April 15, 2024 Reading Time: 7 minutes
A public message endorsing FDR’s wartime price-control campaign. ~1942.

The US financial system has been shaped by hundreds of years of laws enacted to finance wars, cure financial crises, and settle issues raised by political movements. For over 100 years of the nation’s history, government-issued paper, state and national bank notes, gold, and at times, silver coins constituted legal money. For many years, tariffs and wage and price controls were the primary federal policies used to manage the economy.  

From 1914 onward, lawful money included a new national currency, Federal Reserve notes, that were initially backed by gold, commercial paper, and the full faith and credit of the federal government. These notes, issued by the 12 separately incorporated regional banks of the Federal Reserve System when rediscounting short-term commercial and agricultural paper, would provide the nation with a new “elastic currency” to prevent the recurrent liquidity crisis that had plagued the nation.  

The Federal Reserve’s mission, limited at inception, evolved over time. Soon after it was founded, the Fed was called upon to assist the Treasury in financing wars. Its remit expanded as the world abandoned a strict gold standard and the Fed became responsible for maintaining price stability. In time, the Fed’s mission came to reflect the Keynesian belief that the federal government has a responsibility for delivering full employment.   

Carola Binder’s Shock Values: Prices and Inflation in American Democracy (2024), “provide[s] an account of how price fluctuations and attempts to manage them — through price controls, monetary policy, tariff policy, and other means — have shaped American democracy since its very beginning.” Professor Binder recounts the evolution of government inflation-fighting policies. Covering just 285 pages, Shock Values is necessarily parsimonious when recounting US financial history.  

Bouts of exceptionally high rates of inflation and deflation have been important political issues at several junctures in US history. While it is fashionable to recall Milton Friedman’s statement that “inflation is always and everywhere a monetary phenomenon,” Shock Values reminds us that the federal government’s attempts to control inflation have often focused on wage and price controls and political attacks on alleged “price gouging” by unions, monopolists and “hoarders” who allegedly raise prices by restricting supply.  

Wage and price controls were the norm for the federal government as it attempted to prevent war-driven inflations while the Fed was enlisted to depress interest rates on the bonds needed to finance the US war efforts. Wage and price controls were also invoked as the government attempted to tame the “Great Inflation” of the 1970s. Even today, the current administration has argued that inflation owes, at least in part, to corporate greed.    

While providing a concise accounting of the many efforts taken to address inflation and deflation over the history of the republic, there is a cost to recounting such a rich history in so few pages. The personalities, extensive debates, and contemporaneous viewpoints that shaped US economic history are often lost in such a condensed history. 

Shock Values recounts history through the lens of modern academic theories regarding the conduct of monetary policy. In my opinion, this is a “bug,” not a feature. The “bug” shows up in the guise of simplified and sometimes distorted interpretations of important historical events.  

In one example, Shock Values pays special deference to Irving Fisher’s contemporary critique of the Gold Standard in its discussion of the Congressional debate surrounding the passage of the 1913 Federal Reserve Act. Mirroring modern economic thought, Fisher argued that professional economists should actively manage monetary policy to stabilize the price level. According to Fisher, professional economists should be charged with varying the dollar’s weight in gold to eliminate the short term bouts of inflation and deflation that occurred under the Gold Standard. Today, few economists think in terms of a gold standard, but many have adopted Fisher’s idea that active monetary intervention is needed to achieve “price stability.”

While Irving Fisher was an important economic voice, other well-respected economic historians discount Fisher’s influence on Congress as it debated the 1913 Federal Reserve Act. According to Allan Meltzer, “[Fisher] worked hard to get his ideas about money and monetary standards adopted. …Central bankers seem generally to have regarded Fisher as a bright but annoying crank.” Meltzer continues, “None of the [Congressional Reports] discusses the effect of changes in money on prices or pays much attention to problems of inflation or deflation. …A principal reason for the omission is the Gold Standard Act of 1900 that legally established the gold standard as the United States monetary standard.”  

I was also mildly shocked, so to speak, by Professor Binder’s assessment of the economic efficacy of wage and price controls. Shortly after president Wilson signed the Federal Reserve Act in 1913, the world went to war. European combatant nations suspended gold convertibility thereby short-circuiting the mechanism that had regulated national price levels. During the war years, gold migrated to the US, stimulating a credit expansion and high domestic inflation. President Wilson instituted wage and price controls in 1917 when the US joined the conflict.  

While Shock Values discusses how WWI wage and price controls could lead to resource misallocations, it fails to convey the severity of the negative consequences these controls imposed on the economy. Instead, it credits president Wilson for the growth in the administrative state that ensured that ”[c]ompliance with price controls was good.”  After finishing the book, I have the impression that Professor Binder does not think that wage and price controls are such a bad thing. Of Wilson’s wage and price controls she writes, “the production of munitions in American factories increased, other wartime objectives were achieved, and the US economy expanded.” Summarizing her views in the final chapter, Professor Binder writes: “This book is not a total condemnation of price controls, but I do caution against their adoption in current circumstance.”  

My reading of the literature is that president Wilson’s wage and price controls caused severe disruptions in rail transportation and the production of many commodities important for domestic consumption as well as the war effort. For example, in The Forgotten Depression, James Grant writes: 

In January 1918, America’s economy was stymied and half-frozen. Coal was in short supply in the coldest winter in half a century. The reason for the scarcity lay neither with the miners nor the mine operators — nor, really, with the newly commandeered railroads. The underlying difficulty was rather a price set too low to ration demand or to call forth adequate supply.  And who was the errant czar of the coal price? Why, none other than Woodrow Wilson.  

Three dollars a ton was a good and fair price for bituminous coal, a high level conference of coal producers and federal officials had decided in the summer of 2017. The president brushed aside that consensus opinion; the maximum price of soft coal would rather be $2 a ton, he ruled. Miners and operators each protested, the operators contending that the price Wilson imposed would shut off 22 percent of American production by forcing the closure of marginal mines. The president refused to budge. 

Historians introduce bias when they interpret past policy decisions as if currently fashionable economic theories were contemporaneously known or knowable, and current economic orthodoxy seems to have skewed Professor Binder’s interpretation when recounting some events. While I share her admiration for Federal Reserve Chair Martin, and I agree that he and “other Fed officials were highly inflation adverse, [and] viewed low and stable inflation as a top priority for monetary policy,” it is clearly an overstatement to claim that, in the early 1950s, Chairman Martin and senior Fed officials, “had a pretty good understanding of how to achieve [low and stable inflation].”  

In Chairman of the Fed, Robert Bremner recounts a speech Chairman Martin gave in 1953, discussing the problems the FOMC faced when formulating its reserve management monetary policies: 

[Chairman Martin] described the first element the Fed considered, the Treasury’s estimate of its borrowing needs for the rest of the year: ‘A group of intelligent men at Treasury wrestled with that problem, but their views changed to the tune of $5 or $6 billion frequently.  Money management isn’t easy under this condition.’ Martin went on to describe the inexact science of estimating the seasonal financing needs of the banking system: ‘[D]espite using the best Fed statisticians and the best talent from the banking community, we were just about a hundred percent too high.’ Next, the Fed forecast the growth in the money supply needed to finance the economy, ‘which was projected at three percent, and it leaked to the press as these things do,’ and soon economists and analysts were voicing their concern about excessive easing and potential inflation. Finally, the Fed predicted a rational psychological atmosphere, which meant that, ‘if business were flat or declining, interest rates would be flat or declining. We didn’t do very well here… our judgment wasn’t equal to the task.’ With so many uncertain factors, a reliable estimate of future reserve needs was impossible, and the FOMC simply advised the open-market account manager to ‘feel his way’ as he sought to supply reserves to keep the market from tightening any further. 

Under modern mainstream monetary theory, Chairman Martin’s intuition about price stability, unemployment and monetary policy were sound. However, at that time, there was no consensus in economics or politics regarding the basic tenets of sound monetary policy. Throughout the 1950s, the Fed was constantly defending itself from attacks by influential voices arguing that the Fed’s policies were too restrictive. Indeed, as late as 1959, Chairman Martin’s beliefs regarding inflation were explicitly attacked in a Staff Report of the Joint Economic Committee: 

The theory that in an environment of stable prices the economy will experience sustainable healthy growth is fallacious. The severe, restrictive application of present monetary and fiscal tools which would be necessary to halt the increase in prices would keep the economy in a perpetual state of slack. (JEC staff report as quoted in Meltzer, History of the Federal Reserve

Moreover, in Chairman’s Martin’s own words, the Fed was a long way from having “a pretty good understanding of how to achieve” its reserve management policy goals. Indeed, more than forty years after Chairman Martin’s aforementioned speech, the FOMC transcripts reveal that under Chairman Greenspan, the FOMC was still struggling to implement its Phillips curve approach for conducting monetary policy. 

During the late 1990s, several FOMC members became critical of the Phillips curve framework they were using to set monetary policy when it consistently overestimated the inflation rate. The source of the forecast errors was a topic of considerable FOMC debate. Some FOMC members attributed forecast errors to changes in business and household inflation expectations while other thought the errors were caused by unanticipated variation in the NAIRU. FOMC transcripts show that Chairman Greenspan summarized the debate: ”saying that the NAIRU has fallen, which is what we tend to do, is not very helpful. That is because whenever we miss the inflation forecast, we say the NAIRU fell.”   

Today, Fed Chairman Powell has been candid about the FOMC’s inability to accurately estimate the NAIRU or its interest rate counterpart, so-called r-star — the neutral rate of interest — let alone explain why the FOMC missed its inflation targets.  

Some readers may also be disappointed by the abbreviated coverage Shock Values gives to some important monetary events. For example, entire books have been dedicated to a discussion of President Roosevelt’s decision to suspend domestic convertibility, revalue the dollar, and abrogate domestic gold clauses. For example, Sebastian Edwards’ American Default dedicates an entire book to this historic episode while Shock Values devotes only a few pages.  

If you enjoy reading historical accounts of US financial history embellished with extensive discussions of contemporary ideas, news stories, and personalities, Shock Values may not be the favorite book in your library. But if you are looking for a concise recounting of all of the legal forms of money, tariffs, wage and price controls, and an abbreviated (if somewhat idiosyncratic) history of the evolution of the Federal Reserve, add Shock Values to your reading list.   

Paul H. Kupiec

Paul H. Kupiec is a senior fellow at the American Enterprise Institute (AEI), where he studies systemic risk and the management and regulations of banks and financial markets. He also follows the work of financial regulators such as the Federal Reserve and examines the impact of financial regulations on the US economy.

He has a bachelor of science degree in economics from George Washington University and a doctorate in economics — with a specialization in finance, theory, and econometrics — from the University of Pennsylvania.

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