Applications: Money in the Depression:

One of the many unusual events of the 1930s is that the stock of money actually fell by 35 percent between March 1930 and March 1933. Some economists (notably Milton Friedman and Anna Schwartz) have argued that this decline was one the major factors in the Depression, and point to a 30 percent decline in the price level (deflation). Interestingly, while the stock of money fell, the monetary base rose by about 20 percent.

What happened? Clearly the money multiplier fell, but why? Two reasons stick out.

i) There was a great deal of uncertainty about the health of the banking system. One of the consequences was a sharp increase in the currency-deposit ratio as people pulled their money out of banks.

ii) Banks held large excess reserves, in anticipation of runs, and the Federal Reserve (in one of the dumb-headed moves of all  time) increased reserve requirements to match. Thus both excess reserves as well as cash reserve ratio (CRR) rose and this led, as in our theory, to a sharp decline in the money multiplier.

Problems with the banking system in the 1930s led to changes in banking legislation in the U.S. that are still important today:   Glass-Steagall Act, deposit insurance, and so on. Many other countries taking from the U.S. have adopted similar measures. Reports from the 1930s sounded, in some ways, much like the late 1980s early 2000s but none of these resulted in any  depression situation due to the better understanding of the linkages between the real and monetary sectors of the economies by economist and policymakers.