Has the Fed Been a Failure?

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.  


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.

Bill must be joking, the biggest financial panic and largest number of bank failures happened after the Fed was established.

My opinion is that they have a considerable blame for the disaster

"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.

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?

The Fed is not only a failure, it is emblematic of the failure of the central bank and fractional reserve banking as concepts.

Commodity-backed money. 100% Reserve. Explicit lending. There is no stable alternative.

I find the use of such old data to be highly dubious not only in its accuracy but its applicability - ceteris paribus certainly does not hold. How much of this volatility is due to financial "innovations", for example, that just happened to be developed during the Fed's existence? In addition, the number of sizable "financial panics" is not large before OR during, so asserting that their frequency can be attributed to something other than chance is a non-sequitur at this point. Better and more data is needed before this argument will have any rigorous empirical evidence to back it up.

Bill: I love it when people go to Wikipedia to see whether some new research is correct. Kinda makes me wonder anyone does any research at all instead of just looking up the answers online!

Bill, this is from the paper (and it is actually a quotation from somebody else - Wicker 1996, 2000):
there were no more than three major banking panics between 1873 and 1907
[inclusive], and two incipient banking panics in 1884 and 1890. Twelve years
elapsed between the panic of 1861 and the panic of 1873, twenty years
between the panics of 1873 and 1893, and fourteen years between 1893 and
1907: three banking panics in half a century! And in only one of the three,
1893, did the number of bank suspensions match those of the Great
Depression (ibid.

I think we will stay with dust from the drum. That is all we will recover. In my kind of scam is a bit smaller, meaning that they provide their salaries and so our money.

"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."

How would you know this?

"Inflation is clearly higher in the post-Fed era as is price variability" this is a BIG FAT LIE, government first began tracking it in 1913 but hey how many times we have inflation above 15% since then and how many we had between 1813 and 1913, all this non government non sense is just insane

I just wonder how anyone who saw a graph of CPI over last 200 years could disagree with the claim that inflation is clearly higher in the post-Fed era.... reminds me of the psychological idea that people are absolutely unwilling to accepts facts that don't match their beliefs.

Btw, Bill, I have read one recent history book about economic development of one small central-european country in 18th century. About the Great depression (1870's) era they conclude that it wasn't that bad as it is described in quite a lot of literature (which is quite interesting as the authors are historians not economists). You can read similar findings here and there; I would opine that the NBER classification is really very likely wrong on this one.

My cursor didn't go further, so add these to the list:

21st century

2001 – Bursting of dot-com bubble – speculations concerning internet companies crashed

2007–10 – Financial crisis of 2007–2010, followed by the late 2000s recession and the 2010 European sovereign debt crisis


"gotten very little" Compared to what alternative? And, since we've gotten so little, what clearly better arrangement presents itself?

Hopefully Wikipedia will have a featured article on the Great Depression so Bill can learn of it and its happening after the establishment of the Fed.

There may also be an article on how to do historical/comparative analysis of panics based on some text copy-pasted from a wiki.

Given our huge wealth through technology, and the Fed/USG's total financial control, it is a serious indictment against the Fed that any economic problems happen at all, let alone the two largest financial crisis, though the latest is ameliorated by cheap food and free money.

I don't see how you can discuss the efficacy of the Fed without comparing the monetary environment in the Great Depression and the recent recession of '07-'10 (and 19th and early 20th century "panics"). The Fed existed as an organization in the 30's but there has been a huge improvement in the conduct of monetary policy since then.

Lew and Lewis: We certainly do consider the Fed's post-depression performance. Indeed, as Alex points out, most of our comparisons are between the pre-Fed and post-WWII periods. We discuss the recent crisis, and also have a separate discussion of the Great Moderation.

Mind you, comparing different regimes in different time periods raises many issues. Our paper merely surveys what extant research (plus a little bit of new econometric work of our own) tells us, with the aim of combating the view--expressed here a number of times--that the Fed "obviously" has made things better, so as to suggest that there is after all reason for considering alternatives (as opposed to merely doing a little tinkering here and there). Available research simply doesn't support economists generally complacent attitude toward our present monetary arrangment.

Cui bono? Large banks.

The banks have been helped to grow until they are too big to let fail anymore. We know. We know.

Again, the question is at what cost? FDIC reduced bank runs, but it's not a free lunch either.

It's interesting that the 19th century panics are described as "pervasive recession with bank failures" but they don't list the recessions in the 20th century. Something wrong there. I'm guessing things got pervasiver and pervasiver, but the top of the iceberg was chopped off so things appear better.

Also, don't forget that according to a full time channel on my cable service the Fed is a private bank run by "money lenders" who are in collusion with all the other private "money lender" owners of central banks around the world. They are all descendants of the Rothchilds or something.

Right, because a bunch of vacant houses filled with stuff from the factories that moved overseas with debt that has to be paid to the people that got the factories is the goal of capital accumulation.

Our paper includes a chart showing total number of bank failures as a percentage of all banks, annually from the 1870s onwards. I'm not sure what it would mean to scale to GDP, since it seems that what matters is what portion of the financial system goes belly-up.

Statistics for liabilities of failed banks as a percentage of total liabilities show a very similar pattern, except the data are not available for a couple years.

The last aricle cited by Andrew, and the one he quotes fro, concludes:

Disappearance of Panics after 1933
The long era of banking disturbances finally ended in 1933 due partly to the introduction of deposit insurance, improved performance of the Federal Reserve, and a better understanding of the sources of systemic banking unrest. Knowledge alone, we have learned, is not a sufficient guarantee to forestall banking panics. Leadership and policymaker competence are important as well.

Well with reading in it entirety.
It is an article in in the Economic History Association

Here is also a description of the failure of private mechanisms to avert
Panic by the same author, Wicker, that Andrew cites

One other historical note that illuminates another important cost of heterogeneity.  In Banking Panics of the Gilded Age, Elmus Wicker shows that with one notable exception (the Panic of 1873), the New York Clearinghouse was unsuccessful in dealing with financial panics and contagion.   (NYCH was a bank clearinghouse, not a derivatives clearinghouse, but there are important similarities.  Most importantly, NYCH had the ability to mutualize some risks.)  Wicker argues that conflicts between heterogeneous members were the main impediment in dealing with panics.  Although mutualization of risks would have mitigated panic (because the banks collectively were more likely to be solvent than any individual bank), mutualization transferred wealth from the stronger banks to the weaker ones.  The inability to overcome this distributive conflict stymied the ability of the NYCH to respond to crises in an effective way.   Thus, not only can heterogeneity increase the likelihood of a problem at a CCP (due to its effect on the severity of moral hazard problems), it can reduce the effectiveness of a CCP in dealing with a crisis situation.

J Thomas, you may ahve to look at teh concept of demurrage:

Yes, that's OK. It looks to me like inflation does all the same things with less bookkeeping, except that the result is inflationary instead of deflationary. The problem comes when you get more inflation than you want, and you want to take away people's money so they won't have so much so prices will go down....

The problem I have with all this is that the concepts are so fuzzy. They seem real clear but they're hard to make concrete. If all the official money stayed in government computers and people did transactions with debit cards (or unofficially with barter or silver etc) then you could know the amount of official money to the penny, and you could get its speed by measuring transactions times transaction size per day. But inflation is hard to quantify.

It's like, everybody has a clear concept of justice and injustice, but if you try to measure how much justice and how much injustice our legal system does, you get nowhere. Inflation isn't that bad but it's pretty bad.

People say we want to control inflation because of the people on fixed incomes. But I don't believe all this effort is actually for the widows and orphans. We do it for the banks, who would lose money to unexpected inflation. If we didn't have banks, you could perhaps arrange loans as follows: Pick eleven commodities, and note how much of each commodity the sum loaned would buy today. If at the end, the loan should return 20% total interest, calculate the cost of 120% as much of those eleven commodities, and chose the median one to assign the value that should be paid.

Also, I think its called "capitalism" because the concept of large private accumulations of capital that fund investment is central to the system (I realize some people confuse capitalism with the free market).

You can have large accumulations of capital without banks, if you really want to. Presumably Bill Gates and Sam Walton etc would acquire a lot of capital. They could hire people to invest or lend their money if they wanted to. But their loans would not be inflationary because they would lend their own money, not money they created with a shell game.

Now its been proposed in the past to have the government handle the large amounts of capital formation and investment. But I've never seen anyone propose doing without the large pools of capital altogether. Its an interesting idea.

As a metaphor, higher plants grow from seeds. They start with enough stored energy and materials to grow some leaves and roots and become a small going concern, that finances further growth by collecting sunlight. The bigger it grows the faster it can grow until it runs into some limiting factor.

Kudzu can grow as much as a foot a day, once it's well established. It keeps giant reserves of starch in underground roots, and sends them to speed the growth of whichever stems get the most sunlight. Once it has collected big reserves it can outcompete other plants for sunlight.

Large pools of capital can help companies grow faster to meet special opportunities. Companies that get surplus capital can grow faster and exploit their niches faster than other companies, so they get a competitive advantage. They pay for that later, but it's better to get market share and then lose profits paying for the capital that let you get market share, than to not get the sales in the first place.

Even with a stable money supply people could accumulate lots of capital and then use it to win. But if they didn't, if businesses tended to finance their growth out of current profits or stock offerings, would that be bad? Grow too fast and it's harder to figure out what you're doing. If businesses tended to grow at the rate they could pay for it, they might do better -- provided they didn't get oucompeted. Capital that allows one business to grow super-fast, and make frivolous patent challenges, and slanderous whisper campaigns, and industrial espionage, and hire away top researchers, and do hostile takeovers etc etc etc does provide a competitive advantage over other businesses. But does it really improve the economy?

Oh, Bill did it again...

The long era of banking disturbances finally ended in 1933 due partly to the introduction of deposit insurance, improved performance of the Federal Reserve, and a better understanding of the sources of systemic banking unrest

In the paper they said that they think that the role of Fed was miniscule and what 'helped' was FDIC. What's your argument that it isn't so? Because the history association (certainly economicsts??) said it?

Bill: I have read Wicker, and he clearly thinks the Fed a failure w.r.t. the prevention of crises.

As for the Fed contributing to the dramatic post-1933 decline in bank failures, it's hard to see how it did so. Certainly it didn't make life easier for bankers (or anyone else) by doubling reserve requirements in 36 and 37. The evidence pretty clearly indicates that the lion's share of credit for the elimination of runs and reduction in suspensions belongs to the FDIC, with the RFC next in line, and the Fed deserving no credit at all. (Oh, yeah: the fact that most of the insolvent banks had already failed by the time of the holiday and were never reopened helped a lot, too.)

Andy, Here is the quote from Wicker--in the same article:

" Did the fault lie in the legislation creating the Fed or was Fed leadership culpable? Friedman and Schwartz (1963) attempted to unlock this riddle in terms of personalities, but there is a compelling alternative, which they rejected, that deserves reconsideration. Structural weaknesses in the original Federal Reserve Act can explain equally well, if not better, why the Fed failed to prevent the panics of the Great Depression. There were at least three important structural flaws in the 1913 Federal Reserve Act: l) membership was not compulsory for all banks; it was mandatory for national banks and optional for state banks and trust companies thereby restricting access to the discount window; 2) paper eligible for discount by member banks was too narrowly defined; and 3) power was decentralized among the twelve Federal Reserve Banks and the Federal Reserve Board making consistent and effective policy action difficult. These combined structural weaknesses hindered policymakers' efforts to respond quickly at the onset of banking panics. When four out of five bank suspensions during the three panics of 1930 and 1931 were nonmember banks, it is time to reconsider the membership question as a cause of the Great Depression panics."

Here is the link: read it and decide for yourself what Wicker said: http://eh.net/encyclopedia/article/wicker.banking...

Bill, your long post puzzles me. I never said that Elmus Wicker advocates abolishing the Fed. What he does say is that panics became more severe in the post-1914-pre FDIC period than they had been during the National banking system era, and that earlier anti-panic arrangements, for all their shortcomings, would have done a better job than the Fed did in preventing them. (Friedman and Schwartz reach a similar conclusion.) These conclusions come from Wicker's two books on the subject, which are his most exhaustive treatments, and you will find relevant quotes in the paper.

As for the rest, I see nothing in the passages you refer to that contradicts what I have said either here or in our paper. (It was, though, the the Banking Act of 1933 rather than that of 1935 that created the FDIC.)

George, responding to your comment: "I never said that Elmus Wicker advocates abolishing the Fed."

I never said that. Here is what I said that elicited the response above:

"'George, you said that Wicker "clearly thinks the Fed a failure w.r.t. the prevention of crises.' I could read that as the Fed's failure to inject liquidity in the Great Depression, or saying that Wicker's view is that the Fed is a failure."

It is clear I didn't say that Wicker advocates abolishing the Fed, as you stated.

It is also clear he, as others, thought the Fed did not respond correctly during the Great Depression, but for reasons related to their belief in their authority. Sweeping that under the phrase he "thinks the Fed a failure w.r.t. the prevention of crises.' implies more than it states, given that his works clearly state that the Fed and banking legislation since the 30's have prevented banking panics. See "long posting" above for citations. If you have any citations that Wicker argues that the Fed since 1930 has been a failure, please show me. What I have seen is that there may be a need for more regulation and more supervisory authority. See, http://mpra.ub.uni-muenchen.de/21839/1/MPRA_paper...

George, I am sorry, but while I agree with your statement (and never disagreed with it, btw) that the Fed (which came into existence in 1913) was not effective between 1913 and 1933 to prevent panics,

I do not believe you are correct when you say that "pre-Fed private clearinghouse anti-panic measures probably would have handled things better.", that is, handled panics better between 1913 and 1933.

First, Wicker states that pre-fed clearinghouses (NYCH) failed in previous panics to solve the problem. I believe in two cases he said they failed.

Second, Wicker states in his recent paper that the Fed needs additional authority because of the greater interconnectedness and opacity in the current system.

Third, even if I were to buy this claim, if you are trying to make comparisons of programs in period 1 with circumstances in period 2 to draw an inference, the conditions of period 1 and 2 have to be the same. Wicker in this paper clearly states the there are substantial differences between period 1 and today. Read the current Wicker posting cited above.

Four, I am proud that you say that my questions and comments are "like being given the third degree!" I'm a lawyer, and adjunct prof in antitrust and occaisionally a graduate program in marketing. I've enjoyed this discussion and I'm sure we both learned from it.


Here's how I understand Wicker's rankings of arrangements for dealing with panics:

(1) Clearinghouse-type intervention with reserve equalization a la 1873 panic/Coe report
(2) Clearinghouse response as practiced generally before 1914;
(3) The pre-1933 Fed's response.

I'm also sure that Wicker prefers the post-33 Fed to the pre-33 Fed and (quite likely) the overall pre-Fed clearinghouse arrangements. But I'm not sure that he would rate it better than (1).

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