Michael D. Bordo

We evaluate the decentralized structure of the Federal Reserve System as a mechanism for generating and processing new ideas on monetary policy over the 1960 - 2000 period. We document the introduction of monetarism, rational expectations, credibility, transparency, and other monetary policy ideas by Reserve Banks into the Federal Reserve System. We argue that the Reserve Banks were willing to support and develop new ideas due to internal reforms to the FOMC that Chairman William McChesney Martin implemented in the 1950s and the increased ties with academia that developed in this period. Furthermore, the Reserve Banks were able to succeed at this because of their private-public governance structure. We illustrate this with a time-consistency model in which a decentralized organization is better at producing new ideas than a centralized one. We argue that this role of the Reserve Banks is an important benefit of the Federal Reserve’s decentralized structure by allowing for more competition in formulating ideas and by reducing groupthink.

This essay was written in memory of Marvin Goodfriend for a Federal Reserve Bank of Richmond book called Essays in Honor of Marvin Goodfriend: Economist and Central Banker. We discuss his Carnegie-Rochester conference paper titled "The Role of a Regional Bank in a System of Central Banks." In that paper, Marvin argued that the Federal Reserve's decentralized structure allowed for competing ideas about monetary and banking policy to develop with the central bank. In our essay, we describe how Marvin demonstrated this argument during his long career at the Federal Reserve Bank of Richmond. We also describe the institutional developments that led to this competition, including reforms that Chairman William McChesney Martin made to the operation of the Federal Open Market Committee in the 1950s and the introduction of monetary policy ideas such as monetarism and rational expectations by the Reserve Banks.

Does the yield curve's ability to predict future output and recessions differ when interest rates and inflation are low, as in the current global environment? We explore the issue using historical data going back to the 19th century for the US. This paper is similar in spirit to Ramey and Zubairy (2018), who look at the government spending multiplier in times of low interest rates. If anything, the yield curve tends to predict output growth better in low interest rate environments, though this result is stronger for RGDP than for IP.

Does the yield curve’s ability to predict future output and recessions differ when interest rates are low, as in the current global environment? In this paper we build on recent econometric work by Shi, Phillips, and Hurn that detects changes in the causal impact of the yield curve and relate that to the level of interest rates. We explore the issue using historical data going back to the 19th century for the United States and more recent data for the United Kingdom, Germany, and Japan. This paper is similar in spirit to Ramey and Zubairy (2018), who look at the government spending multiplier in times of low interest rates.

The decentralized structure of the Federal Reserve System is evaluated as a mechanism for generating and processing new ideas on monetary and financial policy. The role of the Reserve Banks starting in the 1960s is emphasized. The introduction of monetarism in the 1960s, rational expectations in the 1970s, credibility in the 1980s, transparency, and other monetary policy ideas by Reserve Banks into the Federal Reserve System is documented. Contributions by Reserve Banks to policy on bank structure, bank regulation, and lender of last resort are also discussed. We argue that the Reserve Banks were willing to support and develop new ideas due to internal reforms to the FOMC that Chairman William McChesney Martin implemented in the 1950s. Furthermore, the Reserve Banks were able to succeed at this because of their private-public governance structure, a structure set up in 1913 for a highly decentralized Federal Reserve System, but which survived the centralization of the System in the Banking Act of 1935. We argue that this role of the Reserve Banks is an important benefit of the Federal Reserve’s decentralized structure and contributes to better policy by allowing for more competition in ideas and reducing groupthink.

In this paper, we describe the evolution of the Federal Reserve’s swap lines from their inception in 1962 as a mechanism to forestall claims on US gold reserves under Bretton Woods to their use during the Great Recession as a means of extending emergency dollar liquidity. We describe the Federal Reserve’s successes and failures. We argue that swaps calm crisis situations by both supplementing foreign countries’ dollar reserves and by signaling central-bank cooperation. We show how swaps exposed the Federal Reserve to conditionality and raised fears that they bypassed the Congressional appropriations process.

During the Bretton Woods era, balance-of-payments developments, gold losses, and exchange rate concerns had little influence on Federal Reserve monetary policy, even after 1958 when such issues became critical. The Federal Reserve could largely disregard international considerations because the U.S. Treasury instituted a number of stop-gap devices—the gold pool, the general agreement to borrow, capital restraints, sterilized foreign-exchange operations—to shore up the dollar and Bretton Woods. These, however, gave Federal Reserve policymakers the latitude to focus on domestic objectives and shifted responsibility for international developments to the Treasury. Removing the pressure of international considerations from Federal Reserve policy decisions made it easier for the Federal Reserve to pursue the inflationary policies of the late 1960s and 1970s that ultimately destroyed Bretton Woods. In the end, the Treasury’s stop-gap devices, which were intended to support Bretton Woods, contributed to its demise.

This paper describes the United States’ first line of defense against shortcomings in the Bretton Woods system, which threatened the system’s continuation as early as 1960.

If official interventions convey private information useful for price discovery in foreign-exchange markets, then they should have value as a forecast of near-term exchange-rate movements.

Do steep recoveries follow deep recessions? Does it matter if a credit crunch or banking panic accompanies the recession? Moreover, does it matter if the recession is associated with a housing bust?

Foreign-exchange operations did not end after the United States stopped its activist approach to intervention. Japan persisted in such operations, but avoided overt conflict with its monetary policy. With the onset of the Great Recession, Switzerland has transacted in foreign exchange both for monetary and exchange-rate purposes, and key central banks have used swap facilities to extended their lender-of-last-resort functions. Developing and emerging-market economies continue to intervene, but their actions may hamper the development of their own foreign-exchange markets. China’s undervalued exchange rate is producing inflation and real appreciation, despite China’s efforts to sterilize its reserve accumulation.

The United States all but abandoned its foreign-exchange-market intervention operations in late 1995, when they proved corrosive to the credibility of the Federal Reserve's commitment to price stability. We view this decision as the culmination of the evolution of U.S. monetary policy over the past century from a gold standard to a fiat money regime. The abandonment of intervention was necessary to secure monetary policy credibility.

If official interventions convey private information useful for price discovery in foreign-exchange markets, then they should have value as a forecast of near-term exchange-rate movements. Using a set of standard criteria, we show that approximately 60 percent of all U.S. foreign-exchange interventions between 1973 and 1995 were successful in this sense. This percentage, however, is no better than random. U.S. intervention sales and purchases of foreign exchange were incapable of forecasting dollar appreciations or depreciations. U.S. interventions, however, were associated with more moderate dollar movements in a manner consistent with leaning against the wind, but only about 22 percent of all U.S. interventions conformed to this pattern. We also found that the larger the size of an intervention, the greater was its probability of success, although some interventions were inefficiently large. Other potential characteristics of intervention, notably coordination and secrecy, did not seem to influence our success rates.

Attitudes about foreign-exchange-market intervention in the United States evolved in tandem with views about monetary policy as policy makers grappled with the perennial problem of having more economic objectives than independent instruments with which to achieve them. This paper—the introductory chapter to our history of U.S. foreign exchange market intervention—explains this thesis and summarizes our conclusion: The Federal Reserve abandoned frequent foreign-exchange-market intervention because, rather than providing a solution to the instruments-versus-objectives problem, it interfered with the Federal Reserve’s ability to credibly commit to low and stable inflation. This chapter also provides a theoretical discussion of intervention, background on U.S. institutions for conducting intervention, and a roadmap to the remainder of our book.

By the early 1960s, outstanding U.S. dollar liabilities began to exceed the U.S. gold stock, suggesting that the United States could not completely maintain its pledge to convert dollars into gold at the official price. This raised uncertainty about the Bretton Woods parity grid, and speculation seemed to grow. In response, the Federal Reserve instituted a series of swap lines to provide central banks with cover for unwanted, but temporary accumulations of dollars and to provide foreign central banks with dollar funds to finance their own interventions. The Treasury also began intervening in the market. The operations often forestalled gold losses, but in so doing, delayed the need to solve Bretton Woods’ fundamental underlying problems. In addition, the institutional arrangements forged between the Federal Reserve and the U.S. Treasury raised important questions bearing on Federal Reserve independence.

The dollar’s depreciation during the early floating rate period, 1973–1981, was a symptom of the Great Inflation. In that environment, sterilized foreign exchange interventions were ineffective in halting the dollar’s decline, but they showed a limited ability to smooth dollar movements. Only after the Volcker FOMC changed its monetary-policy approach and demonstrated a willingness to maintain a disinflationary stance despite severe economic weakness and high unemployment did the dollar begin a sustained appreciation. Also contributing to the ineffectiveness of the interventions was the Desk’s method of operation. The small, covert interventions, particularly prior to 1977, seemed inconsistent with an expectations channel of influence, and financing intervention with short-term borrowed funds seemed inconsistent with a portfolio-balance channel of influence. The Desk never clearly articulated an intervention transmission mechanism. The episode indicated the shortcomings of sterilized intervention and led to their cessation in April 1981.

The Federal Reserve abandoned foreign-exchange-market intervention because it conflicted with the System’s commitment to price stability. By the early 1980s, economists generally concluded that, absent a portfolio-balance channel, sterilized foreign-exchange-market intervention did not provide central banks with a mechanism for systematically influencing exchange rates independent of their monetary policies. If intervention were to have anything other than a fleeting, hit-or-miss effect on exchange rates, monetary policy had to support it. Exchange rates, however, often responded to U.S. monetary-policy initiatives, so intervention to offset or reverse those exchange-rate responses can seem a contrary policy move and can create uncertainty about the strength of the System’s commitment to price stability. That the U.S. Treasury maintained primary responsibility for foreign-exchange intervention only compounded this uncertainty. In addition, many FOMC participants feared that swap drawings and warehousing could contravene the Congressional appropriations process and, therefore, potentially pose a threat to System independence, a necessary condition for monetary-policy credibility.

The relatively infrequent nature of major credit distress events makes a historical approach particularly useful.

Using the yield curve helps forecast real growth over the period 1875 to 1997. Using both the level and slope of the curve improves forecasts more than using either variable alone.

The deterioration in the U.S. balance of payments after 1957 and an accelerating loss of gold reserves prompted U.S. monetary authorities to undertake foreign-exchange-market interventions beginning in 1961. We discuss the events leading up to these interventions, the institutional arrangements developed for that purpose, and the controversies that ensued. Although these interventions forestalled a loss of U.S. gold reserves, in the end, they only delayed more fundamental adjustments and, in that respect, were a failure.

This paper brings historical evidence to bear on the stylized fact that the yield curve predicts future growth.

In this paper, we show that the monetary rule followed by a number of key countries before 1914 represented a commitment technology preventing the monetary authorities from changing planned future policy.

A central bank is the term used to describe the authority responsible for policies that affect a country’s supply of money and credit.

Across America, schools are embarking on grand experiments to improve educational outcomes. At the same time, economists are examining what works and what doesn't. The latest issue of Forefront takes an illustrated look at some of the myriad reforms happening in Anytown, USA.