The Once and Future Fed – and Treasury

Abstract I argue that central banks cannot perform their familiar function of modulating credit-money aggregates without engaging in at least some degree of credit-allocation - specifically, to productive rather than speculative projects - on their own or in collaboration with finance ministries. I show further that the “spread Fed” in the U.S., operative from 1913 to 1935 and working in close collaboration with Treasury, did just that, and that it was error to end rather than supplement this practice. That error in turn stemmed from a misdiagnosis of where the Fed had gone wrong during the early 1930s. The Fed had gone wrong not in thinking “real bills” discounting necessary to good allocation and modulation of credit, but in thinking it sufficient. For while much of the money supply is endogenous as Wicksell taught, some of it is not - as Wicksell also taught. In future, the Fed will have to return to its allocative pre-1935 focus on productive investment facilitated by regional Fed discounting on the one hand, while retaining its modulatory post-1935 apparatus (FOMC, FRBNY Trading Desk, etc.) for counteracting exogenous shocks to the money supply on the other hand. It will have to attend, in other words, both to Wicksellian “bank money” and to Wicksellian “cumulative processes.” I call the upshot a “Spread,” “Wicksellian,” or “Two-Bladed Scissors” Fed.