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A Monetary History of the United States, 1867-1960

Author(s):Friedman, Milton
Schwartz, Anna Jacobson
Reviewer(s):Rockoff, Hugh

Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press (for the National Bureau of Economic Research), 1963. xxiv + 860 pp.

Review Essay by Hugh Rockoff, Department of Economics, Rutgers University.

On Monetarist Economics and the Economics of a Monetary History

A Monetary History of the United States, 1867-1960 by Milton Friedman and Anna J. Schwartz is surely one of the most important books in economic history, and indeed, in all of economics, written in the twentieth century. It has had a profound impact on the way economists think about monetary theory and policy. And it is still one of the most frequently cited books in economics. To some extent, it has suffered the fate of most classics: it is often cited, but seldom read. In the course of preparing this review essay, I have been repeatedly struck by the difference between what people think Friedman and Schwartz say, and what they actually say. Below I try to set out some of the reasons for the enormous impact of A Monetary History, and some of the reasons why there is such a large gap between (to subvert the title of Axel Leijonhufvud’s fine book on Keynes) “Monetarist Economics and the Economics of A Monetary History.”

The main point of A Monetary History is that “money matters: ” The quantity of money is an independent and controllable force that strongly influences the economy. This view, which is now accepted, at least in some measure, by most economists is very different from the view that prevailed when A Monetary History was published. At that time the professional consensus considered monetary policy ineffective. The job of central bankers was to keep interest rates as low as possible as long as unemployment was a problem. Following this policy would mean, however, only that investment might be bit higher than it would otherwise be and unemployment a bit lower. And although inflation might be countered with higher interest rates, the presumption was that monetary policy would have little impact. The rate of unemployment and the behavior of costs, particularly wage rates, largely determined the rate of inflation. Controlling labor unions was important for controlling inflation; monetary policy was at best a secondary consideration. The main tool for keeping the economy on an even keel was fiscal policy. It was a development in the real world, of course, the growing problem of inflation in the 1960s and 1970s, that was the main factor overturning the Keynesian orthodoxy. But A Monetary History was a powerful voice for restoring to monetary policy some of its former prestige. How did Friedman and Schwartz persuade the majority of the profession that money matters? The basic methodology of A Monetary History is to highlight “natural experiments,” occasions when the stock of money changed for reasons unrelated to the current state of the economy, so that we can then attribute the corresponding changes in the economy to changes in money.

Friedman and Schwartz offer an impressive array of case studies. To convey a sense of their approach, let me cite three of their most famous examples: (1) the contrast between 1879-1896 and 1896-1914 in terms of the behavior of the price level; (2) the contrast between World War I and World War II in terms of the behavior of the price level; and (3) the impact of restrictive actions taken by the Federal Reserve system in 1937.

(1) Prices (the NNP deflator) fell -0.93 percent per year between 1879, when the United States returned to the gold standard, and 1896, when the deflation came to an end, and then rose 2.08 percent per year between 1897 and 1914. The stock of money behaved in a similar way. Money per unit of output (money divided by real NNP) rose 2.99 percent per year from 1879 to 1896, and then rose 4.23 percent per year between 1897 and 1914. The acceleration in money growth was the result of the flow of new gold, much of it from the mines of South Africa. (High-powered money rose 3.49 percent per year between 1879 and 1896 and 4.83 percent per year between 1897 and 1914.) To be sure, the intense searches for new gold mines and new ways of refining gold ore that were rewarded when the mines of the Rand became productive and the cyanide process for refining it had been perfected, had been encouraged by rising real price of gold before 1896. But these events long preceded the post-1896 inflation. The correlation between rising money supplies and rising prices after 1896, Friedman and Schwartz argue, must be chance or must reflect a causal connection running from money to prices.

(2) Surprisingly, prices rose more in World War I than in World War II, and by about the same magnitude in World War I as in, to go outside the strict boundaries of A Monetary History, the Civil War. Yet measured in almost any conventional way (length of war, casualties, government deficits, etc.) World War I was a much smaller war for the United States than the Civil War or World War II. The monetary facts, however, are roughly in line with the inflation facts. From 1914 to 1920 money per unit of output rose 8.45 percent per year while the price level rose 10.84 percent per year. From 1939 to 1948 money per unit of output rose 7.90 percent per year while the price level rose 6.65 percent per year.

As these figures indicate, money cannot explain everything. The difference in inflation in the two wars exceeds the difference in the rate of growth of money per unit of output. Nevertheless, the striking fact is that the rate of inflation and the rate of growth of money per unit of output were broadly similar in the two wars. One would have expected, based on the degree of mobilization, far more money growth and inflation in World War II.

Part of the reason that the United States could “get away with” slower monetary growth in World War II was that the deposit-reserve ratio of the banking system was lower during World War II. The government, therefore, received a larger share of the revenues produced by increases in the stock of money. High-powered money, the main channel through which the government acquires seigniorage, rose 10.78 percent per year in World War II compared with 12.25 percent per year in World War I. Friedman and Schwartz conclude that the correlation between prices and money per unit of output suggests causation running from money to prices, rather than the common effect of some third factor, such as the intensity of the mobilization.

(3) One of the most famous and most hotly debated examples offered by Friedman and Schwartz is the 1937-1938 recession. In early 1937 the Federal Reserve doubled the required reserve ratios of the banking system with the purpose of immobilizing reserves and preventing future inflation. After some months, this action was followed by declines in the stock of money and real output. Money fell -0.37 percent between 1937 and 1938 while prices fell -0.50 percent, and real output fell -8.23 percent. High-powered money, responding to other forces, rose by 7.95 percent during the same year. Friedman and Schwartz conclude that the correlation between the decline in the stock of money and the decline in economic activity must have resulted from chance or from causation running from money to economic activity.

These case studies, I should note, arose in three different institutional regimes. In case (1) the United States was on the gold standard, and there was no central bank. In case (2) the Federal Reserve was constrained by the need to finance large wartime government deficits, and had to follow the Treasury’s lead. In case (3) the Federal Reserve was relatively independent, and could follow its own judgments about appropriate monetary policy. Drawing examples from different institutional environments strengthens the argument. In each case there is a rough correlation between monetary changes and changes in the economy, yet the factors determining the supply of money are very different. This suggests that the proposition “money matters,” represents a fundamental economic relationship, and is not the adventitious result of some particular set of institutional arrangements.

None of these “natural experiments” or the many others cited in A Monetary History, was conducted in a laboratory. Many variables were changing, and it is always possible, although not always easy, to construct an alternative explanation based on some other key factor. An extensive literature, for example, has grown up elaborating and contesting the Friedman-Schwartz interpretation of case (3), and attributing the 1937 downturn to other factors, such as fiscal policy. But for someone seeking to overturn A Monetary History, contesting one of these explanations is only the beginning. What gives weight to Friedman and Schwartz’s argument is the multiplicity of examples. So far, I would argue, none of Friedman and Schwartz’s critics has been able to forge an alternative explanation – whether based on fiscal policy, or labor union militancy, or technological change, or whatever – that fits all of the examples explored in A Monetary History. Indeed, to my way of thinking, the major advances since A Monetary History, have been the attempts by Brunner and Meltzer, Bernanke, and others to enrich the picture of how disturbances in the financial sector, and in particular the banking sector, affect the rest of the economy, rather than attempts to explain macroeconomic events from totally different perspectives.

Perhaps the greatest mystery is not that the Friedman-Schwartz methodology was persuasive, but rather that despite the enormous impact of A Monetary History, few economists use its methodology. Typically, when an economist attempts to persuade other economists, the first step is to feed the numbers through the computer and in the process strip away the historical circumstances that adhere to them.

Friedman and Schwartz’s interpretation of the Great Depression is both figuratively and literally at the heart of their book. The detailed discussion occupies about 30 percent of the total, and the episode is referred to by way of contrast in discussions of other episodes. Princeton University Press later issued this section as a separate volume, The Great Contraction.

Their point, as most college students of economics now know (or should know), is that the Great Depression could have been greatly ameliorated by better monetary policy. Today, only a few dyed-in-the-wool Keynesians reject any causal role for monetary policy, although many economic historians would place the major blame for the Depression on other factors, and relegate bad monetary policy to a secondary role. The Friedman-Schwartz interpretation of the Depression was crucial, moreover, to the revival of confidence in market-based economics. The Great Depression, and the way it was interpreted by Keynesian economists, convinced a generation of American intellectuals that only socialism (or near-socialism) could save the American economy from periodic economic meltdowns. If Great Depressions could be prevented through timely actions by the monetary authority (or by a monetary rule), as Friedman and Schwartz contended, then the case for market economies was measurably stronger.

It has been objected that Friedman and Schwartz don’t prove that monetary forces caused the Great Depression. They merely describe the Great Depression in great detail as if monetary forces were the causal factor. This objection is true, but not as decisive as it might seem at first glance. From the point of view of proving the importance of money, the Depression is merely another period, although a particularly revealing one, in which to search for natural experiments. It provides additional evidence, such as the case of the doubling of required reserve ratios in 1937 discussed above, and other episodes, but this one short period by itself cannot prove anything.

Friedman and Schwartz are doctors writing up the results of a detailed clinical examination of a patient who entered the hospital on the verge of death. Their observation that the patient was suffering from a bacterial infection is not by itself proof that the infection caused the patient’s illness. The fact that other patients with the same symptoms and the same infection have been seen at other hospitals in other places and at other times is what makes their argument persuasive. And it is the evidence taken as a whole that makes the prescription offered by Drs. Friedman and Schwartz, that the patient should have been given a strong dose of antibiotics (high-powered money), appear so sensible.

Perhaps the most misunderstood aspect of A Monetary History is the way that Friedman and Schwartz treat Nonmonetary factors. Their approach is to assume a “real” business cycle, which is then pushed a pulled by monetary factors. I use the term “real” with some trepidation. What Friedman and Schwartz have in mind is the sort of cycle described by Wesley C. Mitchell, Arthur Burns, and other scholars at the National Bureau of Economic Research in work that preceded A Monetary History, rather than what now goes by the name “real business cycle.” Yet there is a family resemblance worth stressing. Friedman and Schwartz, unfortunately for us, say little about the sources of this cycle, although at times they make some interesting observations about the tendency of good harvests in the United States to occur at the same time as bad harvests in Europe, and a few other factors. Nevertheless, it is clear that various supply-side shocks including technological shocks that now appear important to macroeconomists would fit easily into the Nonmonetary cycle that forms the backdrop for Friedman and Schwartz’s analysis.

The real cycles in which Friedman and Schwartz impound other factors are often forgotten when economic historians recount “monetarist” interpretations of historical episodes. I have heard economic historians claim that Friedman and Schwartz “say” that the recession of 1937 was caused by the doubling of reserve requirements in 1937. In fact, they write the following.

“Consideration of the effects of monetary policy [the increase in required reserve ratios] on the stock of money certainly strengthens the case for attributing an important role to monetary changes as a factor that significantly intensified the severity of the decline and also probably caused it to occur earlier than otherwise” (p. 544).

Similarly, I have heard economic historians claim that Friedman and Schwartz say that money caused the Great Depression, or that the stock market crash did not cause the Great Depression. In fact their statements on both points are more circumspect, and assume a Nonmonetary contraction of some magnitude. Of the stock-market crash Friedman and Schwartz write that “… its [the stock market crash’s] occurrence must have helped to deepen the contraction in economic activity. It changed the atmosphere within which businessmen and others were making their plans, and spread uncertainty where dazzling hopes of a new era had prevailed” (p. 306).

The crucial turning point in the Depression, according to Friedman and Schwartz, was late 1930 or early 1931, when they thought the contraction might have come to an end in the absence of the banking crises. But they acknowledge that even so, the contraction of the early 1930s “would have ranked as one of the more severe contractions on record” (p. 306).

In their counterfactual discussion of the effects of an open market purchase of $1 billion, they conclude that if undertaken between January 1930 and October 1930 the open market purchase would have “reduced the magnitude of any crisis that did occur and hence the magnitude of its aftereffects” (p.393). If undertaken between September 1931 and January 1932, the open market purchase would have produced a change in the monetary tide and as a result “the economic situation could hardly have deteriorated so rapidly and sharply as it did” (p. 399).

In discussing the banking panic of 1907, to give an earlier example, Friedman and Schwartz conclude that “There can be little doubt that the banking panic served to intensify and deepen the contraction: its occurrence coincides with a notable change in both the statistical indicators and the qualitative comment. If it had been completely avoided, the contraction would almost surely have been milder” (p. 163).

In short, Friedman and Schwartz tried to show that good monetary policy – best of all, as Friedman argued elsewhere, a monetary rule – would make the world a better place; they never promised a rose garden.

Although the central thesis is “money matters,” Friedman and Schwartz follow a large number of closely related threads. These range from the determinants of the greenback price of gold after the Civil War, to the relative effects of mild inflation and mild deflation on long-term economic growth, to the effects of deposit insurance on the stability of the banking system, and so on. Their discussions of these episodes are invariably intelligent, and often at variance with what was the conventional wisdom at the time they wrote. Not only do these discussions help us to understand these particular episodes; they also increase our confidence in their central thesis. They convince us that we are reading economic historians of outstanding ability who have explored every nook and cranny of American monetary history.

As most readers of A Monetary History recognize the book also succeeds in part because of how well it is written. Friedman and Schwartz employ a style that might be called high-NBER. It is written for the intelligent lay person. No special knowledge of statistics is required to read it, and no equations appear in the text, although there is an appendix on the determinants of the stock of money that uses equations. The quantity theory of money never appears in algebraic form. The sentences flow in magisterial fashion, and yet one is aware that the authors have thought about what they are discussing and are eager to make sure that the reader understands. In many ways their book, with its myriad of examples and its telling analogies, is the most similar, among all the classics of economics, to The Wealth of Nations. One can’t help but feel that the former lecturer on rhetoric would have approved of Friedman and Schwartz’s polished yet straightforward style.

For all these reasons, my choice for the most significant book in the field of economic history in the twentieth century is A Monetary History of the United States, 1867-1960 by Milton Friedman and Anna J. Schwartz.

Annotated References:

There is a large and growing literature on A Monetary History. Here I will mention just a few sources that I have found particularly useful.

Bernanke, Ben S., Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression. American Economic Review. Vol. 73 (3): 257-76, June 1983.

Bordo, Michael D., editor, Money, History, and International Finance: Essays in Honor of Anna J. Schwartz. National Bureau of Economic Research Conference Report series. Chicago: University of Chicago Press, 1989. (This volume, a Festschrift for Anna J. Schwartz, contains a number of relevant essays, including one by Bordo that focuses explicitly on the contributions of A Monetary History.)

Brunner, Karl and Allan H. Meltzer, “Money and Credit in the Monetary Transmission Process.” American Economic Review. Vol. 78 (2): 446-51, May 1988.

Hammond, J. Daniel, Theory and Measurement: Causality Issues in Milton Friedman’s Monetary Economics. Cambridge: Cambridge University Press. 1996. (Hammond discusses all of the Friedman-Schwartz work on money focussing on methodological issues and the large volume of criticism their work generated).

Leijonhufvud, Axel, On Keynesian Economics and the Economics of Keynes: A Study in Monetary Theory. New York: Oxford University Press, 1968.

Lucas, Robert E, Jr., “Review of Milton Friedman and Anna J. Schwartz’s A Monetary History of the United States, 1867-1960.” Journal of Monetary Economics. Vol. 34 (1): 5-16, August 1994. (Lucas lays out what he considers the most important contributions of A Monetary History.)

Miron, Jeffrey A., “Empirical Methodology in Macroeconomics: Explaining the Success of Friedman and Schwartz’s A Monetary History of the United States, 1867-1960. Journal of Monetary Economics. Vol. 34 (1): 17-25, August 1994. (Miron explains why members of the younger generation of macroeconomists, even those not trained at Chicago, found A Monetary History so persuasive.)

Steindl, Frank G., Monetary Interpretations of the Great Depression. Ann Arbor: University of Michigan Press, 1995. (Steindl provides a useful overview, which compares and contrasts the Friedman-Schwartz interpretation of the Great Depression with the interpretations offered by other monetary historians.)

Temin, Peter, Did Monetary Forces Cause the Great Depression? New York: Norton, 1976 and Temin, Peter, Lessons from the Great Depression. Cambridge, MA: MIT Press, 1989. (Temin presents a detailed and extremely skeptical reading of the Friedman-Schwartz interpretation of the Great Depression.)

Subject(s):Macroeconomics and Fluctuations
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII

The Federal Reserve: A New History

Author(s):Hetzel, Robert
Reviewer(s):Bordo, Michael D

Published by EH.Net (August 2023).

Robert Hetzel. The Federal Reserve: A New History. Chicago: University of Chicago Press, 2023. 696 pp. $45 (hardcover), ISBN: 978-0226821658.

Reviewed for EH.Net by Michael D Bordo, Rutgers University.


Robert Hetzel has written an ambitious history of Federal Reserve monetary policy since the establishment of the Federal Reserve System in 1913. The book follows an illustrious narrative tradition going back to Milton Friedman and Anna Schwartz’s A Monetary History of the United States:1867 to 1960 (1963) and Allan Meltzer’s A History of the Federal Reserve (2005, 2010). But unlike the earlier books it is based on the modern macroeconomic theory first pioneered by Robert Lucas (1972) and an analytical approach to monetary policy developed since the 1980s at the Federal Reserve Bank of Richmond, where Hetzel was a senior researcher and advisor for five decades.

The author uses the narrative approach of Friedman and Schwartz (1963) and Romer and Romer (2004), which views the history of business cycles under the Fed as semi-controlled experiments. He compares the performance of the Fed in its use of its policy tools to stabilize the business cycle (maintaining both price stability and real output at full potential) across all cycles since establishment of the Fed.

His analysis is based on two sets of modern tools developed by researchers connected with the Richmond Fed. The first is the microeconomic analysis of the connection between Fed monetary policy and the money market via the demand and supply of borrowed and non-borrowed reserves (“the plumbing of monetary policy”) developed by Marvin Goodfriend and others in Cook and LaRoche (1993). The second is the macroeconomic New Keynesian model under rational expectations and the assumption of sticky price setting developed by Marvin Goodfriend and Robert King (1997), which models the strategies required to match the Fed’s real policy rate (the federal funds rate) to Knut Wicksell’s natural rate of interest (further developed by Michael Woodford 2000).

Hetzel’s analytical framework provides a modern perspective to the Modern Quantity Theory of Money framework followed by Friedman and Schwartz (1963) and Meltzer (2005, 2010). Unlike those books, here the model framework is front and center, instead of subtly intertwined with the narrative and buried in footnotes. Hetzel also comparatively downplays the role of monetary aggregates in the Fed’s monetary policy making. An implication of this approach is that a reader who is not familiar with the post-Lucas macro tradition may have difficulty reading this book.

The author divides his narrative of Fed history into three separate regimes. First is the early pre-World War II Fed, embedded in the gold standard and real bills traditions inherited from the nineteenth century. This was followed by the post-World War II regime (1951-1979), which began under Chairman William McChesney Martin who employed a countercyclical policy based on a reaction function referred to as LAW (Leaning Against the Wind) with tradeoffs. Hetzel refers to the third regime (1979 to 2006) associated with Paul Volcker and Alan Greenspan as LAW with Credibility.

The Early Fed

The Federal Reserve Act of 1913 was based on two principles: the gold standard under which the role of a central bank was to use its discount rate to maintain gold convertibility. With free capital mobility the domestic interest rate was determined by the world interest rate and a central bank only had limited ability to pursue domestic objectives (Bordo and MacDonald 2005). Under the real bills doctrine the Fed could use its discount rate to buy and sell eligible (self-liquidating) commercial paper (real bills) and to eschew operations in speculative assets on the belief that speculation would lead to asset price booms, then to inflation in goods and services, followed by an asset price bust, deflation and depression. According to the real bills doctrine were the Fed to only operate in real bills there would never be a surplus or shortage of money (credit) and the economy would always be in balance.

Hetzel posits that the early Fed should be viewed as the first modern central bank to be on a fiat money standard, that the Fed was not constrained by its adherence to the gold standard, unlike the pre-World War I central banks of Europe. This was because the U.S. was a large relatively closed economy, and the Fed could easily sterilize gold flows by offsetting open market operations. According to him, the key failure of the interwar Fed was that it did not learn to base its policies on a reaction function, whereby the Fed would gear changes in its policy rate on deviations from price stability and real economic potential. Instead, it mistakenly based its policy on the real bills doctrine and seemed to view its sole function as preventing speculative excesses.

The author’s primarily closed economy approach could be challenged by extensive evidence that the international capital markets under the interwar gold exchange standard were as efficient as pre-1914 (Bordo and MacDonald 2002) and hence that the U.S. was influenced by international monetary forces. Indeed, the well-known global gold standard approach of Jacques Rueff, Robert Mundell and Barry Eichengreen is totally absent. At the very least, the U.S. was a large open economy with imperfect capital mobility, as argued by Bordo, Choudhri and Schwartz (2002), and the Fed followed a managed gold standard, as earlier argued by Friedman and Schwartz.

In the Hetzel story, as has been argued earlier by Brunner and Meltzer (1968), Wheelock (1992), and Meltzer (2005), the Fed’s real bills approach led it to begin a tight money policy beginning in early 1928 to stem the Wall Street boom that had begun in 1926. This led to the Great Contraction of 1929 to 1933. Moreover, unlike Friedman and Schwartz, Meltzer (2005) and Bernanke (1983), the author views the entirety of the Great Contraction as due to the Fed’s tight monetary policies as explained via the mechanics of the Richmond Fed plumbing model. Unlike his predecessors, Hetzel downplays the role of the four U.S. banking panics from 1930 to 1933 as the key reason the Great Contraction was so severe and protracted. He is especially critical of Ben Bernanke’s (1983) thesis that the banking panics led to the collapse of financial intermediation (which later led to the development of the credit channel of monetary policy). At the very least, further empirical evidence that confronts the voluminous international historical literature that suggests that financial crises, controlling for other factors, can both cause recessions and make them worse (for a survey see Bordo and Meissner 2016) would be most helpful to back this controversial position. This is particularly so in the face of a moderate rise in policy interest rates before 1929 and a massive decline in the money supply that did not occur until the banking panics began.

The LAW with Tradeoffs

The author views the Federal Reserve Treasury Accord of February 1951 as a watershed in Fed policymaking. He is highly complementary of Chairman Martin’s adoption of the reaction function approach to monetary policymaking. Henceforth the Fed would adjust its policy rate, via its Free Reserves indicator, to offset business cycle shocks. Hetzel provides compelling narrative and empirical evidence that this new approach greatly improved both real and nominal performance compared to the interwar era. However, he argues that because the Fed waited for inflation to rise before commencing its tightening in the upswing of the business cycle, its exit policies would always be too late. This agrees with both the earlier Friedman and Schwartz and Meltzer approaches (see Bordo and Landon Lane 2013 and Bordo and Levy 2022).

Martin’s success was short lived, ending with the Great Inflation, which began on his watch in 1965. In agreement with Meltzer (2010). Hetzel attributes the Great Inflation to President Lyndon Baines Johnson’s fiscal shocks of the Vietnam War and the Great Society leading to pressure on the Fed to accommodate the fiscal deficit, as well as the ascendency of Keynesian doctrines in both the Administration and the Fed. The Keynesian approach emphasized maintaining full employment (at 4%) and the view that the Fed could exploit the Philips curve tradeoff of lower unemployment at the expense of higher inflation on the grounds that the benefits of lower unemployment outweighed the costs of higher inflation as argued by Samuelson and Solow (1960).

Chairman Martin was succeeded by Arthur Burns, who believed that inflation was driven primarily by cost-push forces and not by the Fed’s expansionary monetary policy. His solution to inflation was wage and price controls. Burns was also strongly influenced by pressure from President Richard Nixon not to pursue tight monetary policy, which could lead to a recession and prevent Nixon’s reelection chances in 1972. Hetzel, in sympathy with the articles in Bordo and Orphanides (2013), describes the ratcheting up of inflation and inflationary expectations through the 1970s under Burns and his successor William Miller, neither of whom tightened monetary policy enough, over concern of rising unemployment, to break the back of inflationary expectations. Again, the author ignores the rest of the world and the possible role that Nixon’s abandonment in August 1971 of the gold peg of the dollar under the Bretton Woods system could have played in the de-anchoring of inflationary expectations.

The LAW-with-Credibility Fed

Hetzel sees the Volcker shock of 1979 as another watershed in Fed monetary policy making. Paul Volcker, with the backing of President Ronald Reagan, was able to tighten monetary policy sufficiently to break the back of inflationary expectations and inflation but at the expense of two very serious recessions. Volcker is praised for creating a regime of credibility for low inflation. His mantle was taken in 1987 by Alan Greenspan, who cemented credibility by preemptively tightening in the inflation scare of 1994. Hetzel nicely describes how Greenspan used the bond market – which quicky incorporated expectations of future inflation – as its intermediate target. The author praises the Volcker-Greenspan regime for creating the Great Moderation of low and stable inflation and good real economic performance from the mid 1980s to the early 2000s. He views this period as being so successful because the Fed followed rule-like policies, with its reaction function operating close to that of the Taylor rule (1993).

As for the Global Financial Crisis (GFC) of 2007-2008 that ended the Great Moderation, the author attributes it entirely to the policies of Greenspan’s and later Ben Bernanke’s (who succeeded Greenspan as chair in 2006) Fed, which kept its policy rate too high so as to fend off a temporary run-up in commodity prices in 2006-2008. Hetzel attributes these wholesale price pressures primarily to the integration of China into the WTO. He downplays the role that low interest rates played before 2000 in fueling the housing boom, as argued by Taylor (2007). He also downplays the role of the subprime mortgage induced collapse of credit market intermediation in causing the GFC, in contrast to the view of the Federal Reserve under Bernanke. He is highly critical of the Fed’s deployment of numerous lender of last resort facilities to shore up the financial system, which he refers to as credit policies — a form of fiscal policy involving the picking of winners and losers — leading to resource misallocation, moral hazard, and a threat to the Fed’s independence. Like his interpretation of the Great Contraction, his contrarian view of the Fed’s lender of last resort policies in the GFC could use more empirical evidence. As with the Great Contraction of 1929-1944, it is difficult to attribute a deep downturn solely to a previously, modestly tight stance of monetary policy.

The author also has a contrarian view of the slow recovery following the GFC. Unlike the consensus view, he regards Fed Chairman Janet Yellen’s policies after 2012 as a successful continuation of the Volcker Greenspan doctrine in producing good real and nominal performance. He is highly critical of the FAIT (Flexible Average Inflation Targeting) policy strategy enacted by Chairman Jerome Powell in 2019. It was adopted under the belief that the Fed had been unable with its existing quantitative easing and forward guidance strategy, to reach its 2% inflation target during the recovery from the Great Recession. Under the FAIT strategy the Fed would allow inflation to temporarily overshoot its 2% inflation target to push unemployment low enough to employ disadvantaged groups in society. The risk of a more permanent inflation overshoot would not be problematic under the new strategy because of the assumption that inflation would always be credibly anchored at the 2 % target. Hetzel convincingly argues that FAIT was one of the key factors leading to an increase in the outbreak and persistence of high inflation from 2021 to 2023.

The author is also critical of the financial market rescue policies adopted by the Powell Fed in the spring of 2020 as unnecessary in the face of natural market forces, which by themselves would have led to a quick recovery from the pandemic induced shutdown of the economy. The quick decline in credit market spreads after the Fed intervened in the corporate and municipal bond markets, in his view, had little to do with the Fed’s actions. Again, empirical analysis may suggest an alternative conclusion (Bordo and Duca 2022).

In the concluding chapters, Hetzel makes the case for the Fed to follow more rule-like policies along the lines suggested by Goodfriend King (1997). He posits that the Fed should gear its real federal funds rate to the Wicksellian natural rate of interest. He also recommends a return to the preemptive strategies of the Volcker-Greenspan era and an abandonment of FAIT.

Robert Hetzel’s book is a very important contribution to the literature on the history of U.S. monetary policy. His application of modern macro analysis provides a new approach to the subtleties of Fed policy making. His contrarian views on the causes of the Great Recession and the Global Financial Crisis provide a challenge for future research. In my view this book should be read by monetary policy makers and serious students of the Federal Reserve.


Ben Bernanke (1983) “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression.” American Economic Review, Vol. 73 (June): 257-276.

Michael D Bordo and Ronald MacDonald (2005) “Interest Rate Interactions in the Classical Gold Standard, 1880-1914: Was There Any Monetary Independence?” Journal of Monetary Economics, Vol. 82, No. 2: 307-327.

Michael D Bordo, Ehsan Choudhri, and Anna J Schwartz (2002) “Was Expansionary Monetary Policy Feasible During the Great Contraction?” Explorations in Economic History, Vol. 39, No. 1 (January),: 1-28,

Michael D Bordo and Ronald MacDonald (2003) “The Interwar Gold Exchange Standard: Credibility and Monetary Independence.” Journal of International Money and Finance, Vol. 22, No. 1 (February): 1-32.

Michael Bordo and John Landon Lane (2013) “Exits from Recession: The U.S. Experience 1920-2007.” In Vincent Reinhart, ed., No Way Out: Persistent Government Interventions in the Great Contraction. Washington DC: American Enterprise Institute.

Michael D Bordo and Athanasios Orphanides (2013) The Great Inflation: The Rebirth of Modern Central Banking. Chicago: University of Chicago Press for the NBER.

Michael D Bordo and Christopher Meissner (2016) “Fiscal Crises and Financial Crises.” In John B. Taylor and Harald Uhlig, eds., North Holland Handbook of Macroeconomics. North Holland Publishers.

Michael D Bordo and John Duca (2022) “An Overview of the Fed’s New Credit Policy Tools and Their Cushioning Effect on the Covid-19 Recession.” Journal of Government and Economics, Vol. 3, Issue C.

Michael D Bordo and Mickey Levy (2023) The Fed’s Monetary Policy Exit Once Again Behind the Curve.” In Michael D Bordo, John H. Cochrane, and John B. Taylor, eds., How Monetary Policy Got behind the Curve—and How to Get Back. Stanford: Hoover Institution Press.

Karl Brunner and Allan Meltzer (1968) “What Did We Learn from the Monetary Experience of the United States in the Great Depression?” Canadian Journal of Economics, Vol. 1, No. 2 (May): 334-348.

Timothy Cook and Robert L. LaRoche, eds. Instruments of the Money Market, 7th edition. Federal Reserve Bank of Richmond.

Milton Friedman and Anna J Schwartz (1963) A Monetary History of the United States: 1867 to 1960. Princeton: Princeton University Press.

Marvin Goodfriend and Robert King (1997) “The New Neoclassical Synthesis.” In Ben S. Bernanke and Julio Rottemberg, eds., NBER Macroeconomics Annual 1997, Vol. 12. Cambridge: MIT Press.

Robert E. Lucas, Jr. (1972) “Expectations and the Neutrality of Money.” In Robert E. Lucas, Jr. and Thomas J. Sargent, eds., Studies in Business Cycle Theory. Cambridge: MIT Press.

Allan Meltzer (2005) A History of the Federal Reserve. Volume 1: 1913-1951. Chicago: University of Chicago Press.

Allan Meltzer (2010) A History of the Federal Reserve. Volume 2, Books 1 and 2. Chicago: University of Chicago Press.

Christina and David Romer (2004) “A New Measure of Monetary Shocks: Derivation and Implications.” American Economic Review, Vol. 94, No. 4 (September): 1055-1084.

Paul A. Samuelson and Robert M. Solow (1960) “Analytic Aspects of Anti-Inflation Policy.” American Economic Review, Vol. 50, No. 2 (May): 177-194.

John B. Taylor (1993) “Discretion Versus Policy Rules in Practice.” Carnegie Rochester Conference Series on Public Policy, Vol. 39: 195-214. Amsterdam: North Holland.

John B. Taylor (2007) “Housing and Monetary Policy.” Federal Reserve Bank of Kansas City Jackson Hole Economic Symposium. August.

David Wheelock (1992) “Monetary Policy in the Great Depression: What the Fed Did, and Why.” Federal Reserve Bank of St. Louis Review. March/April.

Michael Woodford (2000) Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton University Press.


Michael D Bordo is a Board of Governors Professor of Economics and a Distinguished Professor of Economics at Rutgers University. He is currently working on a book project with Ned Prescott, “Federal Reserve Structure, Economic Ideas, and Monetary and Financial Policy,” as well as several projects in monetary history.

Copyright (c) 2023 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 ( Published by EH.Net (August 2023). All EH.Net reviews are archived at

Subject(s):Economic Planning and Policy
Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII
20th Century: WWII and post-WWII
21st Century

Essays in Economic History: Purchasing Power Parity, Standard of Living, and Monetary Standards

Author(s):Officer, Lawrence H.
Reviewer(s):Devereux, John

Published by EH.Net (July 2023).

Lawrence H. Officer. Essays in Economic History: Purchasing Power Parity, Standard of Living, and Monetary Standards. New York: Palgrave Macmillan, 2022. xxvii + 542 pp. $109.99 (hardback), ISBN 978-3030959241.

Reviewed for EH.Net by John Devereux, Department of Economics, Queens College, City University of New York.


Lawrence Officer has had a long and productive career. His second collection of articles, Essays in Economic History: Purchasing Power Parity, Standard of Living, and Monetary Standards, covers the highlights of his research in these areas, on which he has worked for most of his career.

The collection begins with purchasing power parity (PPP). Over the past fifty years PPP has gone in and out of fashion. The continuing relevance of PPP is shown by the influential work of Itskhoki and Mukhin (2021), whose reconciliation of the various paradoxes in international macroeconomics hinges on the properties of the real exchange rate.

First up is the history of thought on PPP taken from Officer’s definitive account from 1982.  Here Officer makes clear his intellectual debt to Gustav Cassel. What follows is an exhaustive study of empirical work on PPP, focusing on years before 1940.

Next are three empirical studies, published in 1978, 1986 and 1989, on absolute PPP, the relative price of nontraded goods, and the absolute price level. The papers differ in key respects from the recent empirical literature on PPP. As we might expect, Officer emphasizes getting the data right before starting empirical work. He favors broad-based price indices such as the GDP deflator. At a more subtle level, he identifies thorny index number problems that arise when comparing absolute price levels. In simple terms, we get vastly different price levels if we use Fisher-Ideal or Geary-Khamis measures. For the most part, the literature ignores such problems.  Berka, et al. (2019) is one of the few exceptions.

A second difference with the PPP literature is that Officer evaluates PPP using mostly economic criteria. For example, what are the errors using PPP to forecast absolute price levels (p. 90), and what size of error is consistent with accepting absolute PPP. McCloskey and Zecher (1984) make a similar point. The focus on economic rather than statistical criteria may explain why Officer (p. 50 and elsewhere) appears lukewarm on testing for PPP by looking at real exchange stationarity. He is more receptive towards cointegration tests as they have clearer economic interpretations. Officer’s intellectual honesty is refreshing given that some of the strongest evidence supporting PPP comes from the findings of real exchange rate stationarity in very long run data.

Before leaving PPP, it is worth noting one omission from the book. In 1979, Officer published a paper with Morris Goldstein of the International Monetary Fund providing price indices for tradables and non-tradables derived from output side GDP measures. The paper showed, probably for the first time, that the relative price of nontradables increases with growth. Their methodology is superior to the other measures of nontraded prices developed before or since. It is a wonderful paper that stands with the best work in the area.

Chapters 9 through 12 provide long-run U.S series on the terms of trade, compensation in manufacturing, and the consumer price index. For earnings and the consumer price index, the U.S has seen nothing like British controversies on standards of living during the industrial revolution so there is less work for Officer to begin with. In each case, Officer breaks new ground, improves on previous work, and provides close to a definitive series given the material that he had available to him.

The collection then turns to Officer’s recent work on monetary standards. What follows are chapters on metallic standards – silver and gold – with a short interlude on Bretton Woods. Chapters 17 and 18 on sterling and the dollar are particularly good. Even scholars who work in the area will learn something. A unifying theme is Officer’s notion that the floating and fixed periods for the U.S and U.K should be considered as a single specie standard. The U.S specie standard therefore lasts from 1792 to 1932. There is, however, replication across the various essays that might have been avoided.

Next there are discussions of the bullionist periods in Sweden, Britain, and Ireland, along with the highlights of his well-known work on the efficiency of the dollar/sterling exchange. Chapter 22 is an important chapter as it gives the monetary base for the entire U.S specie standard with a new series before 1867. After 1867, Officer is in the exalted company of Friedman and Schwartz (1963). But he holds his own and he arguably improves on Friedman and Schwartz for the greenback era, where they added estimates in gold and depreciated dollars – apples and oranges. Officer uses gold prices which is surely the correct procedure. The differences are dramatic. Consider 1867, where Officer’s base estimates are half those of Friedman and Schwartz, thereby changing our interpretation of an important period in U.S monetary history. Officer also provides a series for the British base after 1790. It is a pity that he did not present the British results in more detail, as they might fill a large hole in the British series put together by Palma (2018).

The collection concludes with something completely different — a foray through science fiction through the lens of an economist.

Throughout the book, Officer is a happy warrior whose enthusiasm for history and economics is infectious. He is generous in his praise of other scholars and gentlemanly with his critics. Only Paul Samuelson’s gibes against PPP arouse his ire (pp. 32-33). Who should read this book? Clearly, it should be read by anybody interested in PPP or in U.S and British monetary history. Most certainly, it should be read by those who use the long-run data series he creates. Outside of these areas it can be read with pleasure by those of us who enjoy seeing a master craftsman at work.


Berka, Martin, Michael B. Devereux, and Charles Engel (2018). “Real Exchange Rates and Sectoral Productivity in the Eurozone.” American Economic Review, 108, 1543-1581.

Friedman, Milton, and Anna Jacobson Schwartz (1963). A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press.

Goldstein, Morris, and Lawrence H. Officer (1979). “New Measures of Prices and Productivity for Tradable and Nontradable Goods.” Review of Income and Wealth 25: 413-427.

Itskhoki, Oleg, and Dmitry Mukhin (2021). “Exchange Rate Disconnect in General Equilibrium.” Journal of Political Economy 129: 2183-2232.

McCloskey, Deirdre N., and Richard Zecher (1984). “The Success of Purchasing-Power Parity: Historical Evidence and its Implications for Macroeconomics.” In A Retrospective on the Classical Gold Standard, 1821-1931 (pp. 121-172). Chicago: University of Chicago Press.

Officer, Lawrence H. (1982). Purchasing Power Parity and Exchange Rates: Theory, Evidence and Relevance. Greenwich Conn.: JAI Press.

Palma, Nuno (2018). “Reconstruction of Money Supply over the Long Run: the Case of England, 1270–1870.” The Economic History Review71(2), 373-392.


John Devereux is professor of economics at Queens College, City University of New York. His areas of research are International Economics and Economic History.

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Subject(s):Financial Markets, Financial Institutions, and Monetary History
International and Domestic Trade and Relations
Living Standards, Anthropometric History, Economic Anthropology
Geographic Area(s):General, International, or Comparative
North America
Time Period(s):18th Century
19th Century
20th Century: Pre WWII
20th Century: WWII and post-WWII
21st Century

21st Century Monetary Policy: The Federal Reserve from the Great Inflation to COVID-19

Author(s):Bernanke, Ben S.
Reviewer(s):Ebenstein, Lanny

Published by EH.Net (July 2022).

Ben S. Bernanke. 21st Century Monetary Policy: The Federal Reserve from the Great Inflation to COVID-19. New York: W. W. Norton & Company, 2022. xxvi + 480 pp. $35.00 (hardcover), ISBN 978-1324020462.

Reviewed for EH.Net by Lanny Ebenstein, Department of Economics, University of California, Santa Barbara.


Ben Bernanke’s 21st Century Monetary Policy is sure to become a classic work on the history of the Federal Reserve System in the postwar era to the COVID-19 recession. It will be required reading for all future students of and officials at the Fed. Bernanke’s perspective is shaped by two fundamental virtues: his academic work as a scholar of the Fed and of monetary policy and his practical work as a member of the Federal Reserve’s Board of Governors and, from 2006 to 2014, its Chair. Both virtues are displayed in this excellent book.

Bernanke’s description of Fed policymaking will be enlightening to most. There has not really been a work on the history of the Fed that has captured the public or academic minds since Milton Friedman and Anna Schwartz’s A Monetary History of the United States, 1867-1960 (1963). Friedman’s mantra, “Inflation is always and everywhere a monetary phenomenon,” became implanted in popular consciousness, and his monetary interpretation of the Great Depression–that the primary source of the depression was a monetary collapse initiated by the Federal Reserve System or which, in any event, the Fed could largely have forestalled–became the conventional scholarly wisdom.

On the basis of favorable comments Bernanke made at Friedman’s 90th birthday party in 2002–“I would like to say to Milton …: Regarding the Great Depression. You’re right, we [the Fed] did it. We’re very sorry. But thanks to you, we won’t do it again” (p. xvii)–it is sometimes mistakenly thought that Bernanke is basically a Friedmanite monetarist. As he makes clear in 21st Century Monetary Policy, however, Bernanke is fundamentally a Keynesian in analytic apparatus and perspective: “So-called Keynesian economics, in a modernized form, remains the central paradigm at the Fed and other central banks” (p. vii). Friedman’s mantra is replaced by Bernanke’s dictum: “Although growth in the money supply and inflation bear some relation in the long run, at least in certain circumstances, in the short run the connection can be unstable and difficult to predict” (p. 35). For Bernanke–as with his predecessors and successors at the Fed–monetary policy, except in unusual circumstances, is basically interest rate policy.

The early chapters of 21st Century Monetary Policy on the Fed from the 1960s through the 1990s have many nuggets of information and provide great insight into theoretical analysis at the Fed to this day. William McChesney Martin, Chair of the Federal Reserve from 1951 to 1970, famously said that the Fed’s job is to “take away the punch bowl just as the party gets going,” that is, to raise interest rates in order to stem inflation as economic growth increases. This is the policy to which Martin and his successors have largely adhered. Bernanke’s outlook is that inflation is usually conditioned by “changes in economywide demand for goods and services [emphasis in original]” and “shocks to supply rather than demand” (p. 12), with significant emphasis on “expectations”: “Debates about the determinants of inflation expectations and about how central banks can affect those expectations have been central to the analysis and practice of monetary policy since at least the 1960s, if not earlier” (p. 13). Friedman’s focus on money supply is hardly a factor in the analysis.

The Fed Chair to whom Bernanke gives the most praise is Paul Volcker, who served from 1979 to 1987. Bernanke credits Volcker for having the wisdom and tenacity to initiate and maintain the high interest rates between 1979 and 1982, which, in the form of the federal funds rate, reached 20 percent in 1980–the highest ever, before or since. As a result of Volcker’s “war on inflation” (p. 36), as Bernanke and others have called it, inflation “dropped from about 13 percent in 1979 and 1980 to about 4 percent in 1982 … Thus, in only a few years, the Fed largely reversed the increase in inflation built up over a decade and a half” (p. 36).

Bernanke’s appraisal of Alan Greenspan’s long span as Fed Chair from 1987 to 2006 is somewhat more, at least to this reviewer, mixed. Though he gives Greenspan high marks for managing the domestic and, to a significant extent, world economies for most of his tenure in office, it cannot be gainsaid that the roots of the Global Financial Crisis and Great Recession emerged during Greenspan’s chairmanship. Bernanke sagely observes: “The extended rise in the Fed’s [interest] policy rate likely contributed to the decline in housing prices that began in the summer of 2006” (p. 106).

With respect to his own transformative chairmanship, Bernanke recounts the aggressive and unprecedented actions the Fed took to diminish the Global Financial Crisis and Great Recession. He persuasively argues these actions were necessary to prevent the meltdown of the American and world financial systems and thereby economies. About the only criticisms I would offer here of his presentation is that he does not adequately incorporate into his analysis the impact of nonfinancial factors, such as increasing energy prices and demographic changes, on economic activity, but this is perhaps not an entirely fair cavil to make against a work whose title states it concerns monetary policy.

21st Century Monetary Policy: The Federal Reserve from the Great Inflation to COVID-19 extends to 2021 and includes thinking on the future of Federal Reserve and its policy, but it is probably best to defer discussion of these subjects as a result of their proximity to the present. Bernanke believes that a historical approach is the best way to understand “how the Fed’s tools, strategies, and communication have evolved to where they are today” (p. xi). All interested in the history of the Federal Reserve, Federal Reserve policy, and the theory underlying Fed policy will want to read this book.


Lanny Ebenstein is a Lecturer in the Department of Economics at the University of California, Santa Barbara. He is the author of ten books and many articles on economic and political history, history of economic thought, and public policy.

Copyright (c) 2022 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 ( Published by EH.Net (July 2022). All EH.Net reviews are archived at

Subject(s):Economic Planning and Policy
Financial Markets, Financial Institutions, and Monetary History
Macroeconomics and Fluctuations
Geographic Area(s):North America
Time Period(s):20th Century: WWII and post-WWII
21st Century

Milton Friedman & Economic Debate in the United States: 1932-1972

Author(s):Nelson, Edward
Reviewer(s):Sumner, Scott

Published by EH.Net (January 2022).

Edward Nelson. Milton Friedman & Economic Debate in the United States: 1932-1972. Volumes 1 and 2. Chicago: University of Chicago Press, 2020. xx + 737 pp. and xiv + 587 pp. $50 each (hardcover), ISBN: 978-0226683775 and 978-0226684895.

Reviewed for EH.Net by Scott Sumner, Professor Emeritus of Economics, Bentley College.


Milton Friedman was at the center of economic policy debates in the US during much of the 20th century. Edward Nelson, an economist at the Federal Reserve System, has now completed the first two volumes of an intellectual biography of Friedman’s career, focusing on his policy views during the period from 1932 to 1972. It is work of outstanding quality.

While much has been written on Friedman’s career, no previous biographer has Nelson’s deep and sophisticated understanding of monetary economics. This makes his new book especially useful for those with a serious interest in policy issues, especially macro policy. While Friedman had policy views on a wide variety of issues, including the military draft and education voucher programs, Nelson focuses his attention on the areas where Friedman’s influence was greatest–the field of macroeconomics.

The timing of this book is particularly fortuitous. Friedman began his career during a period when left-wing economics was ascendant. During the middle of his career, the economics profession in the US and other developed countries shifted to the right–the so-called neoliberal revolution.  Indeed, Friedman played a major role in that intellectual shift, probably more than any other single economist.

After Friedman’s death in 2006, however, the profession began moving back again toward the left, and Friedman’s reputation declined somewhat. Some younger economists may be unaware of the extent to which ideas they take for granted were highly controversial when first proposed by Friedman.

Today, Friedman is often associated with monetarism, particularly the idea that the Fed should stabilize the growth rate of the money supply, perhaps at 3% or 4% per year. After the early 1980s, however, money supply targeting fell out of favor, mostly due to perceptions that velocity was too unstable. This led many to erroneously conclude that monetarism was discredited.

Nelson shows that money supply targeting was not Friedman’s most important contribution to monetary economics. Instead, Friedman’s critique of Keynesian economics is where he had an enduring influence. Indeed, that critique eventually led to a major evolution in Keynesian thought, toward an approach often dubbed “New Keynesianism”, which combined older Keynesian ideas with monetarist insights developed by Friedman and others.

While the two-volume set covers many topics, here I’ll focus on four key areas where Nelson shows that Friedman dissented from Keynesian orthodoxy during the 1950s and 1960s. Consider these mainstream Keynesian ideas from the 1960s:

1. High nominal interest rates indicate tight money, and vice versa.

2. Fiscal policy is the most effective tool for managing the business cycle.

3. The Phillips Curve demonstrates that we can permanently reduce unemployment by accepting higher inflation.

4. Wage and price controls are often a useful way to control inflation, whereas monetary policy does more harm than good.

Nelson shows that at various times during the 1960s and early 1970s, all four of these ideas were widely accepted by many prominent Keynesian economists. In all four cases, Friedman argued against the conventional wisdom, and in all four cases subsequent events vindicated Friedman’s views. Let’s take them one at a time.

While Irving Fisher’s analysis of nominal and real interest rates was known to most economists, even as late as the 1960s the importance of this distinction was often overlooked. Keynes himself viewed the distinction as a mere theoretical curiosity, except during times of hyperinflation. Thus when Friedman argued that interest rates were rising during the late 1960s due to the Fisher effect, prominent Keynesians such as James Tobin rejected his claim.

By the late 1970s, however, evidence for the importance of the Fisher effect from both time series and cross-sectional data had become overwhelming. Eventually, this insight was incorporated into monetary policymaking, most famously in various versions of the Taylor Rule.

During the second half of the 1960s, many Keynesian economists did understand that the economy was overheating and that inflation was a threat. They advocated fiscal austerity to reduce aggregate demand, and President Johnson responded with a tax increase in 1968, which pushed the Federal budget into surplus. Contrary to popular opinion, the peak years of the Vietnam War were not associated with highly expansionary fiscal policy–the national debt was falling rapidly as a share of GDP.

Friedman argued that the real problem was rapid growth in the money supply, and that fiscal austerity would not reduce inflation. As the rate of inflation continued to accelerate in 1969 and 1970, Friedman’s warning proved to be accurate.  Monetary policy dominates fiscal policy.

During the 1960s, many Keynesian economists became convinced that the Phillips Curve provided a reliable tool for reducing unemployment. In their view, a bit less unemployment could be purchased at the cost of slightly higher inflation.  Friedman argued that this relationship was illusory. Only unanticipated inflation reduced unemployment. Once workers began to anticipate a higher rate of inflation, they would demand compensating pay increases and unemployment would return back to its natural rate.

By the 1970s, it was clear that Friedman was correct. Unemployment was higher than during the 1960s, despite inflation also being much higher. The 1980s would provide further evidence in support of Friedman’s Natural Rate Hypothesis, as after inflation was brought down to much lower levels, the increase in unemployment proved to be only temporary.

When the economy experienced stagflation during the early 1970s, many Keynesians became discouraged by the poor performance of Phillips Curve models. Theories of “cost-push inflation” replaced standard Keynesian demand-pull explanations. This led many prominent Keynesians to support wage/price controls. Friedman warned that artificially suppressing inflation would not solve the problem, and that the only enduring solution was a slower rate of growth in the money supply.

By the mid-1970s it was clear that the wage/price controls had not worked, as inflation reached even higher levels than in the late 1960s. Inflation would not be brought down to a low level until Paul Volcker adopted a contractionary monetary policy during the early 1980s, slowing the growth rate of the money supply.

All four of the insights discussed here have one thing in common; they reflect Friedman’s understanding of the importance of changes in the growth rate of the money supply, as distinct from one-time changes in levels. In 1975, Friedman said:

“Double-digit inflation and double-digit interest rates, not the elegance of theoretical reasoning or the overwhelming persuasiveness of serried masses of statistics massaged through modern computers, explain the rediscovery of money.”

And in the same year:

“As I see it, we have advanced beyond [the theory of money proposed in the eighteenth century by David] Hume in two respects only; first, we now have a more secure grasp of the quantitative magnitudes involved; second, we have gone one derivative beyond Hume.”

Persistent increases in the growth rate of the money supply made the Fisher effect much more important than during the gold standard era. Persistent changes in inflation caused the Phillips Curve to break down. And the inflationary forces unleashed by rapid money growth were too powerful to restrain with fiscal austerity or wage/price controls.

And as Nelson demonstrates, it was Friedman himself who pushed the profession “one derivative beyond Hume.”

In my view, graduate programs in macroeconomics now put too much weight on technique and too little emphasis on the history of macroeconomic ideas and policy. We’d all be better off if graduate students in macroeconomics read Nelson’s authoritative study of the development of Milton Friedman’s views on economic policy.


Scott Sumner is Professor Emeritus of Economics at Bentley College, as well as a research associate in the Program on Monetary Policy at the Mercatus Center at George Mason University and a Research Fellow at the Independent Institute. His most recent book is The Money Illusion: Market Monetarism, the Great Recession, and the Future of Monetary Policy (University of Chicago Press, 2021). He blogs at

Copyright (c) 2022 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 ( Published by EH.Net (January 2022). All EH.Net reviews are archived at

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Government, Law and Regulation, Public Finance
History of Economic Thought; Methodology
Macroeconomics and Fluctuations
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII
20th Century: WWII and post-WWII

Monetary War and Peace: London, Washington, Paris, and the Tripartite Agreement of 1936

Author(s):Harris, Max
Reviewer(s):Otte, T.G.

Published by EH.Net (November 2021).

Author: Max Harris

Reviewer: T.G. Otte

Max Harris. Monetary War and Peace: London, Washington, Paris, and the Tripartite Agreement of 1936. Cambridge: Cambridge University Press, 2021. Xiii + 279 pp. £85 (hardcover), ISBN 978-1-108-48495-4.

Reviewed for EH.Net by T.G. Otte, Professor of Diplomatic History, University of East Anglia.


The history of interwar international finance presents something of a paradox. In many respects, it is a well-known story; and yet, it is not known well enough. Max Harris’ study of the Tripartite Agreement of 26 September 1936, which provided for informal consultation and cooperation on managing their respective currencies between the governments of between France, Great Britain and the United States and their central banks, throws this peculiarity into sharper relief.

In his seminal study The World in Depression, 1929-1939 (1973), Charles Kindleberger called the agreement a “milestone,” though he immediately qualified this statement. Above all, he gave no indication along which particular road this way-marker was to be found, and in which direction it might have pointed. Harris offers an answer of sorts. Monetary War and Peace is an exercise in macroeconomic history. Its chief concern is with the efforts, conceptual and practical, of central bankers and finance ministry officials to grapple with the financial and broader politico-strategic consequences of the collapse of international finances after the First World War and then the global financial crisis of 1929-31.

The inner workings of the international economy during the “golden age” before 1914, of course, are well known and well understood, as are the attempts by various Western governments to adjust their economic and financial arrangements to the altered landscape of the post-war years. Harris offers a succinct and sure-footed account of this and of the decision of Britain’s National Government, an emergency coalition formed to deal with the financial crisis, to go “off” the gold standard. Thereafter, for the first time in almost two hundred years, there was no precedent to guide policymaking. Senior officials at the Bank of England and the Treasury had to feel their way forward and refine what instruments were to hand and proved useful. In Britain’s case the Exchange Equalisation Account, established in 1932, turned out to be the chief monetary innovation. Endowed with sufficient reserves, it allowed the British authorities to intervene on the currency exchange to prop up Sterling. The Americans followed suit, two years later, with the Exchange Stabilization Fund. The EEA and ESF were the principal instruments for currency intervention. Their actions, in turn, as Harris shows with admirable lucidity and fine sense for relevant detail, were the source of considerable transatlantic friction in the mid-1930s.

Harris’ treatment is enriched by vignettes of key central bank and treasury personnel, primarily in Washington and London. In his telling, Bank of England economists such as Harry Siepmann and George Bolton or David Whaley (né Sigismund Schloss) emerge as perhaps unlikely heroes of this story. So does Henry Morgenthau, the slow-speaking, apple-farmer-turned-Treasury-Secretary and Roosevelt confidante. These men had a shrewd appreciation of the disruptive effect of competitive currency interventions and the mutual suspicions they sowed and then entrenched on both sides of the Atlantic. Above all, they understood that cooperation between the democratic nations in the field of finance might counterbalance the increasingly disruptive actions of the revisionist powers on the continent of Europe.

To no small extent, the Tripartite Agreement obscured fundamental differences between Paris, London, and Washington. And yet, it established in the place of the now defunct gold bloc a system of gold clearing, and this helped to stabilise the currency system, gold convertibility remaining the glue that held the whole edifice together. It was informal but transparent; it was focused on day-to-day transactions, but it helped to engrain habits of constant exchanges between the three sides (Belgium, the Netherlands and Switzerland joined the agreement in November 1936). “Ni accord, ni entente, uniquement coopération journalière,” it worked well enough. The absence of carefully coordinated action, for instance during the gold scare in April 1937, however, meant that it did not work as well as it might have.

In the face of the exigencies of war the arrangements of September 1936 did not survive. Both Britain and France, for instance, introduced exchange controls. But as the war progressed and policymakers began to contemplate post-war international arrangements, they drew on the experiences of the Tripartite Agreement and the spirit of 1936. In Harris’ reading, the agreement, then, was a milestone on the road to Bretton Woods and the post-1945 international financial system.

In examining the Tripartite Agreement in detail Max Harris has done a considerable service to scholars of economic and international history alike. His analysis is forensic, and his judgment is shrewd. Similarly, his tentative conclusions as to the possible lessons of 1936 for present-day, post-hegemonic international politics are sensible. There is much to praise in Monetary War and Peace. If it has a defect, it is that is essentially an Anglo-American story, based on British and American archives. French decision-making is reconstructed largely with the aid of Anglo-American sources, and although Belgian, Dutch, French and Swiss archival materials are listed in the bibliography, these offer no more than a decorative sprinkling. As with other works of macroeconomic history, there is sometimes a lack of granularity with regard to government decision-making. Much of the reconstruction of it is refracted here through Bank of England and Treasury lenses. The concerns of other departments, especially the foreign ministries, are given little consideration, even though most took a strong interest in finance; and Harris’ grasp of government decision-making is occasionally less surefooted. Some of the material which used to support conclusions about Treasury thinking, for example, consists of copies of Foreign Office despatches forwarded to the Treasury for information and kept in that department’s files. Further, it would have been interesting and useful to examine whether Neville Chamberlain, a confirmed America-sceptic as Chancellor of the Exchequer, was influenced by experiences of the Tripartite Agreement after his move from No. 11 to No. 10 Downing Street in May 1937 (just after the gold scare).

None of this, however, should detract from the merits of this work, which are considerable.


T.G. Otte is Professor of Diplomatic History at the University of East Anglia. His works include Statesman of Europe: A Life of Sir Edward Grey (Allen Lane (Penguin), 2020) and July Crisis: The World’s Descent into War, Summer 1914 (Cambridge University Press, 2014).


Copyright (c) 2021 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 ( Published by EH.Net (November 2021). All EH.Net reviews are archived at

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Government, Law and Regulation, Public Finance
Macroeconomics and Fluctuations
Geographic Area(s):Europe
North America
Time Period(s):20th Century: Pre WWII

The Evolution of Central Banking: Theory and History

Author(s):Ugolini, Stefano
Reviewer(s):Siklos, Pierre

Published by EH.Net (November 2019)

Stefano Ugolini, The Evolution of Central Banking: Theory and History. London: Palgrave Macmillan, 2017. xiii + 330 pp. €135 (hardcover), ISBN: 978-1-137-48524-3.

Reviewed for EH.Net by Pierre Siklos, Department of Economics, Wilfrid Laurier University.

The so-called Global Financial Crisis raised the profile of central banks around the world. While books about central banks were, of course, published prior to the events of 2008-2009, none captured the attention of the wider public until the monetary authorities intervened on a massive scale and continue to do so well over a decade since the near collapse of the global financial system. A new set of books emerged, with titles like The Only Game in Town, or After the Music Stopped, which used a chronological approach to describe what central banks did as well as contemplating the implications of the shift from conventional to unconventional monetary policies. The approach of these books is largely descriptive and the analysis is largely rooted in depicting the evolution of central banking activities in select countries over time.

Stefano Ugolini, an Assistant Professor at the University of Toulouse, argues that this strategy, termed the institutionalist approach by the author, is not satisfactory. Instead, he proposes a functional approach to the analysis of the evolution of central banking. Four functions of central banking are explored. They are: the payments system, the lender of last resort and supervision, the issuance of money, and monetary policy. The author claims that one need not rank order these functions, though the number of pages devoted to the payments system and the lender of last resort functions suggest that these may perhaps be relatively more important to the author than the remaining two functions.

The discussion blends a history of events that reflect the growing importance of central banks in the global economy together with the history of thought about the balance between public and private roles in carrying out central banking functions. As a result, private banks and their connection with monetary authorities play an important role in the depiction of the evolution of central banking. For example, we see how the emergence of clearinghouses led to the creation of “conventional” central banks via the centralization of this function at the public level. Hence, this function is treated as a “natural monopoly.” The same is true of the evolution of many of the other functions examined. Nevertheless, the author is careful to highlight how in some countries, such as the United States, the tension between a role for government versus a preference for a strong role by the private sector in carrying out certain financial functions can explain certain cross-country differences in how central banks evolved when viewed through the lens of the functional approach. It may also be noted in passing that the experiences of Venice and Naples figure prominently in the discussion.

Ugolini has written a compact history of the critical functions of central banks emphasizing how the forces of centralization spurred or prevented financial innovations. The approach taken is a fresh one and will be useful, especially to scholars who are interested in specific areas where central banks have played an important role in economic development over time. That said, does the book provide new insights into central banks and their functions? This is debatable. For example, while financial stability is often mentioned it is not treated as a separate function. This is a shame in light of the ongoing debate about whether central banks are possibly over-burdened with responsibilities. It is also relevant for the question of the degree of centralization of the various functions considered at the level of a single institution. Stated differently, greater emphasis by the author on governance matters might have helped.

Ugolini concludes as follows: “central banking is deeply rooted in the economic and political context in which it happens to operate, and that the evolution of the former closely depends on the evolution of the latter” (p. 271). Readers of “institutionalist” style books of central banking would have reached the same conclusions. Hopefully, this is welcome as it means that the functional and institutional approaches yield similar results but this also means that no fundamentally new insights about the evolution of central banking are generated.

Three other elements about the functional approach adopted by Ugolini are also worth mentioning. First, the discussion is overwhelmingly centered on the European, British, and American experiences. The book is silent about how central banking functions evolved in Canada, Asia, or Australasia. Second, the chapter on the issuance of money does not discuss how history, or the history of thought, might inform the current debate about the digitization of money. Finally, the discussion of the monetary policy function glosses over the evolution of policy regimes, such as exchange rate or inflation targeting, preferring instead to focus on its role as a means of regulating and taxing the public to ensure something called monetary stability. Unfortunately, the latter expression is never sufficiently clearly explained. Nevertheless, Ugolini is correct to underscore the importance of examining how monetary and fiscal policy interact. After all, this is an issue that is very much at the center of the debate about the future of central banking.

Pierre Siklos is Professor of Economics at Wilfrid Laurier University and the Balsillie School of International Affairs. His latest books on central banking are Central Banks into the Breach: From Triumph to Crisis and the Road Ahead and The Economics of Central Banking, co-edited with David Mayes and Jan-Egbert Sturm, both published by Oxford University Press

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Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):Europe
North America
Time Period(s):18th Century
19th Century
20th Century: Pre WWII
20th Century: WWII and post-WWII

Gold, the Real Bills Doctrine, and the Fed: Sources of Monetary Disorder, 1922-1938

Author(s):Humphrey, Thomas M.
Timberlake, Richard H.
Reviewer(s):Thies, Clifford F.

Published by EH.Net (October 2019)

Thomas M. Humphrey and Richard H. Timberlake, Gold, the Real Bills Doctrine, and the Fed: Sources of Monetary Disorder, 1922-1938. Washington: Cato Institute, 2019. xix + 201 pp. $21.21 (hardcover), ISBN: 978-1-948647-55-7.

Reviewed for EH.Net by Clifford F. Thies, School of Business, Shenandoah University.

Thomas M. Humphrey was a long-time research economist for the Federal Reserve Bank of Richmond with a penchant for the history of thought concerning monetary economics, and Richard H. Timberlake is a professor emeritus at the University of Georgia whose writings on money mainly concern the constitution of money, money and the U.S. Constitution, and other institutional arrangements for money. Their book is meant to debunk the “well-established” view that a slavish devotion to the gold standard condemned the United States and much of the rest of the world to the Great Depression. Instead of gold, the authors argue, the problem was the Real Bills Doctrine. Regardless of how persuasive they are in shifting the blame from gold to the Real Bills Doctrine, they tell a tale delicious in its detail, naming the names of those responsible.

According to Humphrey and Timberlake, John Law’s Bank of Mississippi was the first attempt to implement the Real Bills Doctrine (pp. 9-11). This bank, and other land bank schemes such as characterized the U.S. colonial period, may have had some connection to the Real Bills Doctrine, such as antecedents. However, the doctrine says that an appropriate backing for bank demand liabilities is short-term, “self-liquidating” loans collateralized by goods in transit and other such evidences of real activity. Land, not being self-liquidating, would not be appropriate. In addition to the heterogeneity of land, the value of land is speculative because it is based on the present value of its future services. Speculative assets, according to the Real Bills Doctrine, are not appropriate to back bank demand liabilities. Nor would state-issued or railroad-issued bonds be good backing for banknotes, as was mandated by various states during the Free Bank Era, because their values, too, are speculative. Nor would U.S. Treasury bonds as was allowed during the National Bank Era. The market values of long-term bonds and mortgages, even those that are substantially free of the risk of default, are dependent on interest rates and, therefore, are not appropriate to back bank demand liabilities. The misadventure of John Law has been repeated many times since his day, sometimes with banks, sometimes with depository institutions, and most recently with “shadow banks.” But land banks are more like the opposite of the Real Bills Doctrine, than an example.

A good example of the Real Bills Doctrine in conjunction with an operational gold standard was the chartered banks of Louisiana from 1845 to 1861. These banks backed their demand liabilities with a specie reserve of one-third and the remainder by bills of exchange, discounted commercial paper, and other short-term loans. Crucially, as Humphrey and Timberlake repeatedly state in conjunction with the bank panics of the 1930s, the specie reserve of the Louisiana chartered banks was only an initial reserve. During a bank panic, banks could pay out the specie in their vault. If the run on the banks wasn’t directly ended by the paying out of specie, the coming-due of a bank’s short-term loans (which could be paid in the banknotes of that bank or in specie) would either sop up the remaining banknotes in circulation or provide the specie needed to redeem those banknotes. None of the chartered banks of Louisiana suspended during the Panic of 1857, while the several Free Banks of the state suspended (albeit for a short time). Of course, Louisiana being on the losing side of the Civil War couldn’t provide the model for the National Bank Era. New York with its Free Banking system (based on bond collateral) did. As Humphrey and Timberlake correctly argue, the Real Bills Doctrine by itself wasn’t the culprit for the Great Depression (p. xiii). When operated in conjunction with an operational gold standard, as the Louisiana chartered banks did, the doctrine is innocuous. It is when the Real Bills Doctrine operates in a vacuum, without a commodity-money anchor, that something bad will inevitably happen.

The reason something bad will inevitably happen with the Real Bills Doctrine detached from an operational gold standard is, at one level, obvious, and, at another level, sophisticated. The obvious problem with the doctrine is that it links one nominal variable (the money stock) to another nominal variable (the money-value of qualifying loans), leaving the price level indeterminant (p. 5). The sophisticated argument, captured in the one diagram in Humphrey and Timberlake’s book (p. 24), is that the system is unstable. A move to inflation brings about more inflation, and a move to deflation brings about more deflation. During a hyperinflation, because the velocity of money accelerates, there is a shortage of money, requiring more money to prevent recession. Knut Wicksell called this or something like it the accumulation process; Milton Friedman, the accelerationist hypothesis; and, Friedrich Hayek, a tiger by the tail. The book describes this instability in the case of the German hyperinflation of the 1920s (p. 22). We are currently seeing this instability in Venezuela. The key argument of the book is that this instability works in both directions, downward as well as upward, and explains the deflation that accompanied the Great Depression, as well as various episodes of hyperinflation.

Part of the reason the money supply spirals downward as well as upward is because of fractional reserve banking (p. 28). Every dollar withdrawn from a bank results in a multiple contraction of the money stock. At this point, it is important to distinguish between what is today called base money, or M0, and what is called the money stock or money supply, or M1. Humphrey and Timberlake use the term “common money” to refer to the latter (and perhaps something more). The Real Bills Doctrine justifies fractional reserve banking because it says that real bills and not merely base money can be used to back bank demand liabilities. During the 1920s and early ‘30s, the monetary base consisted of gold coins and Gold Certificates, Silver Certificates and U.S. Notes outside the Fed, Federal Reserve Notes, reserves of banks held on deposit at the Fed, and limited legal tender subsidiary coins, mostly silver. The U.S. Notes were fixed in their supply, as essentially were also the Silver Certificates and coins. The dynamics of the fractional reserve system played out in the fractional backing of Federal Reserve Notes and bank reserves by gold, and by the fractional backing of bank demand and time liabilities by the base money in their vaults and their reserves held on deposit at the Fed. During good times, there was a tendency for the banking system to increase the money multiplier, and during bad times, to decrease it. By tracking the monetary aggregates, central banks can counteract these destabilizing tendencies, but the Fed did not track the monetary aggregates at the time. William McChesney Martin during the 1950s characterized the practice of counteracting destabilizing tendencies by saying the Fed should “lean against the wind.” But, unabashed Real Bills-central bankers run with the wind, instead of lean against the wind.

The real culprit precipitating a downturn in the monetary aggregates, however, wasn’t an automatic tendency. It was an explicit decision to suppress “speculation” made by a narrow majority of the Board of Governors of the Federal Reserve led by Adolph C. Miller, overriding the Federal Reserve Bank Presidents, the Federal Advisory Council, and many prominent private bank presidents. Pages 77-85 are the most engaging part of the book. Although the authors do not say so explicitly, by using terminology such as “an evangelical crusade,” they imply that Miller was from the populist and anti-bank wing of the Democratic Party. From the diary of a member of the Federal Reserve Board who served with him, it appears Miller was self-righteous and dogmatic. This is the impression I got reading the referenced articles by Miller justifying the actions of the Fed. That and a whiff of a backstop defense that the Board was compelled to take the actions it took because of the Federal Reserve Act of 1913.

According to the authors, it was the Fed’s actions to suppress “speculation” that precipitated the Stock Market Crash of 1929, and it was the Fed’s slavish devotion to the Real Bills Doctrine that allowed the monetary aggregates to subsequently spiral downward, taking the economy with it. But, this story, even if its fixes the blame, might not fully exonerate gold. Historically, the problems of inflation and deflation have usually been associated with war. In this country, the problems of post-war adjustment include the messy resumption that followed the War of 1812, and the “Grow to Gold” policy following the Civil War that involved a protracted period of deflation and a series of financial panics. Following the Great War, subsequently renamed World War I, there was a significant post-war deflation, but prices were stabilized at a level higher than pre-war. A second bout of deflation might have been necessary or perhaps there was a more creative solution. As other nations sought to return to the Gold Standard, something was going to have to give. The unfinished job of post-war adjustment didn’t mean, however, that we were condemned to the utter calamity that was the Great Depression.

Clifford F. Thies is the Eldon R. Lindsey Chair of Free Enterprise and Professor of Economics and Finance at Shenandoah University. He has recently written on debt repudiation by Mississippi (The Independent Review).

Copyright (c) 2019 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 ( Published by EH.Net (October 2019). All EH.Net reviews are archived at

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):19th Century
20th Century: Pre WWII

The Second Bank of the United States: “Central” Banker in an Era of Nation-Building, 1816-1836

Author(s):Knodell, Jane Ellen
Reviewer(s):Brennecke, Claire

Published by EH.Net (May 2018)

Jane Ellen Knodell, The Second Bank of the United States: “Central” Banker in an Era of Nation-Building, 1816-1836. New York: Routledge, 2017. xiii + 188 pp. $110 (hardback), ISBN: 978-1-138-78662-2.

Reviewed for EH.Net by Claire Brennecke, Federal Deposit Insurance Corporation.

Many economic historians have analyzed the Second Bank of the United States through the lens of modern central banking. In The Second Bank of the United States: ‘Central’ Banker in an Era of Nation-Building, 1816-1836, Jane Knodell builds on this literature with a unique and nuanced view of the institution. Knodell argues that the Second Bank of the United States did not act as a modern central bank, as it did not provide services to state banks: the Bank did not act as a lender of last resort or issue high powered money for state banks to use as a reserve currency. But neither was the Bank purely a profit-maximizing commercial bank. The Bank acted in the national interest when it took on the role of a fiscal agent for the federal government and when it maintained monetary stability through specie market operations. Knodell draws on a variety of sources to present this case including contemporary accounts, state bank balance sheet data, and Second Bank branch geography.

Knodell begins, in the second chapter, by pointing out that the Second Bank was never intended to explicitly support state banks. Congress chartered the Bank to address specific challenges that the United States government faced in the early nineteenth century. The federal government was more concerned with the possibility of a public finance crisis rather than a banking crisis. The Second Bank was founded in order to create a uniform currency for the national government and transfer public funds around the country. The Bank placed many of its branches to help achieve this goal, as well as placing branches to provide a place to deposit custom duties. It also exploited its monopoly on interstate branching to profit by placing other branches in locations with few state banks and more growth potential.

Modern central banks produce monetary stability in part by issuing high-powered money for commercial banks to use as reserves and by acting as a lender of last resort (LOLR) for banks. Knodell uses state bank balance sheet data to show that those banks never considered Second Bank notes high-powered money. Moreover, the Bank did not even allow state banks to use the Second Bank’s large-denomination notes for interbank payments (p. 104). Neither did the Second Bank create stability by acting as a LOLR to state banks during the crisis of 1825-26.

However, the Second Bank did act to create monetary stability in ways possibly unfamiliar to scholars of modern central banking. Primarily, the Bank managed the monetary system through specie market operations. As discussed in Chapter 4, the Bank accumulated significant specie reserves through its trade in the domestic and foreign bills of exchange markets. These specie reserves allowed the Bank to conduct specie market operations that stabilized the money markets and suppressed private arbitrage. Through these operations, the Bank both earned profit and acted in the national interest.

In this book, Knodell makes a convincing case that the Second Bank of the United States was neither a conventional modern central bank nor a purely profit-motivated commercial bank. Furthermore, she makes excellent use of a variety of data sources to clearly lay out her argument. However, she misses an opportunity to discuss what the history of the Second Bank can tell us about a) the purpose of a central bank and b) the American economy in the early nineteenth century. Modern central banks affect the economy primarily through their interactions with commercial banks. However, the importance of a central bank comes from its impact on the economy, not the specific policies. The book could have gone further to consider how the Second Bank compares to modern central banks in its motives rather than just its policies. Furthermore, the policies of the Bank were specific to the early nineteenth century U.S. economy. The book could have explored what these policies reveal about how the economy functioned historically relative to how it does today. For example, the Second Bank arguably did create high-powered money for merchants even if it did not do so for banks, and so provided a useful service in creating currency for exchange. The Bank allowed non-bank members of the public, but not banks, to redeem notes for specie at par at all bank branches (p. 127). The book could have discussed the goal of the policy, what that goal tells us about central banking, and what the decision to use this policy to achieve that goal tells us about the broader economy. Overall, this book is an important contribution to the understanding of the Second Bank of the United States and an excellent point of reference for scholars of early American economic and political history.

Claire Brennecke is a financial economist with the Federal Deposit Insurance Corporation. Any opinions, findings, conclusions, and recommendations expressed above are those of the author and do not necessarily reflect the views of the Federal Deposit Insurance Corporation. She is the author of “Information Acquisition in Antebellum U.S. Credit Markets: Evidence from Nineteenth-Century Credit Reports,” FDIC Center for Financial Research Working Paper No. 2016-04.

Copyright (c) 2018 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 ( Published by EH.Net (May 2018). All EH.Net reviews are archived at

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):19th Century