Has the Federal Reserve been a failure?

I attended a two-day conference at Wake Forest University on the Federal Reserve. The Fed is the U.S. central banking system and was founded in 1913 to replace the earlier National Banking System experiments that had been in place since the eighteenth century.

I enjoyed a paper presented by George Selgin (University of Georgia) and Lawrence White (George Mason University): “Has the Fed Been a Failure?” Jeffrey Miron (Harvard University) commented on the paper, agreeing with its central conclusions but offering some different policy suggestions.

Selgin and White’s method is to take the Fed’s mission and to ask whether it has achieved its self-stated goals of using monetary policy to (1) achieve maximum employment and (2) stable prices, (3) moderate long term interest rates, (4) contain financial crises and (5) the spread of crises outside the financial system.

Data from economic historians Christina Romer and Elmus Wicker figured frequently in comparing the pre- and post-Fed eras.

With all due qualifications about the complexity and evolution of the economy, here is my summary of Selgin and White’s findings:

(1) Employment: Since establishment of Fed in 1913, unemployment has been consistently higher than pre-1913 (except for one brief stretch). But lots of factors bear on unemployment, so we can’t say how much the Fed’s monetary policy has been a causal factor. But we can say that the Fed with its available tools has not been able to control unemployment.

(2) Prices: The price index was relatively flat from 1779 to 1913, but since then it has increased dramatically. If instead we look at price volatility, the data sets differ but tend to show trivial differences between pre- and post-Fed eras. So either the Fed has been no better at controlling price volatility than the pre-Fed era, or the Fed has contributed to the large price index increases, or both.

(3) Interest rates: I didn’t catch this part of the presentation. (But the interest rate is the price of money, and the Fed’s setting the interest rate is a government price control, so general lessons about the effectiveness of price controls should apply here.)

(4) Contain financial crises: Panics have not been more or less frequent since the Fed’s founding. Defenders of the Fed might say that after March of 1933, panics have been fewer, but Selgin and White point out that that was because (a) by then half of the banks had failed and didn’t reopen, so the banks that could cause panics were out of the system, (b) one couldn’t get gold anymore, thus eliminating that as a cause of bank runs, (c) a Hoover bank-recapitalization program was helping many banks, and (d) FDIC kicked in and helped in a minor way. The Fed, they conclude, had nothing to do with it the fewer bank panics post-1933.

(5) Prevent the spread of crises outside the financial system: The Fed failed to prevent the Great Depression and, many economists now agree (see the conclusion), turned a recession into the Great Depression. But, defenders of the Fed can say, the Fed learned from its mistakes in the G.D. and has since done a good job. If so, say Selgin and White, the Fed seems to have unlearned those lessons in the last few years.

So, has the U.S.’s monopoly central banking system been effective? The Fed’s 100th anniversary is approaching, so that is a timely question. All of us have grown up with the Fed in place and so we tend to see it as a set-in-stone, not-to-be-questioned, necessary institution.

A working paper of Selgin and White’s results is available at the Social Science Research Network.

Related post: Money and Monetary Systems

Selgin is also the author of this fun book.