Foreign Investment

The October 1987 collapse in stock prices conjured visions of 1929 and the Great Depression. Focus on this period is natural because the 32 percent decline in stock values between the market closes of October 13 and 19, 1987. Focus on this period is also appropriate because, despite all that has been learned since to help assure economic stability, we cannot be completely sure that history will not repeat itself. This first section reviews events of the Depression era.

The stock market Crash of October 1929 is frequently credited with making it one of the main reasons of the Depression. The decline was severe and extended; from their peak in September 1929, stock prices declined by 87 percent. Real economic activity decreased by about one‑third between 1929 and 1933; unemployment increased up to 25 percent; prices dropped by more than 25 percent; the money supply contracted by over 30 percent; and close to 10,000 banks suspended operations. It isn’t surprising that people consider these years the worst economic trauma in the history. Policy makers did not stand by as the financial markets and the economy unraveled. But there are some questions about the appropriateness of their responses. Federal Reserve officials were becoming very concerned about the rapid pace of credit expansion, which some was fueling stock market speculation. This policy essentially was maintained until the stock market Crash. While there has been much criticism of Federal Reserve policy in the Depression, its reaction to the October 1929 drop in stock values appeared fully appropriate. Between October 1929 and February 1930, the discount rate was reduced from 6 to 4 percent. The money supply jumped and things were getting more expensive, The economy at this time was doing fairly poor. Such funding satisfied the heightened liquidity demands of nonfinancial corporations and others that had been financing broker‑dealers prior to the Crash and, of course, it helped securities firms maintain normal activities and positions. The increase in required reserves, which necessarily accompanied the bulge in the money supply resulting from the surge in bank lending to securities firms, was met in part by sizable open market purchases of U.S. government securities by the New York Federal Reserve Bank and by discount window borrowing by New York commercial banks. According to a senior official of the New York Fed at the time, that bank kept its "discount window wide open and let it be known that member banks might borrow freely to establish the reserves required against the large increase in deposits resulting from the taking over of loans called by others." As a consequence, the sharp run‑up in short‑term interest rates that had characterized previous financial crises was avoided in this case. Money market rates generally declined in the first few months following October 1929. By the spring of 1930, however, the distinctly easier monetary policy that had characterized the Federal Reserve\'s response to the stock market decline ended. Subsequent policy is more difficult to describe concisely. Open market purchases of government securities became very modest until large purchases were made in 1932. Further, although the discount rate was reduced between March 1930 and September 1931, it then was raised on two occasions late that year before falling back once again in 1932. While the direction of monetary policy was somewhat ambiguous over this period, what happened in financial markets was not. Three severe banking panics occurred, the first in late 1930, another in the spring of 1931, and the final crisis in March 1933. Overall, close...