Category: History

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.

For the moment the very rapidity of these changes is hurting us and bringing difficult problems to solve. Those countries are suffering relatively which are not in the vanguard of progress. We are being afflicted with a new disease of which some readers may not yet have heard the name, but of which they will hear a great deal in the years to come–namely, technological unemployment. This means unemployment due to our discovery of means of economising the use of labour outrunning the pace at which we can find new uses for labour.

Alexander Field, the economic historian, would one day argue much the same, with numbers behind it.  For Keynes even the Great Depression wasn't just an AD problem.  (Obama worries too.)

From Keynes, here is 7 pp. more, fascinating throughout, although mostly totally wrong and there is a naughty mention at the bottom of p.6.  It is his famous essay "Economic Possibilities for our Grandchildren."  Keynes argued we would one day (soon) have enough material prosperity to abolish scarcity.  Most importantly, from his Bloomsbury perspective, pro-commercial norms could fade away, as they would no longer be needed as an incentive.  Society would be much the better for it; Daniel Bell later turned this argument upside down by fearing the decline of this ethic.

More wealth brings, on average, greater happiness (see Wolfers-Stevenson for the evidence, Kahneman too), but often through indirect and circuitous routes, and without guarantees.  The bottom line is that most of us keep on striving for more.  Furthermore, happiness isn't the only end we desire, and money is a route to power and esteem as well, as distinct from happiness.  Material satisfaction isn't enough in life.  Unlike Keynes (and Bell), I expect that norms to both encourage and regulate avarice will be with us for a very long time to come.

If you had asked me to bet in which year the President of the World Bank would recommend that we consider some version of a gold standard, I would have picked the wrong number:

The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.

Indeed that is 2010 and the full proposal is here.  I feel like I should pay something to somebody, but I am not sure to whom.  Or in which medium of exchange.

There is a very good new WSJ article on the research of my colleague David M. Levy and his co-author Sandra Peart.  The article starts:

Decades before anybody had ever heard of a mortgage derivative, an economist named Melchior Palyi predicted key causes of the 2008-2009 financial crisis with precision that makes a modern reader's hair stand on end.

His warnings help explain why investors insist on trusting market gatekeepers they know to be fallible–such as policy makers, regulators and credit-ratings firms.

The seeds of today's problem were planted long ago, and its forgotten history holds important lessons. In 1936, as part of reforms under the new Banking Act, the U.S. government mandated that federally regulated banks could no longer hold securities that weren't rated investment-grade by at least two ratings firms.

…Mr. Palyi, then teaching at the University of Chicago, was a vocal skeptic from the outset. Looking back into the 1920s, he found that investment-grade bonds went bust with alarming frequency, often in the same year they were rated. On average, he showed, a bank that followed the new rules would end up with a third of its bond portfolio going into default.

The record was so unreliable that it would be "still more responsible," Mr. Palyi growled, to "stop the publication of ratings altogether." He was especially troubled that the new banking rules switched the responsibility for credit safety from bankers–and even bank regulators–to ratings firms.

"From there," he warned, it "will have to be shifted again–to someone else," presumably taxpayers. Liquidity, Mr. Palyi argued, was being replaced by what he scornfully called "shiftability," a new kind of risk that could someday "be magnified into catastrophic dimensions."

The underlying research by Levy and Peart is here.  If the WSJ article is gated for you, just enter "Melchior Palyi" into news.google.com and an ungated copy is likely to pop up.

C.J. Chivers, via Andrew Sullivan:

Do you own anything that was manufactured in the 1950s and still is in regular, active use in your life?

Our house!  Otherwise it is a few artworks, but even most of the record collection, or for that matter the book collection, was made after that date.  I was manufactured in the early 1960s.  Am I forgetting something?