Learning about Policy from Federal Reserve History

For much of the past 15 years, my assistants and I have been reading minutes and papers in the National Archives, the Board of Governors, and the New York Federal Reserve Bank. I owe a debt of appreciation to the Board's librarians, to the achivists at the New York bank, to my several assistants, mad to many at the Fed who cooperated helpfully to make this project come to completion. (1) The result has now been published in two volumes of more than 2,000 pages. Volume 1 covers the 1913-1951 period and has been in print several years (Meltzer 2003). Volume 2, published in February, is in two parts: part one (Meltzer 2010a) covers the 1951-69 period, and part two (Meltzer 2010b) chronicles the 1970-86 period. In this article, I discuss some principal findings from volume 2. The starting point is the 1951 Accord with the Treasury that permitted the long-term interest rate to rise above 2.5 percent. The closing point is the end of the Great Inflation in 1986. Volume 2 has two main themes. One is the Great Inflation. I discuss why it started, why it continued for more than 15 years, why it ended when it did, and why it has not returned, at least not yet. The second theme is the changing meaning of independence. Much of my book is about policy errors and mistaken ideas. That is what makes the book so long. I let the principals make their arguments repeatedly to make clear that they believed in their reasons for acting as they did. Repetition reinforces my interpretations. Because I will talk about mistakes, let me start by saying a bit about achievements. The United States is the world's main monetary power. The Federal Reserve presided over file transition from a local or regional system of financial institutions to the current leader of the world monetary system. It managed the transition from the gold standard through several alternatives to the present system, or non-system, of floating rates for principal currencies. It managed the transition from a monetary arrangement based on member bank borrowing and the real bills doctrine to the present system based on open market operations supposedly directed at the dual mandate. Traditional central bank secrecy proved incompatible with democratic openness, so the Federal Reserve has learned to be more open about its operations and now concerns itself with communications policy. In its 96 years, it has remained free of major scandal. And, from the 1920s on it has done pioneering research on monetary policy and has built not one, but many, dedicated mad highly qualified research staffs at the Board and several of the regional banks. After the mistakes that produced the Great Inflation, the Federal Reserve achieved the "Great Moderation." From the mid-1980s to about 2005, the United States experienced a long period of stable growth, low inflation, and short, mild recessions. These years are the best in Federal Reserve history. Unfortunately, the System did not continue the policies that achieved its greatest success. On the opposite side of the ledger are major and minor mistakes, many of which were repeated. Some members recognized most and perhaps all of the main errors. The FOMC minutes record all the main criticisms that I make followed by my comment saying there was no response and no discussion. Recognition by FOMC members implies that at least some of the errors could have been prevented. Reflecting convictions held by many in Congress and in several administrations, Federal Reserve policy gave greatest attention to avoiding unemployment. It usually followed a lexicographic ordering that gave priority to employment. After most countries in western Europe restored currency convertibility for current accounts, the conflict between the goals of the Employment Act and Bretton Woods became apparent. The Federal Reserve treated the exchange rate as a secondary or tertiary consideration, mainly a problem for the Treasury. …