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Monetary Politics: Origins of the Federal Reserve*

Published online by Cambridge University Press:  18 February 2013

Sarah Binder  and
Mark Spindel
Sarah Binder*
Affiliation:
George Washington University and the Brookings Institution
Mark Spindel
Affiliation:
Potomac River Capital, LLC
*
binder@gwu.edu
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Abstract

Nearly unique amongst the world's monetary bodies, the Federal Reserve defies description as a central bank. A century after its creation, the Fed retains a hybrid structure of a president-appointed, Senate-confirmed Washington board and twelve largely privately directed regional reserve banks—each of which remains moored in the cities originally selected in 1914. In this article we investigate the origins of the Federal Reserve System, focusing on the selection of the twelve reserve bank cities. In contrast to accounts that suggest politics played no role in the selection of the cities, we suggest that a range of political interests shaped Democrats' choices in designing the reserve system. The result was a decentralized institution that initially proved unable to coordinate monetary policy—a key contributor to the onset of the Great Depression less than two decades later.

Type
Research Article
Information
Studies in American Political Development , Volume 27 , Issue 1 , April 2013 , pp. 1 - 13
Copyright
Copyright © Cambridge University Press 2013

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Footnotes

*

We thank Justin Buchler, Eric Lawrence, Forrest Maltzman, NolanMcCarty, and seminar participants at the University of Georgia, Texas A&M, Yale, Columbia, and the 2011 Congress & History Conference for helpful comments and advice.

References

1. See, for example, Maxfield, Sylvia, Gatekeepers of Growth: The International Policy Economy of Central Banking in Developing Countries (Princeton, NJ: Princeton University Press, 1997)Google Scholar, and Broz, J. Lawrence, The International Origins of the Federal Reserve System (Ithaca, NY: Cornell University Press, 1997)Google Scholar.

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6. Reserve bank power stemmed from the banks' willingness to initiate their own monetary policies and from disagreements among members of the Federal Reserve Board about whether the Board had authority to initiate its own open-market operations or changes in the regional discount rates. See Wheelock, David, Strategy and Consistency of Federal Reserve Monetary Policy (Cambridge, New York: Cambridge University Press, 1991), 68–70Google Scholar.

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8. See Richardson, Gary and Troost, William, “Monetary Intervention Mitigated Banking Panics During the Great Depression: Quasi-Experimental Evidence from a Federal Reserve District Border, 1929–1933,” Journal of Political Economy 117 (2009): 1031–73CrossRefGoogle Scholar.

9. The conflicts are reviewed in Jeong, Miller, and Sobel, “Political Compromise and Bureaucratic Structure.”

10. See in particular, Sanders, Elizabeth, Roots of Reform: Farmers, Workers, and the American State 1877–1917 (Chicago, IL: University of Chicago Press, 1999)Google Scholar and Jeong, Miller, and Sobel, “Political Compromise and Bureaucratic Structure.”

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12. As quoted in Clarence W. Nelson, “Defining the Districts: Where to Draw the Lines,” February 1973, http://www.minneapolisfed.org/about/role/history/reflect2.cfm (accessed January 13, 2013).

13. See Jeong, Miller, and Sobel, “Political Compromise and Bureaucratic Structure.”

14. On the procedural steps that brought two versions of the bill to the floor, see “Senate to Tackle Three Money Bills,” New York Times, November 21, 1913, p. 13.

15. Despite the binding vote in the Democratic Caucus, two Democrats defected to support Hitchcock's alternative. See “Senators Waver on Currency Bill,” New York Times, November 28, 1913, p. 16.

16. “Wilson Is Blamed for Currency Halt,” New York Times, November 11, 1913, p. 3.

17. We consider the eighteen legislators (including eight Republicans) who voted for Victor Murdock (Progressive-KS) for Speaker in 1913 as Progressives (of whom fifteen cast a vote on the final conference report establishing the Fed).

18. See, for example, Timberlake, Monetary Policy in the United States, and Jeong, Miller, and Sobel, “Political Compromise and Bureaucratic Structure.”

19. Houston, David F., Eight Years with Wilson's Cabinet, 1913 to 1920 (Garden City, NY: Doubleday, Page, 1926), 108Google Scholar.

20. See Reserve Bank Organization Committee, “Stenographer's Minutes: Federal Reserve District Divisions and Location of Federal Reserve Banks,” multiple volumes (1914). http://fraser.stlouisfed.org/topics/?tid=14 (accessed January 15, 2013).

21. Reserve Bank Organization Committee, “Stenographer's Minutes,” 1908–1909.

22. Reserve Bank Organization Committee, “Location of Reserve Districts in the United States,” Letter from the Reserve Bank Organization Committee Transmitting the Briefs and Arguments to the Organization Committee of the Federal Reserve Board Relative to the Location of the Federal Reserve Districts (1914), 35. (accessed January 15, 2013). http://fraser.stlouisfed.org/publication/?pid=606

23. The cities' submission materials can be viewed here: Reserve Bank Organization Committee, “Location of Reserve Districts in the United States.”

24. See Bensel, Richard, Sectionalism and American Political Development, 1880–1980 (Madison: University of Wisconsin Press, 1984)Google Scholar, and McAvoy, Michael, “How Were the Federal Reserve Bank Locations Selected?” Explorations in Economic History, 43 (July 2006), 505–26CrossRefGoogle Scholar.

25. See for example, Reserve Bank Organization Committee, “Stenographer's Minutes,” 1.

26. “Affixes His Signature at 6:02 pm, Using Four Gold Pens,” New York Times, December 24, 1913, p. 1.

27. Willis, Henry Parker, The Federal Reserve System (New York: Ronald Press Co., 1923), 586–87Google Scholar.

28. Board of Governors of the Federal Reserve System, Federal Reserve Act, n.d. http://www.federalreserve.gov/aboutthefed/section2.htm (accessed March 27, 2012).

29. A series of reserve banks had been designated in a nineteenth-century national banking system, with a pyramid of small national banks, larger banks in several dozen “reserve cities,” and the largest banks in the initial three “central reserve” cities. With fluctuating demand, but a relatively fixed currency supply, the national banking system proved unable to stem periodic financial panics. For detail, see Bordo, Michael D., Rappoport, Peter, and Schwartz, Anna J., “Money versus Credit Rationing: Evidence for the National Banking Era, 1880–1914,” in Goldin, Claudia and Rockoff, Hugh, eds., Strategic Factors in Nineteenth Century American Economic History (Chicago: University of Chicago Press, 1992)Google Scholar.

30. Preliminary Committee on Organization, “Report to the Reserve Bank Organization Committee,” June 1, 1914, http://fraser.stlouisfed.org/publication-series/?id=609 (accessed January 15, 2013

31. Reserve Bank Organization Committee, “Location of Reserve Districts in the United States,” 31.

32. Knight, Jack, Institutions and Social Conflict (Cambridge, New York: Cambridge University Press, 1992)CrossRefGoogle Scholar.

33. On the financial underdevelopment of the South and the challenges it posed for the placement of the reserve banks, see Odell, Kerry A. and Weiman, David F., “Metropolitan Development, Regional Financial Centers, and the Founding of the Fed in the Lower South,” The Journal of Economic History 58 (March 1998)CrossRefGoogle Scholar.

34. Reserve Bank Organization Committee, “Location of Reserve Districts in the United States,” 118.

35. Ibid., 120.

36. James, Scott C., Parties, Presidents and the State: A Party System Perspective on Democratic Regulatory Choice, 1884–1936 (Cambridge, New York: Cambridge University Press, 2000)CrossRefGoogle Scholar.

37. On insurgent Progressives' antipathy toward the Federal Reserve Act, see Link, Arthur, Woodrow Wilson and the Progressive Era, 1910–1917 (New York: Harper and Brothers, 1954), Chapter 2Google Scholar. See also Ware, Alan, The Democratic Party Heads North, 1877–1962 (Cambridge, New York: Cambridge University Press, 2006), 131–32CrossRefGoogle Scholar, who argues that Wilson reached out to conservative Democrats rather than Progressive Republicans.

38. The Federal Reserve Act allowed for subsequent changes by the Federal Reserve Board to the boundaries of the reserve districts, but did not allow for the creation of new districts once twelve districts had been designated.

39. See Bensel, Sectionalism and American Political Development, 1880–1980.

40. Ibid., 422.

41. For example, the Maryland–New York dyad would be coded “1,” since the RBOC placed a reserve bank in New York; the Maryland–Baltimore dyad would be coded “0,” since the RBOC did not place a reserve bank in Baltimore.

42. Conditional logit models estimate choices among alternatives in groups, conditional on the decision maker selecting at least one from each group of observations. Figure 2, for example, shows the votes of state banker delegations that were ultimately assigned to the Richmond Federal Reserve district: Maryland; Washington, D.C.; Virginia; the Carolinas; and portions of West Virginia. By modeling banker choices within each of twelve reserve districts, we make the (reasonable) assumption based on Willis that the RBOC planned to select the maximum number of cities (twelve). See Willis, The Federal Reserve System.

43. Office of the Comptroller of the Currency, Annual Report of the Comptroller of the Currency to the Second Session of the Sixty-Third Congress of the United States (Washington, DC: GPO, 1914)Google Scholar.

44. We obtain volume of check clearings in each city in 1913 from Dun's Review.

45. Warburg, Paul M., The Federal Reserve System: Its Origin and Growth, Vol. 1 (New York: Macmillan, 1930), 427Google Scholar.

46. “Huge Bank Advocated,” New York Times, January 6, 1914, p. 9.

47. Decision of the Reserve Bank Organization Committee Determining the Federal Reserve Districts and the Location of Federal Reserve Banks under Federal Reserve Act Approved December 23, 1913. With Statement of the Committee in Relation Thereto (Washington, DC: GPO, April 10, 1914)Google Scholar.

48. Houston, Eight Years With Wilson's Cabinet 1913 to 1920, 103.

49. Michael McAvoy, “How Were the Federal Reserve Bank Locations Selected?” 524.

50. Willis would have concurred: “In none of the preliminary survey . . . was the establishment of a bank at Richmond, Virginia, ever seriously considered.” See Willis, The Federal Reserve System, 585.

51. Reserve Bank Organization Committee, “Location of Reserve Districts in the United States,” 120.

52. Friedman and Schwartz, A Monetary History of the United States, 193.

53. Ibid., 255.

54. Ibid., 298.