The View From 1776
Saturday, March 08, 2008
For What Purpose Was the Fed Created?
The role of the Federal Reserve has changed enormously, not for the good, since its creation in 1913.
Most people today assume that the Fed’s proper function is to manage the economy via monetary policy.
A quotation in today’s Wall Street Journal in the “Ahead of the Tape” column reflects that understanding.
“We may be going from bubble to bubble,” says Ed Yardeni, chief investment strategist at Yardeni Research. The problem is that the only other choice for the Fed is to do nothing and let the economy fall into a recession.
“The Fed was created to avoid financial crises and get us out of them when they happen, and that’s what they’re trying to do.”
In the March 8th edition, Wall Street Journal reporter Greg Ip writes:
The Federal Reserve, facing constraints on how much it can accomplish with lower short-term interest rates, is increasingly pressing alternative approaches to restore order to credit markets and combat the risk of recession.
On Friday, it fired its latest unconventional salvo, announcing it would pump as much as $200 billion into short-term funding markets through two separate mechanisms to ease strains on banks’ funding and on mortgage markets. That followed Chairman Ben Bernanke’s call Tuesday that both lenders and the federal government do more to write down the face value of troubled mortgages, forestalling foreclosures and helping stabilize the housing market, and his earlier support of fiscal stimulus.
None of this was envisioned by Congress in 1913.
Professor Allan H. Meltzer (A History of the Federal Reserve, Volume 1: 1913 - 1951) writes that when Congress passed the Federal Reserve Act in 1913, the act said little about the broad purposes of the Federal Reserve. The reason was the sharp differences between partisans and opponents in Congress and the financial community.
Opponents feared that a central bank would be simply a monopoly for the benefit of bankers, chiefly J. P. Morgan and other New York bankers.
Not even the Fed’s most ardent supporters imagined that it would be empowered to manage the whole economy. Professor Meltzer writes that they wanted a central bank that would moderate fluctuations in market interest rates, particularly those caused by seasonal demands for currency and financing crop harvests.
They also wanted the Fed to facilitate the development of a broad national market in commercial paper and bills of exchange, modeled on the London market. A major reason was the National Banking Act limitation at that time on the amount of currency to the existing stock of government bonds.
Money center bankers also wanted the Fed to act as lender of last resort to provide temporary credit support to the banks in times of financial panic. That, however, is a far cry from the Fed’s present-day undertaking to prevent economic recession in the national economy.
What brought about the vast expansion of the Fed’s mission?
The change was described in Chickens Are Returning to the Roost.
President Roosevelt was advised by his New Deal Brains Trust of socialist economists that centralizing management of the entire economy, for the first time in the history of the United States, would enable the Federal government to restore full employment and raise farm prices.
A main pillar in that new socialistic structure was devaluation of the dollar (see How FDR Destroyed the Dollar).