The Great Depression of the 1930s
The Roaring '20s brought a fast-growing economy and mounting stock prices, but the bubble eventually burst in October 1929. The stock market crash set the stage for a devastating depression that lasted through much of the 1930s.
"When there's a panic, what the Federal Reserve is supposed to do -- or any central bank -- is to lend money to the banks in the form of cash and then recover that later," Edmunds says. "In the early days of the Federal Reserve, they did the reverse."
Banks, which also invested in the stock market, tried to collect on investors' loans to no avail. The Fed raised interest rates, about 9,000 banks failed, according to the Federal Reserve Bank of St. Louis, and a stampede of bank account depositors withdrew their money from banks and hoarded it.
World War II was one of the events that eventually improved employment and economic output, says J. Douglas Wellington, associate professor with the School of Business and Management at Husson University in Bangor, Maine. The Fed learned what could happen when a crisis isn't contained. The Federal Open Market Committee was formed under the Banking Act of 1933, the Fed's Board of Governors gained more power and reserve requirements and bank deposit insurance were implemented.
"The Great Depression, in my view, changed the Fed's view of what its role was," Edmunds says. "In about 1941, they became more accommodating, that is, more expansionist."