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Published by EH.NET (June 2003) 
 
Allan H. Meltzer, _A History of the Federal Reserve, Vol. I:  
1913-51_. Chicago: University of Chicago Press, 2003. xiii + 800 pp.  
$75 (hardcover), ISBN: 0-226-51999-6. 
 
Reviewed for EH.NET by John H. Wood, Department of Economics, Wake  
Forest University. <[log in to unmask]> 
 
 
Allan Meltzer has given us a thorough history of the Federal  
Reserve's monetary policy from its founding in December 1913 to the  
Treasury-Federal Reserve Accord in the spring of 1951. Several  
excellent descriptive and critical studies of various parts of this  
period of the Fed are available, led by a considerable portion of  
Friedman and Schwartz's _Monetary History_. But Meltzer advances our  
understanding of the Fed in two respects that that I explore in this  
review: First, he considers all the significant episodes of monetary  
policy, usually in more detail than can be found elsewhere. This book  
must be the starting point for future studies of Federal Reserve  
monetary policy, not only for the period covered by the book, but  
also for the succeeding fifty years because the Fed's organization  
and most of its beliefs and procedures were developed in the earlier  
period. The second main contribution is an extension of the first.  
Meltzer makes unequalled use of the unpublished minutes,  
correspondence, and other internal papers of the Federal Reserve  
Board and the Federal Reserve Bank of New York. He takes us further  
behind the scenes of policymaking. 
 
This review seeks to locate the book in the literature on the Fed, a  
task made easier by Meltzer's recognition of previous work and the  
absence of radically new interpretations. He supports the positions  
that have been associated with monetarist criticisms by Friedman and  
Schwartz and his work with Karl Brunner since the 1960s, especially  
the Fed's lack of understanding of its role in the economy and its  
obsession with financial markets, commercial bank free reserves in  
particular. His support is in the form of information about the  
ideas, institutions, and personalities behind actions and inactions  
that are well known. We are told that the inflation and deflation of  
1919-21, the Great Depression of 1929-33, the recession of 1937-38,  
and the post-World War II inflation would have been avoided or  
greatly moderated if the Fed had make money grow at a constant rate,  
as Friedman proposed (1959, 92) or as adjusted for velocity and  
inflation as Meltzer proposed (1984). Whether or not we accept these  
conclusions, Meltzer enables us to increase our understanding of the  
Fed's intentions, or rather the intentions of different parts of an  
institution that was at war with itself. 
 
The new material may be the book's most important contribution to  
research because it adds to the information available for the study  
of the policy preferences of different interests in the Federal  
Reserve and their effects on decisions. Internal conflicts often  
involved battles for control between the Board in Washington and the  
regional Reserve Banks. The Federal Reserve Act of 1913 was vague  
about control. The powers of the Fed -- particularly discounting and  
open-market operations -- were vested in the Banks under the Board's  
supervision. The extent of this supervision -- broad or, as the Banks  
complained, amounting to the micro-management of a central bank from  
Washington -- was the main source of these conflicts, which spilled  
over into policy decisions. It is also possible that policy  
differences between the Board and the Banks, especially New York,  
were partly due to the knowledge and interests arising from their  
political and economic environments. Given the importance attached to  
these differences, I would like to have seen more attention paid to  
their possible reasons beyond institutional grasps for power. It is  
no surprise to find the Board more sympathetic to (or under the thumb  
of) the Treasury during the latter's pressures for continued bond  
supports after the two world wars. Less expected, perhaps, was the  
Board's greater skepticism of market forces. Its preference for  
controls over interest rates helped to rationalize its support for  
Treasury low-interest programs. But the Board also differed from New  
York in believing that controls could control stock speculation in  
1928-29 without impinging on "legitimate" credit. Havrilesky  
(288-331) found that the Banks' greater reliance on interest rates  
continued in the second half of the century. Might those, like the  
New York Fed, who are immersed in the financial markets repose more  
trust in their operation, specifically in the efficacy of interest  
rates as rationing devices, compared with credit controls? On the  
other hand, this tack may not be appealing to monetarists who already  
find the Fed too sensitive to markets and interest rates. Meltzer  
finds that a good deal of the Board's criticism of the New York Bank  
after the Crash was motivated more by concern for control than  
different perceptions of economic relations (289). 
 
Meltzer confirms the charge that the Fed neglected to develop a  
model, or guide, to policy. This neglect can be interpreted with more  
sympathy than Meltzer and other critics have shown, although they  
recognize the Fed's difficulties, because important conditions  
assumed by the Fed's creators quickly disintegrated with war and its  
aftermath. They were adrift without a destination, compass, or  
anchor. The great inflow of gold caused by European inflations and  
other disorders divorced the Fed's actions from the historic central  
bank concern for its reserve. The Fed's timid support of credit  
during the Great Depression may have been partly due to a desire to  
preserve the gold standard (Eichengreen; Meltzer is doubtful, 405),  
but its interest in price stability between 1921 and 1929 prevented  
it from taking full advantage of its more-than-ample reserves. 
 
We must also realize that prevalent economic models did not imply the  
countercyclical policy to which economists were converted a decade  
later. An influential theory that implied "liquidation" in depression  
stemmed from the belief that deflations are reactions to inflations  
that had been driven by speculations in inventories and fixed assets.  
These should be allowed to return to normal levels. Deflations must  
be allowed to run their course (Hayek; Treasury Secretary Mellon,  
discussed by Meltzer, 400). Attempts to force money into paths "where  
it was not wanted" merely sow the seeds of future inflation. We can  
see where this policy was conducive to long-run price stability under  
the gold standard -- price indexes in 1933 still exceeded those of  
1914. Even if Meltzer, like Friedman and Schwartz, is right that the  
Fed should have tried for constant money growth or at least a stable  
price level, the application of such a policy would have required  
remarkably prescient theoretical sophistication by a group of  
committees of mainly conventional businessmen unused to abstractions. 
 
Irving Fisher was a notable exception in his resistance to  
conventional sound money. But his "compensated dollar" plan for  
stabilizing the price level by adjusting the price of gold (182) was  
ridiculed as "a rubber dollar" (Hoover, 119) and dismissed by the New  
York Fed's Benjamin Strong as the work of "extreme quantity  
theorists" (Chandler, 203). 
 
Meltzer's criticisms of the Fed, like Friedman and Schwartz's, are  
meant to be lessons for policy. In its theoretical and policy  
implications, the book is mainstream monetarism, deserving of the  
usual plaudits and criticisms: money and output are correlated, so  
that money must be important, but no convincing evidence of the  
direction of causation is offered. 
 
Prospective buyers should note that the book is not about Federal  
Reserve activities that are not directly part of monetary policy.  
Check clearing and other parts of the payments system, on which most  
Fed employees work, are ignored, and the structure and regulation of  
banking receive little attention. The last omission is more the Fed's  
than Meltzer's. The Fed recognized the weakness of the banking system  
as evidenced by the high failure rate of banks during the 1920s, but  
it did not work towards an improvement -- unlike President Hoover  
(121-25), who tried unsuccessfully for a system of larger and  
stronger banks. When Board Chairman Marriner Eccles (266-69) sought  
measures similar to Hoover's in 1936, he was rebuffed by President  
Roosevelt. The Fed's lack of attention to the banking structure is  
striking in light of England's experience, where the encouragement of  
amalgamations after the Panic of 1825, which was attributed to the  
fragility of small banks, contributed to the decline in the frequency  
and severity of panics as the nineteenth century progressed (none  
after 1866). On the other hand, the Fed might have followed Congress  
in taking the banking structure as given because the protection of  
local banks had been a political condition of the Federal Reserve Act. 
 
Returning to the Fed's model, or lack thereof, Meltzer agrees with  
his predecessors that monetary policy was an irregular mix of the  
gold standard rules of the game, the real bills doctrine, and a  
concern for price stability that seemed important only when inflation  
threatened. The place of the real bills doctrine in Fed thinking is  
unclear. The Federal Reserve Act has been interpreted as a legal  
implementation of the doctrine by its limitation of private  
discounting to real bills of exchange, that is, short-term lending  
secured by inventories. This had always been regarded as sound  
practice for commercial banks, and the Fed favored it in aggregate  
because lending for productive purposes was more conducive to  
economic activity and price stability than "speculative" lending on  
securities. But favoring real bills is not the real bills "doctrine,"  
as Meltzer would have it. The doctrine's fallacies had often been  
shown, particularly the indeterminacy of the price level when credit  
is linked to expected prices (Thornton, 244-59), and monetary policy  
(as opposed to rhetoric, for example, Senator Glass; Meltzer, 400)  
did not suggest that the Fed believed it. If it had, there would have  
been no role for interest rates. In the closest it came to  
expressions of policy guides, in the Board's 1923 _Annual Review_ and  
statements by Benjamin Strong (Chandler, 188-246), the Fed indicated  
less fear of inflation from real bills than other lending. But it  
depended on interest rates to rein in excessive borrowing, whatever  
the purposes. Whether credit was "excessive" tended to depend on what  
was happening to the price level, although this connection was cloudy  
in Fed statements at least partly because it did not wish to be held  
responsible for price stability. The reasons for the Fed's opposition  
to an official goal of price stability probably included its  
constraints on the pursuit of other goals, such as the alleviation of  
financial stress, and the fact that its proponents in Congress  
(especially James Strong of Kansas) were most interested in restoring  
agricultural prices to previous heights. 
 
Touching on Meltzer's relations to other controversies: He continues  
to differ from Friedman and Schwartz (692) in his argument (with  
Brunner, 1968, and agreed by Wicker, 1969, and Wheelock, 1991) that  
the Fed's actions during the Great Depression would have been  
approximately the same if Benjamin Strong (who died in 1928) had  
continued at the helm of the New York Bank. Meltzer believes that  
Strong's "attachment" to commercial bank borrowing from the Fed and  
free reserves as policy guides continued after 1928, and were  
responsible for its failure to increase credit between 1929 and 1933  
and its doubling of reserve-requirements ratios in 1936-37. This  
position dates at least from the 1960s, when he and Brunner assisted  
Congressman Patman's investigation of the Fed that initiated the work  
leading to the book under review. 
 
It was a common belief in government and Congress that "international  
cooperation," specifically the creation of inflation in the interests  
of European currencies (Hoover, 1952, 6-14), interfered with domestic  
goals. Meltzer agrees with Hardy (228-32) and Friedman and Schwartz  
that the accusation is unsupported. Quoting the latter: "foreign  
considerations were seldom important in determining the policies  
followed but were cited as additional justification for policies  
adopted primarily on domestic grounds when foreign and domestic  
considerations happened to coincide" (279). 
 
I do not think that Meltzer's treatment of bank failures during the  
Great Depression adequately reflects Wicker's (1996) investigations  
that seriously undermine Friedman and Schwartz's interpretations and  
suggest that the name "runs" is inappropriate. The three banking  
crises of 1930-31 identified by Friedman and Schwartz (and accepted  
by Meltzer, 323, 731) involved mostly small banks that were  
insolvent. Farm and real estate prices had fallen drastically, and  
banks failed because their customers failed. The frequency of  
failures in the "crisis periods" was only slightly greater than in  
the period as a whole, and were geographically concentrated. None  
became national in scope or exerted pressure on, not to say panic in,  
the New York money market. The first consisted largely of the  
collapse of the Caldwell investment banking firm of Nashville,  
Tennessee, which controlled the largest chain of banks in the South  
and was heavily invested in real estate. There is no evidence of  
contagion. The "crisis" of mid-1931 was concentrated in northern Ohio  
and the Chicago suburbs, where small banks had multiplied with the  
real estate boom. The crisis of September-October 1931was wider, but  
concentrated in Chicago, Pittsburgh, and Philadelphia. 
 
This brings us to Meltzer's (and Friedman and Schwartz's) criticism  
of the Fed's failure to apply Bagehot's proposal that the central  
bank act as lender of last resort. That is, as holder of the nation's  
reserve it should stand ready to supply the cash demanded in times of  
panic. Meltzer contends that "Most of the bank failures of 1929 to  
1932, and the final collapse in the winter of 1933, could have been  
avoided" (729) if the Fed had applied Bagehot's rule. However, as he  
(283-91) and Friedman and Schwartz (335-39) recognize elsewhere, the  
New York Fed actively assisted the financial markets during and after  
the Crash, and withdrew when there was no evidence of panic in New  
York, that is, "once borrowing and upward pressure on interest rates"  
declined (Meltzer, 288). I find Meltzer convincing when he suggests  
that this "was consistent with the Riefler-Burgess [free reserves]  
framework," as opposed to Friedman and Schwartz's argument that New  
York eventually yielded to the Board's opposition to its open-market  
purchases. "The dispute was mainly about procedure, not about  
substance," Meltzer (289) argues. "They [the Board] disliked New  
York's decision to act alone." It appears to this reviewer that the  
Fed's actions as described by Meltzer and Friedman and Schwartz,  
generally conformed with Bagehot's advice to relieve illiquidity in  
the money market in times of panic. He had not recommended the rescue  
of insolvent banks in the hinterlands that did not threaten the money  
market. This includes at least the beginnings of the nationwide  
closures of 1933 that were precipitated by the Michigan governor's  
decision to close the banks in his state to protect them from the  
possibility of a run when the failure of Ford's bank in Detroit  
(which was also heavily invested in real estate) was announced. 
 
I end with comments that are more differences of emphasis than of  
substance: The Fed's irrelevance in planning postwar financial  
arrangements is interesting, although Meltzer may exaggerate its  
significance. He wrote: "In the 1930s, the Treasury replaced the  
Federal Reserve as the principal negotiator on international  
financial arrangements" (737). In fact, governments have always,  
directly and firmly, controlled monetary arrangements. Their seizures  
of the details of monetary policy in the U.S. and U.K. in the early  
1930s were remarkable, but the U.S. government's control of changes  
in the monetary system as exemplified by the devaluation of 1933,  
Bretton Woods in 1944, and the Nixon suspension of 1971 had also been  
the practice of Parliament, which decided (with more or less advice  
from the Bank of England) suspensions, resumptions, legal tender, and  
other trade and financial arrangements. The irrelevance of the Fed in  
the negotiation of post-World War II financial agreements was shared  
by the Bank of England. Their places in the row behind finance  
ministers during negotiations continued an age-old practice. It is  
interesting in light of the high visibility of central banks in the  
operation of monetary systems that the structures of those systems  
belong to governments. Without defending the Fed, which ought to have  
behaved better within the framework that it was given, the real  
failure to respond to the catastrophe should be laid at the feet of  
the government. Herbert Hoover was more active than he is often given  
credit for, but he departed from tradition in leaning on the "weak  
reed" that was the Federal Reserve (1952, 212; Meltzer, 413). 
 
Meltzer suggests that the Great Depression was not considered a  
failure of monetary policy at the time (727). He refers to the  
Federal Reserve and economists, and I agree. But this was not true of  
the public or of substantial parts of Congress (which he acknowledges  
on p. 427). Carter Glass was a powerful defender of the Fed in the  
Senate, but the House passed the Goldsborough Bill directing the  
Federal Reserve "to take all available steps to raise the present  
deflated wholesale commodity level of prices as speedily as possible  
to the level existing before the present deflation" by a vote of  
289-60 in 1932, before it was watered down into a meaningless  
resolution in the Senate. The 72nd Congress (1931-33) introduced more  
than fifty bills to increase the money supply, which came closer to  
passage as the depression worsened (Krooss, 2662). It would be  
difficult to imagine a more damaging commentary on Woodrow Wilson's  
idealistic expert (read "remote") institution than Chicago  
Congressman A.J. Sabath's question to Chairman Eugene Meyer in 1931:  
"Does the board maintain that there is no emergency existing at this  
time" (letter entered into the _Congressional Record_, Jan. 19) -- or  
a similar lack of sensitivity of legislators in a democracy. The  
monetary authority supplanted by the Fed -- the Treasury with an  
attentive Congress -- might have done no better. But the sharp  
actions in 1865 (when Congress reversed its decision to retire the  
greenbacks after voters complained) and 1890 and 1893 (when it  
increased and then reduced the monetization of silver during  
recession and then gold flight) suggest that it would not have stayed  
on the sidelines if it had not been inhibited by (and waiting for)  
its expert creation. This is not (necessarily) a plea for free  
banking, but at least for monetary authorities that are closer to the  
effects of their actions. 
 
I would have liked to see Meltzer subject the Fed's existence to a  
little scrutiny, and to consider what kinds of institutions might  
have better responded to events or (this is surely an oversight) been  
more likely to adopt his preferred policy model. My guess is that he,  
Friedman and Schwartz, and most of the rest of the economics  
profession share Woodrow Wilson's desire for experts: The Fed should  
be independent but use the right model. 
 
References: 
 
Karl Brunner and Allan H. Meltzer. _The Federal Reserve's Attachment  
to the Free Reserve Concept_. For Subcommittee on Domestic Finance,  
_The Federal Reserve after Fifty Years_. House Committee on Banking  
and Currency. Washington, 1965. 
 
Karl Brunner and Allan H. Meltzer. "What Did We Learn from the  
Monetary Experience of the United States in the Great Depression?"  
_Canadian Journal of Economics_, May 1968. 
 
W. Randolph Burgess. _The Reserve Banks and the Money Market_. New York, 
1927. 
 
Lester V. Chandler. _Benjamin Strong, Central Banker_. Washington, 1958. 
 
Marriner Eccles. _Beckoning Frontiers_. New York, 1951. 
 
Barry Eichengreen. _Golden Fetters: The Gold Standard and the Great  
Depression, 1919-39_. New York, 1992. 
 
Milton Friedman. _A Program for Monetary Stability_. New York, 1959. 
 
Milton Friedman and Anna J. Schwartz. _A Monetary History of the  
United States, 1867-1960_. Princeton, 1963. 
 
Charles O. Hardy. _Credit Policies of the Federal Reserve System_.  
Washington, 1932. 
 
Thomas Havrilesky. _The Pressures on American Monetary Policy_. Boston, 
1993. 
 
Freidrich A. Hayek. _Prices and Production_. London, 1931. 
 
Herbert Hoover. _Memoirs: The Great Contraction, 1929-41_. New York, 
1952. 
 
Herman E. Krooss, editor. _Documentary History of Banking and  
Currency in the United States_. New York, 1969. 
 
Allan H. Meltzer. "Overview," in Federal Reserve Bank of Kansas City,  
_Price Stability and Public Policy_, 1984. 
 
Winfield W. Riefler. _Money Rates and Money Markets in the United  
States_. New York, 1930. 
 
Henry Thornton. _An Inquiry into the Nature and Effects of the Paper  
Credit of Great Britain_. London, 1802. 
 
Richard H. Timberlake. _Monetary Policy in the United States: An  
Intellectual and Institutional History_. Chicago, 1993. 
 
David C. Wheelock. _The Strategy and Consistency of Federal Reserve  
Monetary Policy, 1924-33_. Cambridge, 1991. 
 
Elmus Wicker. "Brunner and Meltzer on Federal Reserve Monetary Policy  
during the Great Depression," _Canadian Journal of Economics_, May  
1969. 
 
Elmus Wicker. _Banking Panics of the Great Depression_. Cambridge, 1996. 
 
 
John Wood's main research interest is a history of the ideas and  
behavior of British and American central bankers since 1694. Recent  
articles include "Bagehot's Lender of Last Resort: A Hollow Hallowed  
Tradition," _Independent Review_ (Winter 2003), and "The  
Determination of Commercial Bank Reserve Requirements" (with Cara  
Lown), _Review of Financial Economics_ (December 2002). 
 
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