------------ EH.NET BOOK REVIEW --------------
Published by EH.NET (July 2007)

Roger W. Spencer and John H. Huston, _The Federal Reserve and the 
Bull Markets: From Benjamin Strong to Alan Greenspan_. Lewiston, NY: 
Edwin Mellen Press, 2006. x + 251 pp. $110 (cloth), ISBN: 
0-7734-5784-3.

Reviewed for EH.NET by Gary J. Santoni, Department of Economics, Ball 
State University.


This book by Roger Spencer and John Huston examines the relationship 
of Federal Reserve policy to stock market activity by focusing on the 
monetary policy responses of Benjamin Strong, William McChesney 
Martin Jr. and Alan Greenspan to the three major bull markets that 
occurred during their respective tenures as leaders of the Federal 
Reserve. The authors devote three chapters to discussions of each of 
these Fed officials and the bull markets they struggled with. A 
fourth chapter presents an empirical evaluation of the Fed's policy 
response to heated stock market activity.

This is an interesting book. It begins with a very informative 
discussion of the relationship between the twelve district Federal 
Reserve Banks (particularly, the New York district bank), the 
Washington Federal Reserve Board and the U.S. Treasury during the 
Fed's formative years. It discusses the various roles played by 
Carter Glass as author of the legislation that formed the Fed and his 
service as Secretary of the Treasury and (at the same time) member of 
the Washington Federal Reserve Board. The discussion presents a 
rather detailed account of the clashes of personalities and the 
different views of Glass, Strong (president of the New York Fed) and 
William Harding (president of the Washington Board) regarding Fed 
independence, the appropriate tools of policy, their application and, 
in particular, the role of the Fed in controlling speculative 
activity in the stock market. The discussion is lively and extensive 
excerpts from personal letters give the reader a real feel for the 
personalities and motives of the main characters.

A particularly illuminating example of the above is found in an 
excerpt from a letter to Senator Elihu Root from Benjamin Strong. In 
it Strong observes, "In their great desire to lay all of the troubles 
and fancied troubles of this country to the New York Stock Exchange, 
some of our legislators go to such length that it makes it difficult 
to decide where ignorance leaves off and willful misunderstanding 
begins." I suspect there are relatively few present day Fed officials 
who come away from a Congressional hearing without similar thoughts. 
Financial arrangements and markets have evolved considerably since 
1914 but the changes have apparently done little to alter the strife 
between these markets and some of those who occupy the political 
arena.

While this book studies the influence of stock market activity on the 
policy actions implemented by the Federal Reserve, the authors point 
out that each of their three principle characters (Strong, Martin and 
Greenspan) believed the Fed's policy instruments to be ill suited to 
regulating prices in equity markets. Greenspan, for example, argued 
that the Fed can only check a bull market by rationing "credit 
severely enough to paralyze business itself." Strong's view was 
similar suggesting that if the Fed forced interest rates up to curb 
speculation it could penalize the entire country by slowing economic 
growth. Consequently, it may be better to simply allow speculators to 
suffer the ultimate consequences of their own excesses. To do 
otherwise, according to Strong, would result in a degeneration of Fed 
policy actions to those of "regulating the affairs of gamblers."

Greenspan went even further in his critique of the use of monetary 
policy to curb speculative activity in a frothy market. Not only are 
the Fed's tools too blunt to stem this activity without having 
unintended consequences, it is difficult to identify bubbles before 
they crash. Greenspan suggested that, "There is a fundamental problem 
with market intervention (on the part of the Fed). It presumes that 
you know more than the market. ... This raises some fascinating 
questions about what our authority is and who makes the judgment that 
there actually is a bubble." Later, in a speech given in 1996, he 
asked, "_But how would we know_ when irrational exuberance has unduly 
escalated asset values ..." (emphasis added).

Despite their reservations, each of the three attempted to tame the 
bull markets that arose during their tenures. Each failed. The 
markets crashed and the monetary policies that were intended to prick 
the bubbles contributed to the following decline in business activity 
in general.

The book does not tell us why these Fed leaders ignored their better 
instincts to become involved in attempts to regulate stock prices. 
That is disappointing. In fairness, Spencer and Huston do not 
completely buy the argument regarding the difficulty in detecting 
bubbles in equity prices, so, perhaps, they are more willing to 
accept the Fed's intervention in these instances without question.

On the whole, this is a very enjoyable and informative book. I 
recommend it to those interested in the evolution of Fed 
independence, the development of its policy tools, and particularly, 
the role of the Fed in controlling speculative activity in the stock 
market.


Gary Santoni is an Emeritus Professor of Economics at Ball State 
University. His recent research is on federal regulation of 
securities markets and stock returns.

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