Monday, August 22, 2022

Review of A History Of The Federal Reserve: Volume 1, 1913-1951 by Allan Meltzer

This book review was written by Eugene Kernes   

Book can be found in:
Intriguing Connections = 1) Monetary Policy, A Leaver of the Economy

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“Fears that a privately owned bank would place the bank’s interest above the public interest had to be reconciled with concerns about empowering the government to control money.” – Allan Meltzer, Chapter One: Introduction, Page 2

“They wanted the central bank to damp fluctuations in market interest rates, particularly those created by the seasonal demand for currency and the financing of crop harvest, and to encourage the development of a broad national market in commercial paper and bills of exchange patterned on the London Market.” – Allan Meltzer, Chapter Three: In the Beginning, 1914 to 1922, Page 65-66

“The belief spread that the Federal Reserve had learned how to maintain prosperity, damp recessions, and prevent inflation.  The return of many countries to the gold standard by 1927 reinforced the view that the world economy was on a stable foundation and that inflation and deflation were unlikely to occur.” – Allan Meltzer, Chapter Four: New Procedures, New Problems, 1923 to 1929, Page 253

The Federal Reserve framework came from considering the functions of European central banks, mainly the Bank of England.  Even before Federal Reserve operations, there were fears that either the central bank could be used for temporary political advantages, for government could abuse the public control of money.  Alternatively, others feared that as a private bank, it would favor its own interests above the public interest.  What the Federal Reserve was meant to do was stabilize business cycles, and encourage a national financial market.  An accepted central bank role is to be lender of last resort, to prevent financial panics from spreading further.  

There were many policy debates, with uncertainty about what to do, and the impact of monetary policy.  There were doubts that monetary policy was even effective.  At times the Federal Reserve had overconfidence in its ability to control business cycles, for business cycles did not end.  In practice the Federal Reserve changed from a passive role, to an active role, while sometimes not doing enough.  Being politically influenced to do more than was desired.  Politics was not only an external influence, for internally there was a power struggle between the regional banks and the Board.  

When the Federal Reserve was envisioned, leading central banks were privately owned institutions with public responsibilities.  Their duties were to provide currency for payments, and lender of last resort during exigent times.  It was by late 19th century, that the central bank raison d’etre was understood to be lender of last resort, which was a responsibility to preventing widespread financial institutions failures.  To prevent the failures of institutions which would otherwise be solvent.  

Based on records of Bank of England, they believed that a central bank can reduce panics by serving as lender of last resort.  Even open market operations as a tool were influenced by the Bank of England.

Power Within The Federal Reserve:
It was not the founders intent to precipitate in creation of a central bank, or a powerful institution.  They might not have germinated the process, if they had known to what it would lead.  It was not even until the McFadden Act of 1927 that gave permanence to the Federal Reserve.  The Federal Reserve Charter was initially temporary, much like its predecessors.  

The Board and regional banks did not have synergy.  The regional banks created a Governors Conference to discuss policies, with the Board wanting to limit their interactions.  The Governors Conference was considered a competitor to the Board’s authority.  The governors did ask the Board to send representatives, and sent summaries of the meetings to the Board.  It was the Banking Act of 1935 which created the Federal Open Market Committee and shifted power to the Board.

Learning Monetary policy:
Policies had unintended consequences which the Federal Reserve members did not like or want.  But after practicing monetary policy, and seeing the impact that the policies had, learned from their failures.  There was and is a lot of uncertainty to the impacts of policy changes, for the evidence they had was that monetary disturbances had no lasting effect. 

There were three initially accepted rules for monetary policy.  1) The use of the discount rate to protect gold stock and exchange rate.  2) Become lender of last resort during panics.  3) Accommodate needs of trade and agriculture by discounting commercial paper.  

Banks themselves had a choice to become members within Federal Reserve System.  Banks were resistant to become members because of par collection of checks cleared at the Federal Reserve Banks, and the reserve requirements that did not earn interest.  Certain programs with the Federal Reserve System seemed to favor banks with clients in particular industries. 

Federal Reserve was more passive until wartime experience taught it to look for more active approaches.  Sometimes the Federal Reserve was more passive, but then political pressure made them take action. 

For each World War, the Federal Reserve was in the service of the Treasury to finance the war effort.  A role that compromised Federal Reserve independence.  The problem was extricating itself from the Treasury.

To facilitate quality outcomes, some thought that the Federal Reserve needed more power, others thought that the Federal Reserve needed more independence.  

This is not an introductory book on monetary policy.  To understand the decisions made would require a background in monetary policy terminology and tools.  

There is often not enough history provided about the situation that the Federal Reserve was reacting to.  To understand the context of the decisions would need supplementary research on the economic conditions during the era.  

Questions to Consider while Reading the Book

•What is the raison d’etre of the book?  For what purpose did the author write the book?  Why do people read this book?
•What are some limitations of the book?
•What provided the framework for the Federal Reserve?
•What is a central bank meant to do?
•Why was there a power struggle within the Federal Reserve?
•What tools do central banks have?
•What monetary effect do central banks have?
•What did the Federal Reserve do during the Great Depression?
•Was the Federal Reserve able to stabilize business cycles?
•What were some fears about central banks?
•How active as the Federal Reserve in managing the economy?
•What influenced Federal Reserve policies?
•Is the Federal Reserve independent? 

Book Details
Publisher:         The University of Chicago Press
Edition ISBN:  0226519996
Pages to read:   750
Publication:     2003
1st Edition:      2003
Format:            Paperback

Ratings out of 5:
Readability    3
Content          3
Overall           3