deposit insurance was virtually nonexistent, so that the failure of a bank might cause depositors to lose all or most of their savings. thus, depositors who feared that a bank might fail rushed to withdraw their funds. banking panics, if severe enough, could become self - confirming prophecies. during the 1930s, thousands of u. s. banks experienced runs by depositors and subsequently failed. long - established central banking practice required that the fed respond both to the speculative attack on the dollar and to the domestic banking panics. however, the fed decided to ignore the plight of the banking system and to focus only on stopping the loss of gold reserves to protect the dollar. to stabilize the dollar, the fed once again raised interest rates sharply, on the view that currency speculators would be less willing to liquidate dollar assets if they could earn a higher rate of return on them. the fed's strategy worked, in that the attack on the dollar subsided and the u. s. commitment to the gold standard was successfully defended, at least for the moment. however, once again the fed had chosen to tighten monetary policy despite the fact that macroeconomic conditions - including an accelerating decline in output, prices, and the money supply - seemed to demand policy ease. the third policy action highlighted by friedman and schwartz occurred in 1932. by the spring of that year, the depression was well advanced, and congress began to place considerable pressure on the federal reserve to ease monetary policy. the board was quite reluctant to comply, but in response to the ongoing pressure the board conducted open - market operations between april and june of 1932 designed to increase the national money supply and thus ease policy. these policy actions reduced interest rates on government bonds and corporate debt and appeared to arrest the decline in prices and economic activity. however, fed officials remained ambivalent about their policy of monetary expansion. some viewed the depression as the necessary purging of financial excesses built up during the 1920s ; in this view, slowing the economic collapse by easing monetary policy only delayed the inevitable adjustment. other officials, noting among other indicators the very low level of nominal interest rates, concluded that monetary policy was in fact already quite easy and that no more should be done. these policymakers did not appear to appreciate that, even though nominal interest rates were very low, the ongoing deflation meant that the real cost of borrowing was very high because any loans would have to be repaid in dollars of much greater value (

of each currency's value in terms of gold defines a system of fixed exchange rates, in which the relative value of ( say ) the u. s. dollar and the british pound are fixed at a rate determined by the relative gold content of each currency. to maintain the gold standard, central banks had to promise to exchange actual gold for their paper currencies at the legal rate. the gold standard appeared to be highly successful from about 1870 to the beginning of world war i in 1914. during the so - called “ classical ” gold standard period, international trade and capital flows expanded markedly, and central banks experienced relatively few problems ensuring that their currencies retained their legal value. the gold standard was suspended during world war i, however, because of disruptions to trade and international capital flows and because countries needed more financial flexibility to finance their war efforts. ( the united states remained technically on the gold standard throughout the war, but with many restrictions. ) after 1918, when the war ended, nations around the world made extensive efforts to reconstitute the gold standard, believing that it would be a key element in the return to normal functioning of the international economic system. great britain was among the first of the major countries to return to the gold standard, in 1925, and by 1929 the great majority of the world's nations had done so. unlike the gold standard before world war i, however, the gold standard as reconstituted in the 1920s proved to be both unstable and destabilizing. economic historians have identified a number of reasons why the reconstituted gold standard was so much less successful than its prewar counterpart. first, the war had left behind enormous economic destruction and dislocation. major financial problems also remained, including both large government debts from the war and banking systems whose solvency had been deeply compromised by the war and by the periods of hyperinflation that followed in a number of countries. these underlying problems created stresses for the gold standard that had not existed to the same degree before the war. second, the new system lacked effective international leadership. during the classical period, the bank of england, in operation since 1694, provided sophisticated management of the international system, with the cooperation of other major central banks. this leadership helped the system adjust to imbalances and strains ; for example, a consortium of central banks might lend gold to one of their number that was experiencing a shortage of reserves. after the war, with great britain economically and financially