Introduction

Standard accounts of the Great Depression (notably the seminal offering of Friedman and Schwartz, 1963) attribute an important causal role to monetary policy errors in accounting for the catastrophic collapse in economic activity observed in the early 1930s. In particular, the Federal Reserve’s failure to halt the collapse in the money stock following the banking crisis of 1931 is seen as a crucial mistake (Meltzer, 2007). While views vary on the relative importance of money versus credit contraction in the propagation of this policy error to the wider economy and ultimately price developments (see, e.g., Bernanke, 1983), a broad consensus exists in the economics profession around the view that the collapse in financial intermediation was a crucial intermediary step.

What lessons have monetary policy makers taken from this episode? And how have they informed the conduct of monetary policy by leading central banks in recent times? Using the frameworks developed by Giannone et al. (2010) and Lenza et al. (2010), this chapter sets out to address these questions, in the context of the financial crisis of 2008–9 and with application to the euro area. In doing so, the chapter draws together two strands of literature: one that explores the nature and rationale of non-standard monetary policy measures, understood as those relying on instruments other than changes to short-term official interest rates, and another which investigates the evolution of bank balance sheets, as reflected in monetary and credit developments, and their impact on monetary policy transmission.