Excess Reserves During the Great Contraction: Evidence from the Central Money Market of New York City, 1929 to 1932

Abstract

The banking industry experienced a significant amount of turmoil during the Great Contraction of 1929-1933. In response, banks were forced to adjust their portfolios with the changing economic climate. One aspect banks had control over was their reserves. While there has been extensive analysis of bank reserves after the bank holiday of 1933, little is known about bank-level reserve holdings during the Great Contraction. This paper exploits a unique data set of Federal Reserve state member and state nonmember banks in New York City during that period. My results show that nonmember banks had a precautionary demand for reserves, increasing their ratio of excess reserves to assets after the first banking panic. Also, compared to state member banks, nonmember banks held a higher ratio of assets in excess reserves. The interest rates on short-term, liquid securities had a negative correlation with reserves and support the opportunity cost theory of Frost (1971). The discount rate, representing the price of liquidity, had a positive relationship with reserves and suggests that Federal Reserve policy could have affected excess reserves during the Great Contraction. These results provide new evidence on the macroeconomic and monetary factors affecting bank behavior in the central money market during the Great Contraction.

Keywords: great depression, excess reserves, central money market, money and banking

JEL Classification: E44, E52, E51, E41, G11, G21, N00, N12, N22, N82