Has the Fed Been a Failure?
The Federal Reserve System was established by legislation enacted in 1913, and the Federal Reserve began operations the following year. As the centennial of the Fed’s birth nears, and in light of the controversy regarding the Fed’s actions in the recent ﬁnancial crisis, it now seems to be an appropriate time to take a broad view and assess the performance of the Fed over its ﬁrst 100 years. This special section presents ﬁve papers that examine several dimensions of the Fed’s performance over its life. We took the opportunity of the submission of the paper entitled ‘‘Has the Fed Been a Failure?’’ by George Selgin, William D. Lastrapes, and Lawrence H. White to solicit the views of other monetary economists on the performance of the Fed over time. Following the Selgin, Lastrapes, and White paper are papers, presented in alphabetical order, by Michael D. Bordo, Benjamin M. Friedman, Robert L. Hetzel, Allan H. Meltzer, and Jeffrey Miron.
In their provocative paper, Selgin, Lastrapes, and White (SLW hereafter) carefully consider current research and present new empirical evidence on the Fed’s performance. They conclude there is no convincing evidence that the Fed has contributed to improvements in monetary and macroeconomic stability during the post-WWII period. In light of their assessment of the Fed’s performance, they call for a renewal of the debate on the nature of the Fed and suggest that alternatives to the current discretionary regime such as a commodity standard or a rules-based ﬁat money regime that accommodates the observed instability in the velocity of money should be considered in this debate.
In answering the question ‘‘Could the United States Have Had a Better Central Bank?’’, Michael Bordo considers two counterfactuals—one in which the Second Bank of the United States survived as the nation’s central bank and one in which the Second Bank did not survive but a central bank was later established based on Warburg’s 1910 plan for a central bank. Bordo argues that, in either scenario, ﬁnancial instability would likely have been less than experienced since the establishment of the Fed and that overall macroeconomic performance may have been better as well. He concludes with some lessons from history for a central bank.
Friedman, in his paper ‘‘Rules versus Discretion at the Federal Reserve System: On to the Second Century’’, stresses that there has been a tension between rule-based policymaking and discretionary policymaking throughout the Fed’s history and that the Fed’s position on the rules vs. discretion spectrum has shifted over time. Friedman considers the case for and against rules, but argues that practical issues like the need to respond to extraordinary circumstances such as those characterizing the recent ﬁnancial crisis induce central bankers to retain an essential role for discretion in monetary policy decisions. He notes that, throughout US history, periods of severe, long-lived economic distress have led to calls for fundamental changes in the conduct of monetary policy and that, as it nears the beginning of its second century, the political challenges faced by the Fed today are more severe than they have been for some time. Although he notes that these political pressures will likely fade as the economy rebounds, he argues the perennial debate over rules vs. discretion will continue.
In his paper ‘‘Central Bank Accountability and Independence: Are They Inconsistent?’’, Hetzel notes that a key issue in monetary arrangements is the design of an institutional structure that promotes accountability while simultaneously limiting political pressures on monetary policy. To limit political pressure, the Fed uses the language of discretion in which each policy action is optimal in the context of the contemporaneous behavior of the economy. This language limits the ability of the Fed to learn why throughout history ‘‘. . . monetary arrangements have periodically created instability.’’ In the spirit of this language, bad outcomes result from real shocks that overwhelm the stabilizing powers of monetary policy. Hetzel calls for the Fed to incorporate into the policy-making process a group of economists charged with learning from history and applying the lessons learned to policy.
Allan Meltzer, in ‘‘The Federal Reserve (almost) 100’’, notes that the Fed’s record since its inception has been mixed, with periods of good and bad policy. He argues that Fed policy contributed to two long periods of growth with low inﬂation, the ﬁrst of which occurred during adherence to the gold standard and the second in which the Fed’s behavior was consistent with the Taylor Rule. However, he argues the good periods constituted only about a third of the Fed’s existence, and he suggests two reasons for frequent Fed failure—errors of commission that stem from ﬂawed analysis and errors of omission that stem from focus on the near-term and neglect of the medium-and long-terms. Meltzer calls for amendment of the Federal Reserve Act to require adherence to a quasi-rule for monetary policy along the lines of the Taylor Rule and to a rule like the Bagehot Rule for responding to ﬁnancial crises.
In his comment on SLW, Miron argues that the average growth rate of per capita output should be considered along with the measures used by SLW in evaluating the performance of the Fed. Miron ﬁnds that the average growth rate of per capita output was lower in the era before the Fed than in the post-WWII period, a result that weakens the case against the Fed. Although he is more skeptical of the potential efﬁcacy of commodity standards than are SLW, Miron agrees with them that rule-based ﬁat money systems are worth exploring, but he notes that it is difﬁcult to design a good monetary system in which the government, especially a large government, has control of the monetary base. We trust that readers will ﬁnd these papers insightful and informative.