The 1920s saw the Fed reject a state-of-the-art quantity theory framework for a flawed real bills one. The quantity theory framework featured the money stock, price level, and real interest rates as policy guides. By contrast, the real bills framework featured nominal interest rates, volume of discount window borrowing, and type of commercial paper eligible for discount. When the start of the Great Depression put these rival sets of indicators to the test, the quantity theory set correctly signaled that monetary policy was sharply contractionary, while the real bills set incorrectly signaled that money and credit conditions were sufficiently easy and needed no correction. This experience shows that policy guides originating in a theoretically flawed framework can lead the policymaker astray.

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