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A History of the Federal Reserve
A History of the Federal Reserve, Volume 2, Book 1, 1951-1969
Allan H. Meltzer’s critically acclaimed history of the Federal Reserve is the most ambitious, most intensive, and most revealing investigation of the subject ever conducted. Its first volume, published to widespread critical acclaim in 2003, spanned the period from the institution’s founding in 1913 to the restoration of its independence in 1951. This two-part second volume of the history chronicles the evolution and development of this institution from the Treasury–Federal Reserve accord in 1951 to the mid-1980s, when the great inflation ended. It reveals the inner workings of the Fed during a period of rapid and extensive change. An epilogue discusses the role of the Fed in resolving our current economic crisis and the needed reforms of the financial system. In rich detail, drawing on the Federal Reserve’s own documents, Meltzer traces the relation between its decisions and economic and monetary theory, its experience as an institution independent of politics, and its role in tempering inflation. He explains, for example, how the Federal Reserve’s independence was often compromised by the active policy-making roles of Congress, the Treasury Department, different presidents, and even White House staff, who often pressured the bank to take a short-term view of its responsibilities. With an eye on the present, Meltzer also offers solutions for improving the Federal Reserve, arguing that as a regulator of financial firms and lender of last resort, it should focus more attention on incentives for reform, medium-term consequences, and rule-like behavior for mitigating financial crises. Less attention should be paid, he contends, to command and control of the markets and the noise of quarterly data. At a time when the United States finds itself in an unprecedented financial crisis, Meltzer’s fascinating history will be the source of record for scholars and policy makers navigating an uncertain economic future.
696 pages, Hardcover
First published May 31, 2007
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December 4, 2012
The second of three books of Meltzer's exhaustive history of the Federal Reserve. I would also say it is exhaust-ing at times, but a fascinating read for anyone interested in monetary policy history (a very small group of people that includes me). This book covers a period bookended by the Fed-Treasury accord, which restored some measure of independence to the FR, and the beginning of the Great Inflation of the late 1960s and 1970s.
As with a classical tragedy, it is sometimes painful to watch the action unfold while knowing the grim ending that is coming. In particular William McChesney Martin (chair for much of the action) comes across as a somewhat tragic figure, a man whose goals are admirable but who fails to reach them through a deferent and consensus-building leadership style, as well as a misplaced trust in the partnership of presidential administrations (particularly LBJ's).
There is no doubt that the FR bears much responsibility for the Great Inflation, but I think a few lessons stood out to me in this volume:
1. Fed independence was subordinated to administration policy not through hardball tactics from the White House, but by a kind of soft "capture." We see Fed leaders, including the chairmen Martin and Burns, relishing the role of vizier to the president and, perhaps, as CS Lewis would have it, admittance to the "inner ring." They do not see that they pay a price for that admission, which includes giving the administration the benefit of the doubt even when they have shown they are not worthy of it. (Tyler Cowen's phrase that "the monetary authority moves last" shows how far we have come since the period covered by this volume.)
2. Economic models matter. Meltzer in this volume derides (rightly I think) the way the FOMC set directives to the account manager to operate policy according to the "tone and feel" of the market. This reflected a lack of consensus, and worse, an unwillingness to admit that the committee did not hold clear goals or have a real framework for thinking about how monetary policy operated. Furthermore, the policy errors of this period largely stemmed from a reliance on the correlational Phillips Curve, which implied that it was possible to "trade off" some increased inflation for increased employment, even in the long run. Economists including Milton Friedman had already shown by this time how the role of expectations invalidated this assumed relationship. (This prior error makes me a bit uneasy about the current movement for NGDP targeting, which seems like it enfolds a similar relationship.)
3. The weight on the Fed's policy objectives (high employment and low inflation) is unclear, something the Fed continues to struggle with today. Even if there is no permanent tradeoff between unemployment and inflation available to policymakers, it seems that there are circumstances where the two objectives are in tension. Meltzer tends to come down very hard in favor of controlling inflation, and perhaps this is appropriate, particularly if the central bank has more control over inflation than it does over employment. But it's interesting to note, as Meltzer does in the text, that even as the Great Inflation commenced, a relatively small proportion of the American population cited inflation as a major problem in their lives. There are unavoidable distributional effects that Meltzer only touches on in a minor way: unemployment vs. inflation pits the working-age population against retirees, and those whose wealth primarily consists of their labor capacity against those whose wealth primarily consists of financial assets. The existence of these distributional consequences, it seems to me, raises the question of whether it is really preferable to have a monetary authority that is truly independent of the electorate.
As with the first volume, this book simultaneously made me proud at how far my institution has come in the intervening years, and humbled because it seems almost certain that we today are not exempt from unnoticed errors on the scale of those committed in the '60s.
As with a classical tragedy, it is sometimes painful to watch the action unfold while knowing the grim ending that is coming. In particular William McChesney Martin (chair for much of the action) comes across as a somewhat tragic figure, a man whose goals are admirable but who fails to reach them through a deferent and consensus-building leadership style, as well as a misplaced trust in the partnership of presidential administrations (particularly LBJ's).
There is no doubt that the FR bears much responsibility for the Great Inflation, but I think a few lessons stood out to me in this volume:
1. Fed independence was subordinated to administration policy not through hardball tactics from the White House, but by a kind of soft "capture." We see Fed leaders, including the chairmen Martin and Burns, relishing the role of vizier to the president and, perhaps, as CS Lewis would have it, admittance to the "inner ring." They do not see that they pay a price for that admission, which includes giving the administration the benefit of the doubt even when they have shown they are not worthy of it. (Tyler Cowen's phrase that "the monetary authority moves last" shows how far we have come since the period covered by this volume.)
2. Economic models matter. Meltzer in this volume derides (rightly I think) the way the FOMC set directives to the account manager to operate policy according to the "tone and feel" of the market. This reflected a lack of consensus, and worse, an unwillingness to admit that the committee did not hold clear goals or have a real framework for thinking about how monetary policy operated. Furthermore, the policy errors of this period largely stemmed from a reliance on the correlational Phillips Curve, which implied that it was possible to "trade off" some increased inflation for increased employment, even in the long run. Economists including Milton Friedman had already shown by this time how the role of expectations invalidated this assumed relationship. (This prior error makes me a bit uneasy about the current movement for NGDP targeting, which seems like it enfolds a similar relationship.)
3. The weight on the Fed's policy objectives (high employment and low inflation) is unclear, something the Fed continues to struggle with today. Even if there is no permanent tradeoff between unemployment and inflation available to policymakers, it seems that there are circumstances where the two objectives are in tension. Meltzer tends to come down very hard in favor of controlling inflation, and perhaps this is appropriate, particularly if the central bank has more control over inflation than it does over employment. But it's interesting to note, as Meltzer does in the text, that even as the Great Inflation commenced, a relatively small proportion of the American population cited inflation as a major problem in their lives. There are unavoidable distributional effects that Meltzer only touches on in a minor way: unemployment vs. inflation pits the working-age population against retirees, and those whose wealth primarily consists of their labor capacity against those whose wealth primarily consists of financial assets. The existence of these distributional consequences, it seems to me, raises the question of whether it is really preferable to have a monetary authority that is truly independent of the electorate.
As with the first volume, this book simultaneously made me proud at how far my institution has come in the intervening years, and humbled because it seems almost certain that we today are not exempt from unnoticed errors on the scale of those committed in the '60s.
September 30, 2022
Overview:
The Federal Reserve took responsibility for economic stabilization and fiscal policy. In addition to the normal duties of the Federal Reserve, the Federal Reserve was tasked with managing the unemployment rate. This arose because citizens were demanding maintenance of economic prosperity. Greater interest in Federal Reserve operations by Congress, challenged the Federal Reserve’s independence.
This was a Keynesian Era, for many of the economists developed Keynesian methodology, and wanted to try out their tools. Keynesian economists became prominent within politics. Keynesianism took a proactive approach to the economy, by using discretionary resources for smoothing business cycles. The Federal Reserve did improve its ability to resolve crises, but at a cost of incentivizing further bailouts. There was also a high rate of inflation. The Federal Reserve was limited in its ability to manage inflation because of other regulations.
Responsibility, and Accountability:
Historically there was a need to separate the power to spend, and the power to finance spending by expanding money. Rules such as the gold standard rule, and balanced budge rule enforced the separation between fiscal and monetary policy. Both rules lost prominence by 1951.
The Federal Reserve regained authority to manage interest rate, reserves, and money during 1951. Making the Federal Reserve co-equal partners with the Treasury, rather than subservient to the Treasury.
William McChesney Martin ended the struggle of power between Washington and New York, with Washington in charge. Greater cohesion of the System also made the System susceptible to political pressure.
Although Congress could be punished for Federal Reserve action via voting, the Federal Reserve maintained a separation between responsibility and authority. Even after having major economic failures, no Federal Reserve officials was asked to resign. A way to align responsibility and authority is by coordinating a transient policy objective between Federal Reserve Chairman and the Secretary of the Treasury. Not meeting the objective would require an explanation, or a resignation if the explanation was not accepted.
Policies Followed:
Policy followed by the United States was Too Big To Fail, where size of financial firms excused them from failure and obtained bailouts. The author claims that size should not prevent a failure. The institution can remain, but with different management and a loss to the stockholders.
Many banks resisted joining the System to avoid par collection, and costly reserve requirements. Even without membership, all banks had to par collect and adhere to Federal Reserve’s reserve requirements by Congress.
Under the Employment Act, the Federal Reserve was tasked with reducing the unemployment rate. The emphasis on employment came from congressional interest in Federal Reserve operations and decisions. Which also included more frequent congressional hearings. Policy coordination sometimes challenged the Federal reserve independence.
Federal Reserve members questioned the rate that banks should repay their debts. Wanted to apply pressure for repayment, but without causing other banks to borrow.
Economic Ideas, and Economists:
Economists gained more political power during the 1960s. Demand for their services was due to frequent international monetary crises, and public policy. Services that improved due to professionalization of monetary policy.
There was conflict within economic perspectives. A battle of ideas between Monetarists and Keynesians. Monetarists claimed that monetary authority determined the stock of money but public demand determined the price level. Wanting to follow rules of policy, rather than discretionary policy. Discretionary policy created uncertainty in planning for future actions. Keynesians thought that discretionary policy can stabilize an inherently unstable economy by adjusting expenditures, tax rates, and interest rates. The monetarists thought that the private sector is self-stabilizing and that government policy usually made outcomes worse.
Caveats?
This is not an introductory book on monetary policy. To understand much of the history presented, would require the reader to have a background in monetary policy. Supplementary research might be needed to understand the context of the disagreements of monetary policy ideas.
The Federal Reserve took responsibility for economic stabilization and fiscal policy. In addition to the normal duties of the Federal Reserve, the Federal Reserve was tasked with managing the unemployment rate. This arose because citizens were demanding maintenance of economic prosperity. Greater interest in Federal Reserve operations by Congress, challenged the Federal Reserve’s independence.
This was a Keynesian Era, for many of the economists developed Keynesian methodology, and wanted to try out their tools. Keynesian economists became prominent within politics. Keynesianism took a proactive approach to the economy, by using discretionary resources for smoothing business cycles. The Federal Reserve did improve its ability to resolve crises, but at a cost of incentivizing further bailouts. There was also a high rate of inflation. The Federal Reserve was limited in its ability to manage inflation because of other regulations.
Responsibility, and Accountability:
Historically there was a need to separate the power to spend, and the power to finance spending by expanding money. Rules such as the gold standard rule, and balanced budge rule enforced the separation between fiscal and monetary policy. Both rules lost prominence by 1951.
The Federal Reserve regained authority to manage interest rate, reserves, and money during 1951. Making the Federal Reserve co-equal partners with the Treasury, rather than subservient to the Treasury.
William McChesney Martin ended the struggle of power between Washington and New York, with Washington in charge. Greater cohesion of the System also made the System susceptible to political pressure.
Although Congress could be punished for Federal Reserve action via voting, the Federal Reserve maintained a separation between responsibility and authority. Even after having major economic failures, no Federal Reserve officials was asked to resign. A way to align responsibility and authority is by coordinating a transient policy objective between Federal Reserve Chairman and the Secretary of the Treasury. Not meeting the objective would require an explanation, or a resignation if the explanation was not accepted.
Policies Followed:
Policy followed by the United States was Too Big To Fail, where size of financial firms excused them from failure and obtained bailouts. The author claims that size should not prevent a failure. The institution can remain, but with different management and a loss to the stockholders.
Many banks resisted joining the System to avoid par collection, and costly reserve requirements. Even without membership, all banks had to par collect and adhere to Federal Reserve’s reserve requirements by Congress.
Under the Employment Act, the Federal Reserve was tasked with reducing the unemployment rate. The emphasis on employment came from congressional interest in Federal Reserve operations and decisions. Which also included more frequent congressional hearings. Policy coordination sometimes challenged the Federal reserve independence.
Federal Reserve members questioned the rate that banks should repay their debts. Wanted to apply pressure for repayment, but without causing other banks to borrow.
Economic Ideas, and Economists:
Economists gained more political power during the 1960s. Demand for their services was due to frequent international monetary crises, and public policy. Services that improved due to professionalization of monetary policy.
There was conflict within economic perspectives. A battle of ideas between Monetarists and Keynesians. Monetarists claimed that monetary authority determined the stock of money but public demand determined the price level. Wanting to follow rules of policy, rather than discretionary policy. Discretionary policy created uncertainty in planning for future actions. Keynesians thought that discretionary policy can stabilize an inherently unstable economy by adjusting expenditures, tax rates, and interest rates. The monetarists thought that the private sector is self-stabilizing and that government policy usually made outcomes worse.
Caveats?
This is not an introductory book on monetary policy. To understand much of the history presented, would require the reader to have a background in monetary policy. Supplementary research might be needed to understand the context of the disagreements of monetary policy ideas.
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