* The research, distributed by the National Bureau of Economic Research this week, argues the policy path the Fed is following is based on lessons learned when countries, desperate to keep their gold supplies out of the clutches of the Nazis, shipped them to New York. The NBER explained how the Fed initially made a policy mistake with the ebb and flow of gold into the US on the eve of World War II, and then corrected its policy error. The history lesson could play as a road map for the Fed and its cautious shift toward shrinking its balance sheet this month.
* Over $14.5bn of gold flowed into the US between 1934 and 1941, more than ANY other period, dramatically increasing the amount of money available for lending in the economy. Many authors, including former Fed Chairman Ben Bernanke, think this period was similar to Quantitative Easing, or the bond buying engineered after the 2008 financial crisis. In the 1930s case, the Fed decided to convert the gold into currency, making more money available for lending even when short-term rates were close to zero.
* The gold flows stoked fears at the Fed about higher inflation and the central bank soon took steps to tighten policy. But the economy, already frail from the Great Depression, faltered and sank into the recession of 1937-38. The central bank was forced to retreat. Ultimately in the 1940s, the inflows of gold ceased and the Fed allowed bank reserves to fall naturally.
* Matthew Jaremski, a professor of economics at Colgate University, and one author of the study, said the Yellen Fed seems to have learned the lesson from that period. “The Fed’s [current] policy seems historically grounded,” the study said. “The Fed’s plans for an unwinding without tightening... resembles the stance taken in the 1940s and suggests it has learned from the premature tightening before the 1937-38 recession,” the researchers said.
* The researchers noted that comparisons between the two periods are not exact and care must be taken not to draw exact conclusions. For instance, the size of the modern day expansion of the Fed’s balance sheet is much larger than in the Great Depression. Excess reserves were about 4% of GDP in 1935 compared to about 15% in 2014.
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