Despite mounting evidence that a major economic contraction was under way following the stock market crash in October 1929, the federal government took little in the way of monetary action to support the economy. Admittedly, the scope for policy action was constrained, since advances under the Finance Act were made at the initiative of banks, and there was no money market. Also, Canada was, at least notionally, still on the gold standard. Nonetheless, the government set the Advance Rate, and chose to hold it unchanged at 4.5 per cent from September 1928 to October 1931. As a result, questions were widely voiced regarding Treasury Board officials’ understanding of monetary issues.
In his 1933 book on central banking in Canada, James Creighton argued that J. C. Saunders, Deputy Minister of Finance during the 1920s and ex officio Secretary of the Treasury Board, which administered the Finance Act on behalf of the Minister of Finance, was not competent in monetary matters. Creighton noted that Saunders and other deputy ministers had "neither an academic training in economics nor practical experience in banking.” Moreover, the position of deputy minister was left vacant after Saunders’ death for an extended and critical period—April 1930 to November 1932—leaving a serious policy vacuum.
Coincidentally, Benjamin Strong, Governor of the New York Federal Reserve since its establishment in 1914 and dominant personality in the Federal Reserve system during its formative years, died in October 1928. His death also left a policy vacuum in the United States at a critical time.
There is considerable controversy about Strong’s policies and what would have happened had he lived. Some argue that his expansionary policies during the mid-1920s encouraged the speculative excesses that led to the stock market crash. Others contend that, had he lived, Strong would have moved quickly to moderate the effects of the Depression. Nonetheless, the Federal Reserve Bank of New York acted more quickly and aggressively to cut interest rates than did the Canadian government. The Fed’s Discount Rate, the equivalent of the Canadian Advance Rate, was cut from 6 per cent at the time of the stock market crash in 1929 to 2 per cent by December 1930.
At the same time that the Canadian government was doing nothing on the monetary front, the chartered banks were repaying their borrowings from the government under the Finance Act. The resulting monetary contraction exacerbated the economic downturn. The banks became increasingly cautious about their own lending activities as the economic environment deteriorated. Banks may have also repaid their borrowings under the Finance Act in response to earlier criticism for having borrowed so extensively prior to the stock market crash.
While the extent of the economic downturn in Canada was undoubtedly made worse by these monetary developments, the monetary contraction helped to strengthen the Canadian dollar, which reached US$0.90 by the spring of 1932.
The government finally reduced the Advance Rate to 3 per cent in October 1931 and to 2.5 per cent in May 1933. In the autumn of 1932, it also used moral suasion to force the banks to borrow under the Finance Act and reflate the economy. This easing in monetary policy led to some temporary weakness in the Canadian dollar, which briefly fell as low as US$0.80. The weakness was short-lived, however. Following the U.S. decision to prohibit the export of gold in April 1933 and similar efforts in the United States to reflate, the Canadian dollar began to strengthen. The Canadian government’s decision in 1934 to expand the amount of Dominion notes in circulation by reducing their gold backing to 25 per cent did not have much impact on the Canadian dollar. In the economic circumstances of the time, and given similar developments in the United States, this move was viewed as appropriate and elicited little market reaction. The Canadian dollar returned to rough parity with its U.S. counterpart by 1934 (Chart 3) and, at times, even traded at a small premium. With the U.S. dollar depreciating against gold and the pound sterling, the Canadian dollar returned to its old parity with sterling.
Editorial cartoon by Arthur Racey, Montreal Star, October 1932