During the early 1930s there were a number of bank failures in the United States. What did this do to the money supply? The New York Federal Reserve Bank advocated open market purchases. Would these purchases have reversed the change in the money supply and helped banks? Explain.

Bank failures cause people to lose confidence in the banking system so that deposits fall and banks have less to lend. Further, under these circumstances banks are probably more cautious about lending. Both of these reactions would tend to decrease the money supply. Open market purchases increase bank reserves and so would have at least made the decrease smaller. The increase in reserves would also have provided banks with greater liquidity to meet the demands of customers who wanted to make withdrawals. In short, while the actions of depositors and banks lowered the money supply, the Fed could have increased it by buying bonds.