Richardson on Hetzel, _The Monetary Policy of the Federal Reserve: A History_

[Book Reviews in Economic and Business History]

Published by EH.NET (December 2008)

Robert L. Hetzel, _The Monetary Policy of the Federal Reserve: A 
History_. Cambridge: Cambridge University Press, 2008. xvi + 390 pp. $50 
(cloth), ISBN: 978-0-521-88132-6.

Reviewed for EH.NET by Gary Richardson, Department of Economics, 
University of California -- Irvine.


_The Monetary Policy of the Federal Reserve: A History_ by Robert Hetzel 
studies the evolution of monetary policy from the beginning of the 
Federal Reserve until the end of the Greenspan Era. The title claims the 
book is a history, and it is that, but it is much more. As a history, 
Hetzel’s book details the conduct of monetary policy over nearly ninety 
years, and sets that conduct in the context of the intellectual and 
political environment of the time. As an economic synthesis, Hetzel’s 
book views the evolution of monetary policies as a series of experiments 
useful for understanding fundamental issues concerning money, prices, 
and macroeconomic policy. The past serves as a laboratory for 
understanding the present. The emergence of modern monetary policy and 
prospects for our nation’s financial future are understood by studying 
the learning-curve of the leaders of the Federal Reserve, the painful 
process of replacing the gold standard with a fiat money standard, and 
the recurrent monetary instability during the decades following the 
Second World War.

Enough for the sales pitch. Let me get to the details.

The book contains 26 chapters and an appendix listing the data that the 
FOMC saw during the “stop-go” period from 1963 to 1982. Chapter 3, “From 
Gold to Fiat Money,” examines policy from the founding of the Federal 
Reserve System in 1913 through the end of the Great Depression. Chapters 
4 and 9 examine the creation of the postwar monetary system (note that 
one of my few suggestions to the author would have been to place most of 
the material in Chapter 9 in the fourth chapter). Chapters 10 through 14 
discuss the Great Inflation of the 1970s, Volcker’s disinflation at the 
tail end of the 1970s and beginning of the next decade, and monetary 
policies during the early 1980s. Chapters 15 through 25 focus on 
monetary policies during the Greenspan Era. The distribution of time 
across chapters reveals the focus of the book, which is largely on 
postwar monetary policy and particularly on recent decades. As a student 
of the Great Depression, I desired more analysis of earlier decades, but 
I realize that the author’s research and experience make his insights on 
the later decades more valuable, and believe that his decisions about 
emphasis and pacing reflect carefully considered judgments about his 
marginal product. In other words, he made sensible choices about where 
he should devote his time and attention.

A strength of the book is its integrative chapters, including Chapters 
1, 2, 23, and 26. These shed light on broad policy issues that cut 
across time and elaborate on his insight that monetary policy during the 
twentieth century consisted of a series of policy experiments whose 
outcomes we are just beginning to understand.

Chapter 1 examines the evolution of the monetary standard. It points out 
the importance of this issue. Monetary instability coincided with social 
upheaval and political disorder throughout the twentieth century. An 
example is the rise of Nazism in Germany after the hyperinflation of the 
1920s and during the depression of the 1930s. The success of society in 
the twenty-first century may depend on whether societies learn the 
lessons from the twentieth century. “One of the ‘grand’ monetary 
experiments of the last century was the replacement of the gold standard 
with a fiat money standard.”

Initially, central banks did not understand their new powers and 
responsibilities, and failed to provide a nominal anchor for prices. 
Keynesian economists tried to exploit expectations of price stability 
and fine tune the economy. Their stop-go aggregate demand management led 
to gradually increasing inflation during the 1950s and 1960s and the 
spectacular monetary failures of the 1970s. Eventually, central banks 
realized the importance of nominal anchoring, and adopted policies that 
promoted price stability. This period coincided with Paul Volcker and 
Alan Greenspan’s reigns over the Federal Reserve.  From this experience, 
the author concludes that “The central bank cannot predictably 
manipulate real variables -- real money or unemployment. It can control 
trend inflation, but it must do so through consistent (rule-like) 
behavior that creates the expectation of unchanging trend inflation.”

Chapter 2 continues the overview of the monetary experiments of the 
twentieth century and the author’s conclusions. The chapter discusses 
disagreements over the nature of monetary policy and the political 
advantages of policy ambiguity relative to the confusion that ambiguity 
causes about the appropriate role for monetary policy.

Chapter 26 summarizes “a century of monetary experiments.” The chapter 
emphasizes three key lessons. (1) Inflation and deflation are monetary 
phenomenon. In a world with fiat money, the behavior of the central bank 
determines the level and rate of change of prices. (2) To stabilize 
inflation, central banks must maintain a consistent and credible policy 
designed to fight inflation. (3) The government must allow the price 
system to operate and relative prices to allocate resources among 
competing opportunities.

Overall, I find Hetzel’s book cogent and comprehensive. Hetzel 
participated in many of the monetary experiments that he describes. His 
seminal innovation is the Treasury Inflation Protected Securities (TIPS) 
program. Returns on half of these securities are fixed in nominal terms. 
Returns on the other half are indexed to the price level. The difference 
in the prices of these securities provides a market measure of expected 
inflation, providing the Federal Reserve with the information it needs 
to establish a nominal anchor for the price level. The importance of 
this innovation and the quality of Hetzel’s book insure that it will be 
widely read for many years to come.


Gary Richardson is an Associate Professor of Economics at the University 
of California in Irvine who studies the causes and consequences of the 
banking panics of the Great Depression.

Copyright (c) 2008 by EH.Net. All rights reserved. This work may be 
copied for non-profit educational uses if proper credit is given to the 
author and the list. For other permission, please contact the EH.Net 
Administrator (administrator at eh.net; Telephone: 513-529-2229). Published 
by EH.Net (December 2008). All EH.Net reviews are archived at 
http://www.eh.net/BookReview.