A History of the Federal Reserve

A History of the Federal Reserve, vol. 1: 1913–1951. By Allan H. Meltzer. (Chicago: University of Chicago Press, 2003. xiv, 800 pp. ISBN 0-226-51999-6.)

Allan H. Meltzer is one of the world’s leading experts on monetary economics. In this book, long in the making, he provides a history of the Federal Reserve System from its founding in 1913 to 1951 set within a wide-ranging discussion of the political and economic history of the period. Meltzer has studiously read the minutes, correspondence, and internal documents of the Federal Reserve Board and many related public and private documents, and he has produced a history of unprecedented scope and persuasiveness.

Perhaps the most surprising aspect is the importance Meltzer places on the role of ideas and on the role of the inventors of economic ideas, the economists. To be sure, institutional politics and pressures from special interests and Congress play their roles in his story. Meltzer, however, attributes the major failures of the Federal Reserve to mistaken ideas. One problem was the failure to distinguish between nominal interest rates (the rates we see in the newspaper) and “real” interest rates (nominal rates adjusted by deducting inflation). The failure to look at real interest rates led the Federal Reserve to conclude that monetary policy was easy in the early 1930s because nominal interest rates were low. Every undergraduate major in economics is now taught this distinction, so perhaps there is progress in economics after all. A related failure was the adoption of what Meltzer terms the Riefler-Burgess doctrine, after the economists in the system who developed it. This doctrine held that borrowing by banks at the Federal Reserve was the key link in the chain between Federal Reserve actions and the economy as a whole. Banks, according to Riefler-Burgess, although perhaps not in fact, were reluctant to borrow and tried to repay as soon as possible. If bank borrowing was high, monetary policy was tight because banks would soon contract their lending in order to reduce their need to borrow; if borrowing was low, policy was easy. Bank borrowing in the early 1930s, like nominal interest rates, often provided a misleading guide to action.

Meltzer’s book will inevitably be compared to Milton Friedman and Anna J. Schwartz’s A Monetary History of the United States (1963). In many ways, Meltzer’s work, although based on documents not available to Friedman and Schwartz, confirms many of their conclusions. There are, however, some important differences. Friedman and Schwartz suggest, for example, that with good leadership the Federal Reserve would have avoided its crucial mistakes. In particular, they argue that the mistakes of the 1930s would have been avoided if Benjamin Strong, the forceful president of the New York Federal Reserve, had not died prematurely in 1928. Meltzer, however, shows that the Federal Reserve, operating thorough the lens provided by the Riefler-Burgess doctrine, would have acted much as it did even if Strong had lived.

This book will be one of the major building blocks of any study of monetary policy in the United States for decades to come. There is, incidentally, a foreword by Alan Greenspan. We can all sleep a little better knowing that Alan Greenspan has absorbed Allan Meltzer’s lessons.

By: Hugh Rockoff