How has the Federal Reserve System managed since its inception?

It seems to me a strong Federal Reserve System established and then enhanced under the Glass Stegall Act led the way out of the Great Depression (along with tremendous government borrowing and Stimulus). The massive panics that happened prior to Glass Stegall and since its repeal were completely absent from 1933 to its weakening in the 1990s.

I am shocked that there are people who would think the economy functions better now that it has been weakened.

Can you be more descriptive? Was the system required to get out of the Depression, or could there have been a more effective means to the end?

@Imadethisupwithnoforethought Wasn’t it the war and postwar boom that dragged us out of the Depression? Could have sworn that it was.

I think tremendous borrowing and stimulus led the way out of the Depression.

I think the Federal Reserve System and it’s powers kept private institutions from creating financial panics once the economy was once again operating at healthy output.

When banks were prevented from getting too big too fail, and limited to certain lines of investment, the Federal Reserve was able to exert far more influence on monetary policy than any individual company.

@Nullo I do not mean to sound flippant, but I hear people say that and I am at a loss how they divide in their minds the stimulus/deficiet spending from World War 2, the Marshall plan, and the GI Bill from government borrowing and stimulus. I hear people say “postwar boom” as if it is some magical event that was not stimulus.

The Federal Reserve has generally been effective at curtailing inflation and, later, keeping bank runs largely a thing of the past.

A pretty broad failing is that fiscal policy (how the government spends) can have one effect on the economy while monetary policy (how currency is regulated) can have another. We are seeing this now, as the Fed cuts interest rates to stimulate spending while the Congress crafts fiscal policy that reduces spending.

Then, there is the problem of moral hazard that has infected the system a few times. The savings and loan scandal and the current crisis come to mind. In both cases, runaway speculation eventually pushed the system to the brink, and the feds had to bail it out. Obviously some people did underhanded things, which didn’t help the situation (Bernie Madoff?), but there was still incentive to take risks because the reward was individually high and the harm was spread out over the whole of society.

Maybe I would tweak the system, but I’m not sure I’m smart enough to come up with a better one myself. :(

Look at the record. Notice the tremendous number of financial panics and bank runs that occurred before the creation of the Fed.

The Fed is tool by which the government can manage the macro-economy. It is not a perfect tool, and oftentimes it is poorly used. In particular, right now, the Fed should really worry less about inflation and more about stimulating employment; it is completely ignoring its duel mandate.

But it would be pretty stupid to throw away the tool.

@Qingu Then what should be done?

The policy I think makes the most sense is NGDP targeting.

The Fed has a dual mandate: fight inflation and fight unemployment. It can fight inflation by raising interest rates (they are currently at virtually zero). It can fight unemployment, at least in certain conditions (like the current one, a liquidity trap) by essentially printing money, which puts pressure on the economy to generate economic activity.

Right now, inflation is 2–3% (good). Unemployment is 8% (absolutely terrible). So something is very wrong.

Right now, the Fed is basically saying, “Yeah unemployment is bad, but we don’t want to risk higher inflation to deal with it.” Also, if markets don’t expect inflation, they aren’t incentivized to spend money now (and indeed, many corporations are hoarding cash).

NGDP targeting means the Fed would essentially chain its inflation target to the unemployment picture (loosely correlated with GDP growth). It would tolerate higher inflation until growth or unemployment comes down to an acceptable level. Once it reaches that level, then it would lower the inflation target. It has worked very well for Israel.

@Qingu If it worked for Israel, it should work for us. Not for nothing, but their wealth and knowledge thereof precedes them.

Don’t get me wrong, I like Israel and root for their continued existence and prosperity. But when you consider Israel’s fiscal policies you have to take into account that they receive HUGE subsidies from the U.S. relative to the size of their economy.
On the other hand their policies encouraging domestic production, education, and public service are far smarter than in the U.S. at this point.

I’m not sure what Israel’s subsidies (And I’ll agree they shouldn’t get them) have to do with their management of monetary policy. I guess you could argue that because of the subsidies Israel isn’t constrained as much by debt fears… but that seems neither here nor there since our debt fears haven’t led to inflation…

The Israel article is about monetary policy, not fiscal policy. Subsidies from the U.S. would mainly impact the latter, and inflation would undermine that. However, the subsidies they get are probably largely weapons and the like rather than cash.

Yglesias says, “You get much less in the way of hysteresis, crazy politics, panicked budget moves, and economic trauma.” Kind of ironic to use neo-con dominated Israel as an example of a place free of hysteria and crazy politics. But running inflation higher generally makes sense when there is an overhang of debt.