The Monetary Policy of the Federal Reserve: A History

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The Monetary Policy of the Federal Reserve: A History by Robert L. Hetzel, Cambridge University Press, 2008. 390 pp.

This book is part of the "studies in macroeconomics" series by Cambridge University Press, a collection of titles that are of interest to macroeconomists and economic historians. Author Robert Hetzel's contribution to the series is a review and analysis of the monetary policy of the U.S. Federal Reserve. Robert Hetzel is Senior Economist and Policy Advisor in the Research Department of The Federal Reserve Bank of Richmond. He holds a Ph.D. from the University of Chicago and was a student of leading monetarist and Nobel Prize winner Milton Friedman.

Dr. Hetzel's study of the U.S. central bank is scholarly and comprehensive although most of the book is concerned with the years after the 1951 Accord between the Federal Reserve and the U.S. Treasury. The Accord released the Federal Reserve from the obligation of pegging interest rates of Treasury securities. After the Accord until the end of the 1950s, the Fed, led by William McChesney Martin traded in Treasury bills only and followed what has been called a "lean against the wind" policy. Martin emerges as the real hero of the Federal Reserve monetary policy making in the decade of the 1950s in Hetzel's account. During these years, Chairman Martin was so serious about keeping the lid on inflation that he would direct the Fed to apply the monetary brakes during the early expansionary phase of the business cycle. To describe the role of the Fed during these years Martin liked to say his job entailed "taking away the punch bowl just when the party was getting good."

Martin's job was made easier by the fact that the United States emerged from World War II as the leading economy in the world. Indeed, the decade of the 1950s was a golden age for the U.S. economy. The economy grew during this time with only modest inflation. The growth record was marred only by three relatively mild recessions.

In the decade of the 1960s, however, the Kennedy-Johnson administration put a priority on closing the gap between actual and potential GDP. Paul Samuelson and Robert Solow argued that U.S. policymakers could trade a higher inflation rate for a lower unemployment rate. This set the stage for the tax cut of 1964. The U.S. economy's growth rate accelerated and the unemployment rate fell, but by the end of the 1960s, inflationary pressures began to build.

In the latter part of the Johnson administration most economists argued that a tax increase was necessary. But the price of a tax increase for Johnson was easy money. After Johnson signed the Tax Surcharge of 1968, monetary policy remained expansionary through that year while the inflation rate increased to five percent. In 1969 the Fed tightened monetary policy, but Martin testified before Congress that "a credibility gap has developed over our capacity and willingness to maintain restraint." According to Hetzel, Martin's concern with the "expectational" character of inflation presaged the Volcker-Greenspan years at the Fed.

In 1970, President Nixon appointed Arthur Bums to succeed Martin at the Fed. After several years of moderately tight fiscal and monetary policy Hebert Stein called "gradualism," the Nixon Administration adopted wage and price controls and the Federal Reserve moved toward an easy money policy. The eight Bums years and the very short period that followed under the leadership of G. William Miller is referred to as the years of "stop and go" monetary policy by Hetzel. During this period the Fed was not successful in stimulating the economy nor in bringing inflation under control. Robert Hetzel calls this period as the Fed's "lost decade." During this time, inflationary expectations lost their anchor.

Paul Volcker succeeded G. William Miller and Volcker emerges as the policymaking star of the late 1970s and early 1980s as the Volcker Fed brought inflation down using a resolute monetary policy that focused on the control of monetary aggregates. …