The Federal Reserve System is a great institution that, on balance, has done much to improve the well-being of U.S. society. I was proud to be a small cog in that machine for several years.
But the hair stands up on the back of my neck whenever I hear increasingly frequent comments to the effect that the Fed’s masterful control of the economy is leading us to nirvana, or when I read scornful comments comparing its expertise to the new European Central Bank’s ineptitude.
Sound monetary policy in recent years certainly has supported the long-legged expansion that we enjoy. But we should keep in mind that over the course of its 85-year history, the Fed has gotten it badly wrong more than once.
The 1913 Federal Reserve Act called for an institution to implement “an elastic currency” that would expand and contract with the needs of the U.S. economy and thus avoid repetitions of financial panics, such as the severe one in 1907, that rocked businesses and households. Such crises frequently led to sharp recessions with thousands or millions out of work in an age with virtually no economic safety net.
But the Fed blew it, practically right out of the starting gate. The act was signed in 1913, but the 12 district banks were not up and running until well into 1914, when World War I had broken out in Europe. While the U.S. did not enter the war until 1917, France and the United Kingdom went on an immediate buying spree in the U.S. to support their war efforts and the U.S. economy boomed.
U.S. mobilization fueled further expansion. A postwar contraction of some degree was inevitable. The Fed had been instituted to buffer economic adjustments just as the one the country faced in 1919.
However, instead of cushioning the inevitable postwar contraction, the Fed engineered a sharp credit squeeze. This macroeconomic piling-on pushed the economy into a needlessly painful recession. Historians give the Fed an “F” on its first exam.
Less than a decade later, the Fed blew it again. While not all economic historians agree with Milton Friedman’s charge that the Fed practically caused the Great Depression, most agree that monetary policy from 1929 through 1933 was tragically inept, making the economic slowdown more severe, widespread and prolonged than it should have been. The Fed was particularly bullheaded in allowing the money supply to contract as it did.
When the Fed errs, it is not always on the side of being too restrictive. From 1967 to 1982, the Consumer Price Index rose by a factor of four. While economists had bitter arguments about proper anti-inflationary measures at the time and the Fed itself was reduced to plaintive advice-seeking from outside experts before successive policy meetings, the verdict of history will be clear.
Any time some nation experiences 400 percent inflation in 15 years, its central bank has simply let the money supply grow too fast. There are no ifs, ands or buts about it. All the hoopla about wage and price controls or WIN (Whip Inflation Now) buttons in the 1970s was simply that, hoopla. The greatest peacetime inflation in U.S. history was a Federal Reserve failure, pure and simple.
So enjoy the good economy while it lasts. Give the Fed its due; it has probably done pretty well in contributing to the good times. But don’t forget that the Fed, like all institutions, is one run by humans.
Humans make mistakes, and even the best-run policy institutions commit errors in policy making. The Fed made mistakes in the past, and it is inevitable that it will make more in the future.
© 2000 Edward Lotterman
Chanarambie Consulting, Inc.