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Alex asks this question. I am not so enamored of the pre- and post-Fed macroeconomic comparisons. Presumably the Fed advocate also favors deposit insurance and active exercise of the lender of last resort function. Furthermore most Fed advocates today do not want a gold standard, in part because it ties the hands of the Fed in a crisis. I view 1929-1932 as a better illustration of the workings of "a world without a Fed" than "a world with a Fed," even though of course we had a Fed then. If you take the relevant division to be "before and after WWII," the Fed looks pretty good.
It's also the case that the 19th century had much less interconnected leverage than today's world (not only because of the absence of a Fed) and that agricultural productivity was a much bigger determinant of overall volatility.
I see the historical ledger as follows:
1. The Fed made 1979-1982, and the 1970s in general, much worse than they had to be, and for no good reason. Count that as a strike against the Fed.
2. The Fed made the recent crisis much better than it otherwise would have been. Without a Fed, we would have experienced something akin to a Great Depression, including a frozen payments system.
2b. If you wish to give the recent crisis an anti-Fed spin, you can argue that if previous bailouts had not occurred, we might have avoided the high levels of leverage circa 2006 and thus avoided such a major crash. We would have had one or two big recessions earlier on, however. More to the point, I believe that Congress would have done earlier bailouts; after all, that is what just happened in Ireland and TARP was Congress in any case. What is the point of going that route? People think of the gold standard as fetters on the Fed, but I think of the Fed as an excuse for Congress to step back. Consult the wisdom of Garett Jones.
3. A "real Fed" would have made 1929-1932 much better than it was. In my view this #3 more than cancels out #2b. It is unrealistic to ask for a perfect or even a very good Fed, but it is not unrealistic or utopian to advocate "a Fed better than the 1929 Fed" and indeed we've had that ever since 1937.
4. In the 1950s, 1960s, 1980s, and 1990s, I see the Fed as bringing improvements, of unknown magnitude.
5. Historically central banks have been essential in helping nations fight major wars. The world's preeminent military power simply will have a Fed, for the same reason that it has lots of nuclear weapons.
6. More generally, both Fed and Treasury are usually, in relative terms, voices of economic reason within government, even if they're not everything you wish them to be. It is arguably counterproductive to lower their status. Currently, the relevant alternative is a totally politicized Fed, not no Fed at all; see #5.
Addendum: Bryan Caplan offers relevant comment.
Posted by Tyler Cowen on November 18, 2010 at 07:10 AM in Economics, History | Permalink
2b is an especially good point. Anti Fed sentiment, by the way, is very shallow. I am pretty sure that the vast majority of Americans --including the minority who spout negatives about the Fed-- know virtually nothing about what the Fed does. Without a doubt, though, the existence of the Fed has reduced congressional and executive activism in the last two years, as well as during both terms of George W. Bush.
Posted by: liberalarts at Nov 18, 2010 7:22:45 AM
Re: #4. Relative to what, Tyler? Relative to central banking with a gold standard? Relative to other central banks in history? Relative to free banking? You have made the case that the Fed has been a least-bad central bank, usually, not counting the Great Depression, which for some reason is not the "real Fed". I see an opportunity here for a Cowen-White debate on the case for/against the Fed at GMU.
Posted by: Steve Miller at Nov 18, 2010 7:31:32 AM
If you have to accept that there may need to be a lender of last resort in some circumstances--because banks are unwilling to lend to other banks (ala last crisis), because of assymetrical information, because of shocks (ala Europe right now, or Mexico, or LTCM)
--then acting without a lender of last resort or an entity capable of suddenly adding liquidity--means the following:
1. Institutions that are very large will not be able to fulfill that role in a time of crisis (look at all the major banks during the last crisis--were they willing to lend to each other?) or only a few can, and then only partially (Warren Buffet??, the Kochs?)
2. The lender of last resort--if it is not your government--could be and likely would be another government,
Like China.
It's your choice.
Posted by: Bill at Nov 18, 2010 7:40:11 AM
2b. What about they created the crisis with low interest rates over-reacting to the dot-com and 9/11 recession and then created the crash by raising interest rates steadily from 2005 on until the housing bubble they created became untenable. So, you have to include their role in the cause in the overall net effect on this recession.
Posted by: Andrew at Nov 18, 2010 7:40:38 AM
"If you take the relevant division to be "before and after WWII," the Fed looks pretty good."
But our paper does take that division, for the most part; and still we conclude that the Fed doesn't look so good.
The paper also has a long section eveluating the Fed's performance as a LOLR.
I do appreciate arguments to the effect that a major power is bound to have a Fed, or something like it, to finance wars etc. But (most) economists insist on claiming that the Fed and central banks generally are not merely inevitable but the best possible means for administering nations' money supplies. It is that claim that the paper disputes. And I'm far from certain that, if economists changed their tune on this score--if they ceased to make dubious claims concerning the general macroeconomic benefits of central banks--that even major democratic governments could continue to saddle their nations with destabilizing arrangements for the sake of having access to emergency revenues.
Posted by: George Selgin at Nov 18, 2010 7:42:36 AM
"We had a fed but it acted like a non-fed, so that's not only an outlier, but a data point for non-fed." That's funny. As funny, but less subtle is the fact that the challenges since WWII have been very mild. The Fed's great success is a result of the rising tide. That's over.
Posted by: Andrew at Nov 18, 2010 7:52:06 AM
"More to the point, I believe that Congress would have done earlier bailouts; after all, that is what just happened in Ireland and TARP was Congress in any case."
Do you believe the political tool as USA congress is capable of fast unpopular action? You are joking, right? The reason, US congress makes sense is the fact is not so political, it is one of the few institution in US that can have longer then four years plans and goals.
Posted by: gorianin at Nov 18, 2010 7:59:10 AM
I think a more practical question is what should the Fed's mandate look like? Employment and price stability, or just price stability? I don't know the answer to that one...
Posted by: RHD at Nov 18, 2010 8:07:29 AM
I think a more practical question is what should the Fed's mandate look like? Employment and price stability, or just price stability? I don't know the answer to that one...
Isn't the Fed an organization of bankers, run by bankers for bankers?
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