------------ EH.NET BOOK REVIEW --------------

Published by EH.NET (December 2008)

Robert L. Hetzel, _The Monetary Policy of the Federal Reserve: A
History_. Cambridge: Cambridge University Press, 2008. xvi + 390 pp. $50
(cloth), ISBN: 978-0-521-88132-6.

Reviewed for EH.NET by Gary Richardson, Department of Economics,
University of California -- Irvine.


_The Monetary Policy of the Federal Reserve: A History_ by Robert Hetzel
studies the evolution of monetary policy from the beginning of the
Federal Reserve until the end of the Greenspan Era. The title claims the
book is a history, and it is that, but it is much more. As a history,
Hetzel’s book details the conduct of monetary policy over nearly ninety
years, and sets that conduct in the context of the intellectual and
political environment of the time. As an economic synthesis, Hetzel’s
book views the evolution of monetary policies as a series of experiments
useful for understanding fundamental issues concerning money, prices,
and macroeconomic policy. The past serves as a laboratory for
understanding the present. The emergence of modern monetary policy and
prospects for our nation’s financial future are understood by studying
the learning-curve of the leaders of the Federal Reserve, the painful
process of replacing the gold standard with a fiat money standard, and
the recurrent monetary instability during the decades following the
Second World War.

Enough for the sales pitch. Let me get to the details.

The book contains 26 chapters and an appendix listing the data that the
FOMC saw during the “stop-go” period from 1963 to 1982. Chapter 3, “From
Gold to Fiat Money,” examines policy from the founding of the Federal
Reserve System in 1913 through the end of the Great Depression. Chapters
4 and 9 examine the creation of the postwar monetary system (note that
one of my few suggestions to the author would have been to place most of
the material in Chapter 9 in the fourth chapter). Chapters 10 through 14
discuss the Great Inflation of the 1970s, Volcker’s disinflation at the
tail end of the 1970s and beginning of the next decade, and monetary
policies during the early 1980s. Chapters 15 through 25 focus on
monetary policies during the Greenspan Era. The distribution of time
across chapters reveals the focus of the book, which is largely on
postwar monetary policy and particularly on recent decades. As a student
of the Great Depression, I desired more analysis of earlier decades, but
I realize that the author’s research and experience make his insights on
the later decades more valuable, and believe that his decisions about
emphasis and pacing reflect carefully considered judgments about his
marginal product. In other words, he made sensible choices about where
he should devote his time and attention.

A strength of the book is its integrative chapters, including Chapters
1, 2, 23, and 26. These shed light on broad policy issues that cut
across time and elaborate on his insight that monetary policy during the
twentieth century consisted of a series of policy experiments whose
outcomes we are just beginning to understand.

Chapter 1 examines the evolution of the monetary standard. It points out
the importance of this issue. Monetary instability coincided with social
upheaval and political disorder throughout the twentieth century. An
example is the rise of Nazism in Germany after the hyperinflation of the
1920s and during the depression of the 1930s. The success of society in
the twenty-first century may depend on whether societies learn the
lessons from the twentieth century. “One of the ‘grand’ monetary
experiments of the last century was the replacement of the gold standard
with a fiat money standard.”

Initially, central banks did not understand their new powers and
responsibilities, and failed to provide a nominal anchor for prices.
Keynesian economists tried to exploit expectations of price stability
and fine tune the economy. Their stop-go aggregate demand management led
to gradually increasing inflation during the 1950s and 1960s and the
spectacular monetary failures of the 1970s. Eventually, central banks
realized the importance of nominal anchoring, and adopted policies that
promoted price stability. This period coincided with Paul Volcker and
Alan Greenspan’s reigns over the Federal Reserve.  From this experience,
the author concludes that “The central bank cannot predictably
manipulate real variables -- real money or unemployment. It can control
trend inflation, but it must do so through consistent (rule-like)
behavior that creates the expectation of unchanging trend inflation.”

Chapter 2 continues the overview of the monetary experiments of the
twentieth century and the author’s conclusions. The chapter discusses
disagreements over the nature of monetary policy and the political
advantages of policy ambiguity relative to the confusion that ambiguity
causes about the appropriate role for monetary policy.

Chapter 26 summarizes “a century of monetary experiments.” The chapter
emphasizes three key lessons. (1) Inflation and deflation are monetary
phenomenon. In a world with fiat money, the behavior of the central bank
determines the level and rate of change of prices. (2) To stabilize
inflation, central banks must maintain a consistent and credible policy
designed to fight inflation. (3) The government must allow the price
system to operate and relative prices to allocate resources among
competing opportunities.

Overall, I find Hetzel’s book cogent and comprehensive. Hetzel
participated in many of the monetary experiments that he describes. His
seminal innovation is the Treasury Inflation Protected Securities (TIPS)
program. Returns on half of these securities are fixed in nominal terms.
Returns on the other half are indexed to the price level. The difference
in the prices of these securities provides a market measure of expected
inflation, providing the Federal Reserve with the information it needs
to establish a nominal anchor for the price level. The importance of
this innovation and the quality of Hetzel’s book insure that it will be
widely read for many years to come.


Gary Richardson is an Associate Professor of Economics at the University
of California in Irvine who studies the causes and consequences of the
banking panics of the Great Depression.

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