Published by EH.NET (July 2007)

Roger W. Spencer and John H. Huston, The Federal Reserve and the Bull Markets: From Benjamin Strong to Alan Greenspan. Lewiston, NY: Edwin Mellen Press, 2006. x + 251 pp. $110 (cloth), ISBN: 0-7734-5784-3.

Reviewed for EH.NET by Gary J. Santoni, Department of Economics, Ball State University.

This book by Roger Spencer and John Huston examines the relationship of Federal Reserve policy to stock market activity by focusing on the monetary policy responses of Benjamin Strong, William McChesney Martin Jr. and Alan Greenspan to the three major bull markets that occurred during their respective tenures as leaders of the Federal Reserve. The authors devote three chapters to discussions of each of these Fed officials and the bull markets they struggled with. A fourth chapter presents an empirical evaluation of the Fed’s policy response to heated stock market activity.

This is an interesting book. It begins with a very informative discussion of the relationship between the twelve district Federal Reserve Banks (particularly, the New York district bank), the Washington Federal Reserve Board and the U.S. Treasury during the Fed’s formative years. It discusses the various roles played by Carter Glass as author of the legislation that formed the Fed and his service as Secretary of the Treasury and (at the same time) member of the Washington Federal Reserve Board. The discussion presents a rather detailed account of the clashes of personalities and the different views of Glass, Strong (president of the New York Fed) and William Harding (president of the Washington Board) regarding Fed independence, the appropriate tools of policy, their application and, in particular, the role of the Fed in controlling speculative activity in the stock market. The discussion is lively and extensive excerpts from personal letters give the reader a real feel for the personalities and motives of the main characters.

A particularly illuminating example of the above is found in an excerpt from a letter to Senator Elihu Root from Benjamin Strong. In it Strong observes, “In their great desire to lay all of the troubles and fancied troubles of this country to the New York Stock Exchange, some of our legislators go to such length that it makes it difficult to decide where ignorance leaves off and willful misunderstanding begins.” I suspect there are relatively few present day Fed officials who come away from a Congressional hearing without similar thoughts. Financial arrangements and markets have evolved considerably since 1914 but the changes have apparently done little to alter the strife between these markets and some of those who occupy the political arena.

While this book studies the influence of stock market activity on the policy actions implemented by the Federal Reserve, the authors point out that each of their three principle characters (Strong, Martin and Greenspan) believed the Fed’s policy instruments to be ill suited to regulating prices in equity markets. Greenspan, for example, argued that the Fed can only check a bull market by rationing “credit severely enough to paralyze business itself.” Strong’s view was similar suggesting that if the Fed forced interest rates up to curb speculation it could penalize the entire country by slowing economic growth. Consequently, it may be better to simply allow speculators to suffer the ultimate consequences of their own excesses. To do otherwise, according to Strong, would result in a degeneration of Fed policy actions to those of “regulating the affairs of gamblers.”

Greenspan went even further in his critique of the use of monetary policy to curb speculative activity in a frothy market. Not only are the Fed’s tools too blunt to stem this activity without having unintended consequences, it is difficult to identify bubbles before they crash. Greenspan suggested that, “There is a fundamental problem with market intervention (on the part of the Fed). It presumes that you know more than the market. … This raises some fascinating questions about what our authority is and who makes the judgment that there actually is a bubble.” Later, in a speech given in 1996, he asked, “But how would we know when irrational exuberance has unduly escalated asset values …” (emphasis added).

Despite their reservations, each of the three attempted to tame the bull markets that arose during their tenures. Each failed. The markets crashed and the monetary policies that were intended to prick the bubbles contributed to the following decline in business activity in general.

The book does not tell us why these Fed leaders ignored their better instincts to become involved in attempts to regulate stock prices. That is disappointing. In fairness, Spencer and Huston do not completely buy the argument regarding the difficulty in detecting bubbles in equity prices, so, perhaps, they are more willing to accept the Fed’s intervention in these instances without question.

On the whole, this is a very enjoyable and informative book. I recommend it to those interested in the evolution of Fed independence, the development of its policy tools, and particularly, the role of the Fed in controlling speculative activity in the stock market.

Gary Santoni is an Emeritus Professor of Economics at Ball State University. His recent research is on federal regulation of securities markets and stock returns.