IS THE FEDERAL RESERVE SYSTEM REALLY NECESSARY?

Abstract

SINCE 1964 MARKS THE GOLDEN ANNIVERSARY of the Federal Reserve System, the title of this essay may appear somewhat uncharitable to those who have come to think of the Federal Reserve in terms only slightly less affectionate than those accorded to the Old Lady of Threadneedle Street.1 I hasten to assure the reader that my heresy, if that is what it is, involves principally the word System; that is to say, I shall examine the need for a Federal Reserve System as it is presently constituted, quite apart from the generally acknowledged need for central bank monetary policy. While this task might be thought properly to lie within the province of the political scientist, I shall show that, on the contrary, there are many important economic aspects involved in such an inquiry.2 Central to the analysis which follows is the proposition that the success of the essential function of the central bank, monetary management, is independent of the structural arrangements that characterize its organization. This is to say, central bank policies can be executed within a variety of organizational structures, both internal as well as external vis a vis the commercial banking system. The Federal Reserve System qua System is but one of a number of such structural arrangements within which a monetary policy can be carried on. Unfortunately, this fact is little appreciated. A fair sampling of money and banking textbooks, while explicitly silent on the point, leave one to infer that in some unique sense the existing system is a necessary adjunct to the pursuit of successful monetary management. After a chapter or two on the structure of the Federal Reserve System, the student is successively introduced to functions and to policy. Out of this, or perhaps independent from this, have developed a mythology and a basic fallacy. The mythology has many aspects: it is generally believed that member banks are necessary to the conduct of monetary policy; it is