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08 Oct 2014Working Paper Summaries

The Federal Reserve’s Abandonment of Its 1923 Principles

by Julio J. Rotemberg
One of the most dramatic reversals in Federal Reserve policymaking has been the targeting of monetary policy towards financial stability. In 1923, for example, the Federal Reserve's Annual Report officially announced that the goal of monetary policy was the avoidance of speculative lending, which was thought to lead to inflation and crisis. By contrast, in 2002 there was broad agreement at the Fed with economist Ben Bernanke's view that monetary policy should be aimed exclusively at macroeconomic goals while financial stability should be ensured by regulatory means instead. In this paper the author explains when this reversal occurred and he sheds some light on why it did. He shows that two principles in 1923—the discouraging of speculative lending by commercial banks, and the desire to meet the credit needs of business—remained important in Federal Open Market Committee (FOMC) deliberations until the mid-1960's. After this, the FOMC spent less time discussing the composition of bank loans. Overall, as the author argues, an unwillingness to devote monetary policy to financial stability may well make financial crises more likely. This paper may thus contribute to the understanding of the ultimate sources of the financial crisis of 2007. Key concepts include:
  • This paper explores the persistence and some of the consequences of the eventual abandonment by the FOMC of principles embedded in the Federal Reserve's Tenth Annual Report of 1923.
  • As the Fed directs monetary policy towards financial stability, the history of how it abandoned this earlier goal contains lessons for the future.
  • Understanding the abandonment of the Fed's 1923 principles also sheds light on the relevance of various views about what determines Fed policy.

Author Abstract

This paper studies the persistence and some of the consequences of the eventual abandonment by the Federal Open Market Committee (FOMC) of the principles embedded in the Federal Reserve's Tenth Annual Report of 1923. The three principles I focus on are 1) the discouraging of speculative lending by commercial banks, 2) the desire to meet the credit needs of business, and 3) the preference of a focus on credit over a focus on monetary aggregates. I show that the first two principles remained important in FOMC deliberations until the mid-1960s. After this, the FOMC also spent less time discussing the composition of bank loans.

Paper Information

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