federal reserve

5 major moments in Federal Reserve history

The 1920-21 recession
The 1920-21 recession © optimarc/Shutterstock.com

The 1920-21 recession

Seven years after the Federal Reserve was born, the central bank flexed its monetary-policy muscles during a downturn that began in 1920. This recession cut deeper than the Great Depression, though it lasted perhaps one-tenth as long.

What happened? Consumer prices were high following World War I and gold began to flow out of the country, taking it close to the nation's minimum by law. To gain control, the Fed raised key interest rates, according to the Federal Reserve Bank of Minneapolis. For the first time, the Fed tried to manipulate the money supply to bring down consumer costs. It did so by raising the discount rate.

However, those policies helped create a sharp but short downturn. Gross national product slid 24 percent from 1920 to 1921, and the number of unemployed people jumped from 2.1 million to 4.9 million, according to the Cato Institute.

The Fed didn't lower rates until the second quarter of 1921, a year after the start of the depression, yet the economy improved, Edmunds says. President Warren Harding had cut tax rates and reduced spending. Even the drop in consumer prices is cited as an influence, as purchasing power increased.

But the crisis had a lasting effect. The Fed realized its own power and became apprehensive. Raising interest rates hurt the economy and the Fed was "reluctant to do that again," Meltzer says. "It had a substantial influence on its future."

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