Shifting Mandates: The Federal Reserve's First Centennial

Carmen M Reinhart,Kenneth S Rogoff

doi:10.1257/aer.103.3.48

Abstract

The Federal Reserve's mandate has evolved considerably over the organization's hundred-year history. It was changed from an initial focus in 1913 on financial stability, to fiscal financing in World War II and its aftermath, to a strong anti-inflation focus from the late 1970s, and then back to greater emphasis on financial stability since the Great Contraction. Yet, as the Fed's mandate has expanded in recent years, its range of instruments has narrowed, partly based on a misguided belief in the inherent stability of financial markets. We argue for a return to multiple instruments, including a more active role for reserve requirements.

Highlights

An Act To provide for the establishment of Federal Reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes
After recurring bouts of financial panics and banking crises, including a severe one in 1907, a clamor arose among policy circles and the business community that the United States was in need of serious banking and currency reform
Part of this reform would be the creation of an institution that would, when the system was threatened with periodic regional or national financial crises, provide the necessary liquidity to support the banks that were in duress—the so-called provision of an elastic currency

Summary

Targets and Instruments: A 100-Year Timeline

At the risk of a gross simplification, the Federal Reserve’s first centennial can be roughly divided into three subperiods. With a cumulative output collapse of 31 percent from 1929 until 1933 and the number of banks operating cut roughly in half over 1925–1933, it is safe to conclude that the early Federal Reserve failed miserably at meeting its initial mandate of financial stability. Credit ceilings remained in place through the early 1950s, and financial repression domestically and abroad ruled the day Whatever distortions these policies may have led to in terms of the misallocation of resources, it is important to note that from 1945 until the late 1970s there were no systemic banking crises in the United States or elsewhere.

Interest Rates and Credit

Findings

Policy Implications