Fisher testified at length, explaining the proposal, the benefits of the standard, and the advantages of price stability. He lectured on the differences between nominal and real interest rates and the effect of inflation on nominal rates, a topic that does not appear in Federal Reserve discussions for the next forty or fifty years (House Committee on Banking and Currency 1922–23, 13–14).73
71. Berg and Jonung (1998) report on the successful efforts of the Swedish Riksbank to stabilize the price level after 1931 using a price level rule.
72. Legislation passed the House in 1932 by a vote of 289 to 60 but was defeated in the Senate, owing largely to opposition by Carter Glass. The Federal Reserve opposed the bill.
73. E. W. Kemmerer, John Bates Clark, Henry Wallace, and many others testified for the proposal.
The witnesses who criticized the proposal emphasized the uncertainty and unreliability of price index numbers. Federal Reserve officials did not testify at these hearings. At the time they had not formulated either the Riefler-Burgess doctrine or the policy statement in the tenth annual report. The hearings forced them to recognize the need for publicly stated guides or policy indicators to replace the gold reserve ratio.
Soon after the congressional hearings ended, the governors discussed a proposal by Professor Charles Bullock of Harvard that they announce the factors affecting discount rate changes. Anticipating later arguments about the importance of credibility, Bullock argued that the announcement would benefit businesses by letting them know how the discount rate would change in the near term. The statement would not be a precise rule, but it would require the System to name the factors that replaced the gold reserve ratio as an indicator of policy action.
Case, who substituted for Strong at the meeting, favored the proposal. He listed the main factors: the volume of credit relative to production, interest rates on various classes of paper, and gold movements. Most others opposed. Governor Seay (Richmond) expressed the dominant (and classic) view: “It is never the custom. . . for central banks to give out to the public their reasons for raising rates” (Governors Conference, March 1923, 46).
Nothing more was done until Congress called for hearings on stabilization policy in 1926–27 and 1928 to discuss an amendment to the Federal Reserve Act making price stability an explicit policy goal. The proposed legislation in 1926 added the words “promoting a stable price level for commodities in general” to section 14 of the act. The resolution also amended the purposes of the act by adding: “All the powers of the Federal Reserve System shall be used for promoting stability in the price level” (House Committee on Banking and Currency 1926).
The legislation was the work of Congressman James Strong, a Kansas Republican, who was influenced both by the events of 1920–21 and by Fisher’s work.74 In addition to Congressman Strong, members of the House Banking Committee included eight Democrats, five from cotton-growing states, and thirteen Republicans, about half from other heavily agricultural states. Their presence on the committee contributed to the wariness with which Federal Reserve officials considered the legislation.75
74. Congressman James A. Strong was not related to Governor Benjamin Strong. I will refer to the congressman as Strong (Kansas) when needed to avoid confusion. The wording of the mandate changed many times to respond to objections from Federal Reserve officials and others.
75. Cotton was by far the most important export crop at the time. In most years the value of cotton exports exceeded the combined value of the next four or five export items. The System was concerned that it would be expected to stabilize the prices of individual commodities, especially cotton.
The bill generated unanimity within the Federal Reserve on the need to avoid any “mechanical formula” for setting policy and on the inapplicability of the quantity equation as a guide to price stability. Beyond that, there was not much agreement about how policy should be conducted. Although the spokesmen for the Board and the reserve banks opposed the bill, their reasons differed in several ways.
Strong’s Testimony
Governor Strong gave three main reasons for opposing the Strong bill. First, the mandate was difficult to carry out precisely because monetary velocity was unstable. The price level depended on velocity, and velocity depended on confidence or, in modern terms, anticipations (House Committee on Banking and Currency 1926, 482).76 Second, changes in money, or credit, were one of many factors affecting the price level.77 Third, as noted, he feared that price stability would be interpreted as the stability of individual prices, particularly agricultural prices: “Much of the discussion of prices recently has arisen from the great misfortune which the farmers of the country have suffered, which we all recognize and deplore. If the Federal Reserve Act is amended in these words, is it possible that the farmers of the country will be advised, or will be led to believe upon reading it, that a mandate has been handed to the Federal Reserve System to fix up the matter of farm prices?” (House Committee on Banking and Currency 1926, 293).
76. Strong had written many of the same objections to Professor Bullock in 1923. His first objection criticized “quantity theory extremists,” by which he almost certainly meant to include Fisher (Chandler 1958, 203–5).
77. “Mr. Goldsborough: . . . You [Strong] have said that the Federal Reserve System, by its open market operations and by changes in the discount rate, would influence the supply of credit, which, of course, influences the price level. Now, that being so, what is the objection to a general direction of the Federal Reserve System to use such powers as it has for the purpose of stabilizing the general price level? That is certainly one question in which the committee is deeply interested. Governor Strong: It might be possible, Mr. Goldsborough, to frame some language as an amendment to the act . . . that would safeguard the system against misinterpretation of the intention of that declaration. . . . [I]t certainly would need to contain the limitation, or the recognition of the fact, that credit alone does not control prices. Mr. Goldsborough: Is not that generally understood? Do you not think that is generally understood? . . . Governor Strong: No. If I felt so, I would not feel as strongly as I do about this amendment, which I would fear on that account principally” (House Committee on Banking and Currency 1926, 299). Goldsborough persisted, citing evidence from farm publications. Strong responded by citing the blame heaped on Federal Reserve policy for agricultural problems in 1920–21. This was a non sequitur. The Federal Reserve had contributed to the problems, but Goldsborough did not make that point.
A member of the committee reminded Strong that the bill referred to the price level, not prices in general. Strong was not persuaded. He doubted that noneconomists would recognize the distinction (ibid., 293).
Strong used the opportunity to cite the accomplishments of the Federal Reserve System and to criticize the real bills doctrine as a guide to policy. Using charts to drive home his points, Strong pointed out that the System had eliminated seasonal swings in interest rates, reduced the spread in rates between New York and Chicago (and by inference the spread with other regions) and between different maturities of commercial paper, and lowered the amplitude of interest rate fluctuations (ibid., 426).
The real bills doctrine offered no guidance. He insisted, repeatedly, that the Federal Reserve could control the quantity of credit, not the type of credit outstanding. Asked by a congressman whether the Federal Reserve could direct the way credit was used, Strong replied: “We have no power to do that” (ibid., 260).78
Although Strong opposed the bill, he favored the principle that the bill represented. His testimony included several offers to help the committee redraft the bill and remove his objections, despite his conviction that the legislation was unnecessary (see, inter alia, House Committee on Banking and Currency 1926, 517–18). He told the committee that restoring the international gold standard was a better solution to the problem that concerned them: “I earnestly believe that the greatest service that the Federal Reserve System is capable of performing today in this matter, is
to hasten. . . monetary reform in the countries that have suffered from the war. We can not do it until the time is ripe, and the conditions are favorable in each country” (518).79
78. In contrast to Miller’s testimony (see below), Strong described the Board as solely a supervisory body. Operations were conducted “in cooperation with the Board, and subject to their review.” “Policy results from the discussions and recommendations that are made by the operating officials of the banks; that would necessarily be so.” Strong recognized a change in his own views: “I believe in this regional system. . . . Textbook knowledge had always led me to believe that a central bank was the proper thing. This system suits the needs and feelings of the country much better socially, politically, and in every way.” Then he warned: “The danger in a regional system might be that if each Reserve bank goes its own way, the system as a system would have no policy” (House Committee on Banking and Currency 1926, 341).
79. The gold standard also removed power over the price level from central banks and governments: “When you speak of a gold standard, you are speaking of something where the limitation upon judgment is very exact and precise and the penalty for bad judgment is immediate” (House Committee on Banking and Currency 1926, 295). Like many of his contemporaries, Strong did not recognize that the gold standard did not guarantee a stable long-run price level.
Miller’s Testimony
Miller’s testimony differed markedly from Strong’s. He emphasized accommodating the needs of commerce and preventing speculative uses of credit. He rejected the price level as a policy objective, and he used the opportunity to urge Congress to increase the authority of the Federal Reserve Board over credit decisions. Where Strong, the practical banker, looked for principles to guide policy, Miller, the trained economist, came close to denying that such principles existed.
Miller’s response to the central issue before the committee used a quotation from the Board’s tenth annual report: “No credit system could undertake to perform the function of regulating credit by reference to prices without failing in the endeavor” (House Committee on Banking and Currency 1926, 634). The reason he gave was that the price index records an “accomplished fact.” Credit administration could be based only on judgment. He quoted from the tenth annual report on the role of judgment and the importance of judging each set of circumstances separately:
The Chairman: You [the Federal Reserve] have not, I understand from what you have just said, a definite plan on which you work in dealing with the question of stabilization?
Doctor Miller: We have nothing with reference to stabilization of prices as such.
The Chairman: You deal with the situation as the conditions are presented to you? Doctor Miller: We deal with the credit situation.
The Chairman: And there is a good bit of human equation there in dealing with the subject, is there not?
Doctor Miller: Yes. . . . I think it is important to realize that no two situations are identical. They do not repeat themselves with such accuracy that the method by which you successfully deal with one situation will insure an equally satisfactory result in another situation. (Ibid., 636)
Asked for what end the System regulated credit, Miller replied: “To the end of ‘accommodating commerce and business’ as the act instructs” (ibid., 637). How did it decide when to act? “I should say, gentlemen, that action by the Federal Reserve Board usually lies midway between a deliberate or calculated action, such as is taken with full appreciation of the consequences, and what you may call unconscious action. I could not undertake to give any clear definition of just what considerations move my colleagues from time to time” (647).
Miller, like Strong, argued that restoring the international gold standard would restore price stability.80 But he saw risks in restoring the gold standard that Strong neglected. The principal risk he cited was that the demand for gold by countries restoring gold convertibility could cause a worldwide tightening of credit. Miller compared the current period to the years 1870 to 1880, when many governments restored or joined the gold standard. He concluded: “While the gold standard had very much of the quality of an automatic regulator before the war, it would never do to trust purely and in all situations to devices automatic or quasi automatic in their qualities” (ibid., 695). Miller thought that the price index was the wrong target. Price increases came late.
To the extent that the Federal Reserve System can do something useful and constructive . . . , it has got to have a far more competent guide than the price index offers. . . .
Assuming that we want price stability—I prefer to put it as I have already put it, economic stability with price stability as a concomitant or resultant of that—in order to obtain it we have to look at things closer to the source or beginning of troubles than the price index. . . .
If you are to have competent control of credit, you cannot wait until inflationary developments register themselves in the price index. By that time the thing will have already gotten considerable momentum. (Ibid., 837–38)
Controlling inflation did not depend on the quantity of money or credit. Miller’s remarks on expectations and speculation paralleled many statements by Latin American officials and economists in the inflating economies of the 1970s and 1980s. Inflation was a “vague term” without “precise or generally accepted meaning.” He discussed one type of inflation, inflation due to rising expectations. Businessmen observed “a disturbance in the market for a commodity or group of commodities. . . . You have an inflated state of commercial expectation that leads men to make plans and conceive projects and then make commitments and then, only after a lapse of considerable interval, does [the] thing [inflation] show itself in the form of a demand for increased credit. . . . By that time the thing will have already gotten considerable momentum” (ibid., 838).
Miller had rejected the quantity theory in the tenth annual report. In the 1928 hearings on a revised version of the Strong (Kansas) bill, Miller rejected the theory because it had two incorrect assumptions: “Changes in the level of prices are caused by changes in the volume of credit and currency; . . . [And] changes in the volume of credit and currency are caused by Federal Reserve policy. Neither one of those assumptions is true of the facts or the realities” (House Committee on Banking and Currency 1928, 109).
80. “It will not be a great while before we shall see restored this condition of price stability that was insured to the commercial world before the outbreak of the great war, under the operation of the gold standard” (House Committee on Banking and Currency 1926, 694).
Later, returning to the role of money, Miller explained the irrelevance of the money stock in words that Federal Reserve officials repeated many times in the next fifty years: “The total volume of money in circulation is determined by the community. The Federal Reserve System has no appreciable control over that and no disposition to interfere with it” (ibid., 180).
For Miller, the way to provide economic and price stability was to prevent speculation based on credit. The Federal Reserve must “stop and absolutely foreclose the diversion of any Federal Reserve credit to speculative purposes” (ibid., 671).
Miller used the two hearings to comment on his colleagues, the role of the Board, policy in 1927, and the role of open market operations. Unlike Strong and the reserve bank governors, he claimed not to fear political influence on the Federal Reserve Board. Washington was the right place for the Board. The threat to good Federal Reserve policy came from bankers, not politicians: “The atmosphere of Washington keeps an administrative body on its feet, keeps them alert. . . I am not at all afraid of politics getting into the Federal Reserve Board because the Federal Reserve Board has its headquarters in Washington. I would be afraid of banking and financial interests getting undue preponderance in the deliberations of the board if the board were located in one of our great financial cities” (House Committee on Banking and Currency 1926, 727).81
Miller urged the committee to strengthen the Board’s role in policym
aking, especially over open market operations (ibid., 678–79, 865–66). To strengthen his case, he criticized Strong’s 1927 open market purchases and blamed the policy for stock exchange speculation, neglecting to note that he had voted for the policy: “The money that was released by the Federal Reserve banks to the market through its policy of open market purchases had to go somewhere. . . . [T]he low money rates that resulted from Federal Reserve policy, in the light of subsequent developments, appear to have been particularly effective in stimulating the absorption of credit in stock speculation” (House Committee on Banking and Currency 1928, 172).
Earlier in the hearings he had urged a return to reliance on the discount rate as the principal policy instrument: “I am of the opinion that open-market operations have been the cause of almost as much mischief in credit and economic situations as of good” (ibid., 125).
81. The context makes it difficult to judge whether this statement was a reflection of Miller’s beliefs or a pandering to southern and western congressmen with their traditional fear of “Wall Street.” Perhaps both.
A History of the Federal Reserve, Volume 1 Page 28
