Yesterday, we alluded to trading floor buzz about a research paper by Julio Rotemberg, titled "Penitence after accusations of error: 100 Years of Monetary Policy at the U.S. Federal Reserve". We noted it was one of a series of papers presented at an NBER symposium on “The First Hundred Years of the Federal Reserve: The Policy Record, Lessons Learned, and Prospects for the Future”.
While Mr. Rotemberg's opus is primarily directed at academics, it does provide insights about how the Fed stumbled through the evolution of central banking in the U.S.
One of its earliest concerns after its founding was to prevent inflation from exploding after World War I as many had expected. Other than that it saw its purpose as aiding only solid normal growth in the economy. As Rotemberg notes "The Tenth Annual Report of the Federal Reserve Board said that the Fed was supposed to extend credit only for “productive” and not for “speculative” purposes."
Ironically, less than a year later, the Fed noticed that some loans were being diverted to "securities purchases". (Egad! Speculation.) So, in 1925, they began to tighten. The economy slowed a bit but nothing painful. So far, so good. By 1927, the aptly named Benjamin Strong (New York Fed President) successfully pressed for a policy of ease. It was widely assumed that Strong had hoped to create a climate to assist Britain and its struggles with the gold standard. The regional presidents rebelled, sensing some of the new money was moving into the stock market and other speculations. Strong then strong-armed them, however, and thus the New York Fed became the key voice in the system.