A new paper from the Cato Institute
Has the Fed Been a Failure?
“No major institution in the U.S. has so poor a record of performance over so long a period, yet so high a public reputation.” Milton Friedman (1988).
As the one-hundredth anniversary of the 1913 Federal Reserve Act approaches, we assess whether the nation‘s experiment with the Federal Reserve has been a success or a failure. Drawing on a wide range of recent empirical research, we find the following: (1) The Fed‘s full history (1914 to present) has been characterized by more rather than fewer symptoms of monetary and macroeconomic instability than the decades leading to the Fed‘s establishment. (2) While the Fed‘s performance has undoubtedly improved since World War II, even its postwar performance has not clearly surpassed that of its undoubtedly flawed predecessor, the National Banking system, before World War I. (3) Some proposed alternative arrangements might plausibly do better than the Fed as presently constituted. We conclude that the need for a systematic exploration of alternatives to the established monetary system is as pressing today as it was a century ago.
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.
Its record strongly suggests that the Federal Reserve‘s problems go well beyond those of having lacked good administrators. Although it has manifested itself in different ways during different decades, the Fed‘s failure has been chronic. The problems appear to reside with the institution, and not with particular personalities who have been placed in charge of it. Hence the record would not be likely to improve substantially even with complete turnover in the Board of
Governors. The only real hope for a better monetary system lies in regime change. What sort of change is a question beyond the scope of this paper. The present study has only indicated some possibilities, its main thrust being that the Federal Reserve System, as presently constituted, is no more worthy of being regarded as the last word in monetary management than the National Currency System it replaced almost a century ago.
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