Daron Acemoglu is Elizabeth and James Killian Professor of Economics at the Massachusetts Institute of Technology and co-author of “Why Nations Fail: The Origins of Power, Prosperity and Poverty.” Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”
A hundred years ago, monetary policy – control over interest rates and the availability of credit – was viewed as a highly contentious political issue. People on the left of the political spectrum feared the central bank would be used to prop up Wall Street banks; those on the right thought it would unduly expand the role of government, giving too much power to politicians.
But in the light of the crisis of 2008 and its aftermath, we have to ask: Has our central bank fallen back under the influence of special interests?
The origins of the Federal Reserve System lie in an emotional debate, conducted more than 100 years ago, about whether the government should seek to affect interest rates – and support the credit of Wall Street firms during times of crisis – and, if so, how.
The Panic of 1907 convinced many people that the United States needed a central bank of some kind. A complete collapse of the financial system was too scary a prospect. But there was also a longstanding American aversion against ceding too much power to big banks.
At the dawn of the republic, Thomas Jefferson railed against the risks posed by government backing for concentrated power in the financial sector. President Andrew Jackson fought to abolish the Second Bank of the United States in the 1830s, the leading private bank of his day, which helped manage public finances and the banking system. Consequently, there was nothing resembling a central bank in the United States for much of the 19th century.
The Federal Reserve System, created in 1913, was a uniquely American compromise, trying to balance public and private interests. Banks controlled the boards of the 12 regional Feds – with big Wall Street firms holding great sway over the New York Fed, which had a disproportionate influence within the system as a whole — and still does.
This version of the system presided over a crazed and highly leveraged stock market boom in the 1920s and the catastrophic collapse of credit in the early 1930s, while protecting the big Wall Street firms.
Under Franklin Delano Roosevelt, the role of the Federal Reserve Board of Governors, based in Washington, was strengthened, and Wall Street was more generally constrained by effective changes to a wide range of banking and securities laws. These reforms and the effects of World War II pulled the central bank away from powerful bankers and further into the orbit of elected officials....MORE
