1933) and in March 2009 Bernanke expanded TAF and opened dollar swap lines with a number of central banks around the world.

As the graph below shows FDR’s actions had much more of a “shock-and-awe” impact on the US stock markets than Bernanke’s actions. In only four months from DJIW jumped by nearly 70% after FDR initiated the process of taking the US off the gold standard. This by the way is a powerful illustration of Scott Sumner’s point the monetary policy works with long and variable leads – you see the impact of the expected policy change even before it has actually been implemented. The announcement effects are very powerful. The 1933 episode illustrates that very clearly.

Over the first 12 months from DJIA reaches bottom in 1933 the index increases by more than 90%. That is nearly double of the increase of DJIA in 2009 as is clear from the graph.

Obviously this is an extremely crude comparison and no Market Monetarist would argue that monetary policy changes could account for everything that happened in the US stock market in 1993 or 2009. However, impact of monetary policy on stock market performance is very clear in both years.

NIRA was a disaster

A very strong illustration of the fact that monetary policy is not everything that is important for the US stock market is what happened from June 1933 to May 1935. In that nearly two year period the US stock market was basically flat. Looking that the graph it looks like the stock market rally paused to two years and then took off again in the second half of 1935.

The explanation for this “pause” is the draconian labour market policies implemented by the Roosevelt administration. In June 1933 the so-called National Industrial and Recovery Act was implemented by the Roosevelt administration (NIRA). NIRA massively strengthened the power of US labour unions and was effectively thought to lead to a cartelisation of the US labour market. Effectively NIRA was a massively negative supply shock to the US economy.

So while the decision to go off the gold standard had been a major positive demand shock that on it’s own had a massively positive impact on the US economy NIRA had the exact opposite impact. Any judgement of FDR’s economic policies obviously has to take both factors into account.

That is exactly what the US stock market did. The gold exit led to a sharp stock market rally, but that rally was soon killed by NIRA.

In May 1935 the US Supreme Court ruled that NIRA was unconstitutional. That ruling had a major positive impact positive impact as it “erased” the negative supply shock. As the graph shows very clearly the stock market took off once again after the ruling.

FDR was better for stocks than Bernanke, but…

Overall we have to conclude that FDR’s decision to take the US off the gold standard had an significantly more positive impact on the US stock markets than Ben Bernanke’s actions in 2008/9. However, contrary to the Great Depression the US has avoided the same kind of policy blunders on the supply side over the past four years. While the Obama administration certainly has not impressed with supply side reforms the damage done by his administration on the supply side has been much, much smaller than the disaster called NIRA.

Hence, the conclusion is clear – monetary easing is positive for the stock market, but any gains can be undermined by regulatory mistakes like NIRA. That is a lesson for today’s policy makers. Central banks should ensure stable growth in nominal GDP, while governments should implement supply side reforms to increase real GDP over the longer run. That would not undoubtedly be the best cocktail for the economy but also for stock markets.

Finally it should be noted that both FDR and Bernanke failed to provide a clear rule based framework for the conduct of monetary policy. That made the recovery much weaker in 1930s than it could have been and probably was a major cause why the US fell back into recession in 1937. Similarly the lack of a rule based framework has likely had a major negative impact on the effectiveness of monetary policy over the past four years.

PS this post an my two previous posts (see here and here) to a large degree is influenced by the kind of analysis Scott Sumner presents in his book on the Great Depression. Scott’s book is still unpublished. I look forward to the day it will be available to an wider audience.

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  1. Diego Espinosa

     /  May 28, 2012

    Thanks for publishing the data, which clearly support your thesis that the gold standard exit fueled a more powerful initial gain in stocks. The NIRA explanation for the leveling of stock prices seems entirely plausible.

    I think, however, that there is still an interesting dynamic working underneath the surface. The S&P tells us we had a fairly strong expectations shock in 2009. As a result, corporate profits recovered to peak, the corporate WACC plunged and business investment (ex-structures) boomed. These are all “FDR-lite” results. Why hasn’t employment growth followed the same path? I would cite three factors: 1) the spread between the small business and corporate WACC’s has arguably never been this large; 2) start-up capital for small businesses dried up with the demise of home equity loans; and 3) the lack of new-firm entry, and the secular trend towards industry concentration, allowed large, oligopolistic corporates to invest in labor-saving, and not capacity-adding, equipment (Kacherlakota has also made the latter argument).

    The above are arguably structural, not cyclical factors. For instance, home equity lending was a “failed” technology; and small businesses creditors lack the central bank “put” enjoyed by large business ones. How can monetary policy overcome these factors? Another way of asking: has the SRAS curve steepened as a result? Despite my reservations about NGDP targeting, I wish Bernanke would conduct a real-world experiment to find out!

    • dwb

       /  May 29, 2012

      “Why hasn’t employment growth followed the same path.”

      I don’t know what you mean – in so far as employment growth, we are right about where you’d expect we’d be given the gdp growth we’ve seen since the trough. As far as making up the gap, home prices have not yet reached equilibrium because mortgage contracts are very sticky. That process is only now starting to happen in a few markets in the US. Once prices equilibrate, we ought to see higher employment growth particularly in structures.

      “home equity lending” is not a “failed technology.” It can only be supported by stable home prices, which is turn requires prices to have equilibrated.

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