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« The Schelling-Stapledon model of the Octopus | Main | Fear not hyperinflation »
2013 will mark the 100th anniversary of the Fed. What have we got for our money? Surprisingly little. Inflation is clearly higher in the post-Fed era as is price variability. Deflation is lower, although there is nothing to fear from secular deflation. Barsky, Miron, Mankiw and Weil did find that the Fed dramatically reduced seasonal interest rate variability. I have always found this result puzzling--money is easy to store and seasons are predictable so why aren't interest rates smoothed without a very elastic money supply? In anycase, it's not obvious that smoother rates are better, although there could be small gains.
The big question, of course, is the variability of output. It used to be thought that output variability had decreased post-WW II but, as I pointed out in an earlier post, Romer's work (see also Miron) has shown that when measured on a consistent basis there is no substantial decline in volatility comparing pre-WW 1 to post-WW II. (Note that is generously giving the Fed a pass on the Great Depression!)
Selgin, Lastrapes and White have an excellent review of the empirical literature on inflation, output and other variables and conclude:
The Federal Reserve System has not lived up to its original promise. Early in its career, it presided over both the most severe inflation and the most severe (demand-induced) deflations in post-Civil War U.S. history. Since then, it has tended to err on the side of inflation, allowing the purchasing power of the U.S.dollar to deteriorate considerably. That deterioration has not been compensated for, to any substantial degree, by enhanced stability of real output. Although some early studies suggested otherwise, recent work suggests that there has been no substantial overall improvement in the volatility of real output since the end of World War II compared to before World War I. A genuine improvement did occur during the sub-period known as the "Great Moderation." But that improvement, besides having been temporary, appears to have been due mainly to factors other than improved monetary policy. Finally, the Fed cannot be credited with having reduced the frequency of banking panics or with having wielded its last-resort lending powers responsibly.
The Fed has surely been among the better of the central banks which would make it interesting to run a similiar analysis in other countries.
Posted by Alex Tabarrok on November 17, 2010 at 07:25 AM in Data Source, Economics | Permalink
If you ever read Kindleberger's "Manias, Panics, and Crashes: A History of Financial Crises (Wiley, 2005, 5th edition)" you would not ask this question. He does a great job going through historical financial panics, showing how, beginning in England in the 1820's, how a central bank unstuck some serious financial panics, and how and why the Fed Reserve was created and what its success was.
If you read this MIT economist and economic historian's book, you can answer this question quite easily.
The question that should be asked is a different one: how can we reduce (I am sure you can never eliminate) regulatory capture of the Fed by large financial institutions.
Posted by: Bill at Nov 17, 2010 7:48:34 AM
Finally, the Fed cannot be credited with having reduced the frequency of banking panics
Why not? It was my impression that financial crises were much more frequent in the 19th century compared to the 20th.
Posted by: JSK at Nov 17, 2010 7:51:58 AM
Bill must be joking, the biggest financial panic and largest number of bank failures happened after the Fed was established.
Posted by: anon at Nov 17, 2010 8:09:28 AM
Anon, Prove your statement
Posted by: Bill at Nov 17, 2010 8:30:50 AM
So could we eliminate the Fed along with monetary policy generally? A thought-experiment here.
Posted by: Metamorf at Nov 17, 2010 8:48:37 AM
Not quite related to the thread but here's price controls predictably starting: Bloomberg wire
Has there ever been an undervalued currency with Inflation?
Posted by: kjm at Nov 17, 2010 8:54:00 AM
My opinion is that they have a considerable blame for the disaster
Posted by: Sylter at Nov 17, 2010 8:59:25 AM
Frequency versus scope of these panics? And the cost? 95%+ loss of purchasing power due to inflation since inception.
Give me that kind of power and I could create all kind of benefits and might could even do it without two depressions a century.
Posted by: Andrew at Nov 17, 2010 9:08:53 AM
"Why not? It was my impression that financial crises were much more frequent in the 19th century compared to the 20th. "
Something like 3 financial panics in the last 50 pre-Fed years? Only one of them actually serious? More or less without state stimulus and state-sanctioned bailouts? BTW: they DO distinguish between FED and FDIC in the paper and say that this achievement is very likely because of FDIC, not Fed.
He does a great job going through historical financial panics, showing how, beginning in England in the 1820's, how a central bank unstuck some serious financial panics, and how and why the Fed Reserve was created and what its success was.
And, as you surely know, England had a regulation on the size of banks; a similar regulation in the USA is blamed for the financial panicks in the 1930's.
As far as I remember, during the whole Scotland banking experience there was only 1 panic that was helped by the English central bank. Now what you should ask is: what would happen if there was NOT a central bank? The answer, surprisingly, might be - that the bankers would have found other ways to balance the situation. They found in some parts of the USA (forgot the state - Pennsylvania clearing system?), they found the way in 1907, they found it in other crises.
Posted by: andy at Nov 17, 2010 9:11:18 AM
This is a very interesting post. If we assume the fed is a failure, then the question becomes whether or not there is a viable alternative. It is difficult for me to imagine what a modern economy would look like without a Fed.
Do you have some suggestions or thoughts on what some of the alternatives would be?
Posted by: Mickey at Nov 17, 2010 9:17:08 AM
The difference between the Fed and previous central banks is in degree not kind. A better question would be; has the Bank of England been a failure?
Posted by: josh at Nov 17, 2010 9:31:52 AM
Having non-volatile overnight interest rates surely encourages financial players to use overnight funding. And then we can ask whether that is a good thing.
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