6 - High tide of the Federal Reserve System?

Summary

Introduction

Economic historians tend to view the 1920s as a period when the Federal Reserve System actively used open market operations as an effective policy tool. In chapter 6 of A Monetary History of the US, 1867–1960 Milton Friedman and Anna Schwartz refer to this period as the “high tide of the Federal Reserve System.” During the twenties there

was a conscious attempt, for perhaps the first time in monetary history, to use central-bank powers to promote internal economic stability as well as to preserve balance in international payments and to prevent and moderate strictly financial crises. In retrospect, we can see that this was a major step toward the assumption by government of explicit continuous responsibility for economic stability. As the decade wore on, the System took – and perhaps even more was given – credit for the generally stable conditions that prevailed, and high hopes were placed in the potency of monetary policy as then administered.

(1963, p. 240)

According to Friedman and Schwartz, and other high tide proponents, the ability and willingness of the System to conduct stabilization policy was enhanced by the gradual centralization of open market operations which culminated in the creation of an Open Market Investment Committee in 1923. The centralization of authority allowed the Fed to manipulate Federal Reserve credit to offset secular shocks to the economy and to eliminate seasonal movements in interest rates (Friedman and Schwartz, 1963, pp. 292–8; Miron, 1986).

Friedman and Schwartz's characterization of the 1920s Fed as an adept benevolent stabilizer seems strangely out of place with their discussion of the rest of Fed history.