THE FED: SOLUTION OR PROBLEM?

December 2, 2008

When considering whether the Federal Reserve Bank should be kept, or at least kept in its present form, it is always useful to look at the data, says Richard W. Rahn, a senior fellow with the Cato Institute.  Specifically, what happened in the 94 years prior to 1914 (when the Fed became operational), and what happened in the 94 years since 1914?

  • The United States was on the gold standard in most of the years prior to the Fed, and there was no systemic inflation over the century before the Fed.
  • There were some periods of inflation (during the Civil War) and a sustained period of deflation in the 1890s, but wholesale prices were nearly the same in 1914 as 100 years earlier.
  • There are reasonably reliable wholesale and/or producer price numbers from the late 1700s, but the consumer price index (CPI) did not exist in the 19th century.
  • The CPI has grown by more than 2,000 percent since 1913, meaning the typical item that cost $20 back then would now cost more than $400.

It is unambiguously clear that the Fed has failed in its charge to maintain a stable price level, says Rahn.

The total number of banks grew rapidly in the century before the creation of the Fed, but the number declined rapidly during the Depression of the 1930s, both because of bank failures and mergers.  The merger trend has continued in recent decades, and the total number of banks continues to fall -- not necessarily a bad thing except when they are "too big to fail," explains Rahn:

  • The Fed was supposed to regulate banks (in conjunction with state bank regulators, the Office of Thrift Supervision, and the Comptroller of the Currency) to avoid large numbers of bank failures that occurred in the Panics of 1878, 1893, 1896 and 1907.
  • However, these episodes only resulted in the closure of a few hundred banks, which turned out to be minor compared to the Great Depression where thousands of banks failed, or even the S&L crisis of the late 1980s and early 1990s where a total of approximately 1,600 banks failed.

There is also no evidence unemployment rates have been lower on average since the Fed's creation. The unemployment statistics only go back to 1890, and there were a few years in the early 1890s where unemployment was in the double digits, but this episode was neither as long nor as severe as the one in the 1930s, says Rahn.

Source: Richard Rahn, "The Fed: Solution or Problem?" Washington Times, November 26, 2008.

For text:

http://www.washingtontimes.com/news/2008/nov/26/the-fed-solution-or-problem/

 

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