Money and interest rates in the United States during the Great Depression PeTeR BAS I le , J OHN lANDON - lANe AND HuGH ROCkOFF
The last line of this often quoted paragraph deserves some additional comment. Evidently, Keynes envisioned a liquidity trap not simply as a low rate on shortterm government debt, but rather as low and stable rates on the whole spectrum of maturities. Until all of these rates found their sticking points, more could be done with monetary policy to lower rates, and thereby encourage investment. By dealing boldly Keynes had in mind, we believe, direct cash purchases of debt that expanded the monetary base and the stock of money. One could imagine other sorts of operations, say conversions of one sort of debt into another, but it seems to us that Keynes probably had in mind mainly direct purchases rather than more complicated transactions. The most famous case of debt management was the British stock conversion of 1932 in which a huge government loan dating from World War I was converted into a longer-term debt with a lower coupon. A number of observers claimed that the success of this conversion lowered the whole spectrum of rates. But, as Capie, Mills, and Wood (1986) demonstrate, the effect of this conversion was to alter the slope of the term structure rather than shift the whole function to a lower level. The story of the liquidity trap must be an American story. The depression in Britain was a much milder affair than in the United States, both in terms of financial markets and real outcomes (Capie 1990). It would have been odd to attribute a condition that we associate with depression and nonfunctioning capital markets to an economy that experienced a mild shock and showed rapid signs of improvement. But Keynes was undoubtedly aware that short-term government rates in the United States had fallen to very low levels when he wrote this passage. There is some debate about the chronological evolution of Keynes’s thinking (Patinkin 1993), but it is clear that he was thinking intensively about money, interest rates, and economic activity for several years before the publication of the General Theory (the preface to the General Theory was dated December 13, 1935). Rates on U.S. Treasuries fell below one percent in May 1931 and remained below one percent (except for one month) for the
remainder of the decade. Rates on short-term governments in the U.K. also fell to very low levels. If low rates on Treasuries, rates close to the “zero bound,” were sufficient to constitute a liquidity trap by Keynes’s definition, he would have claimed the United States and Britain as examples in the General Theory. Keynes never, as far as we are aware, reversed this judgment and claimed that there had been a liquidity trap during the depression (Moggridge and Howson 1974). Although the famous passage from the General Theory quoted above might be referring simply to government securities, it is clear that Keynes believed that attention had to be paid to private as well as government rates. In a passage following shortly after the one quoted above, Keynes argued that even though risk free rates might be brought to very low levels by central bank monetary policies, risky rates, perhaps bank lending rates, which were relevant to investment decisions, might remain at unacceptably high levels.