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Economic Review

Nov/Dec, 1985

The Rules versus Discretion Debate over Monetary Policy in the 1920s

Robert L. Hetzel

The question of whether monetary policy should be guided by legislated rules or left to the discretion of the policymaker has been a subject of debate since the early days of central banking. An important episode of the debate occurred in the 1920s when Kansas Congressman James Strong introduced legislation (the Strong bill) which was intended to institutionalize the price level stabilization policy that Benjamin Strong had implicitly followed as head of the New York Federal Reserve Bank from 1923 to 1927.

In this article, Robert Hetzel reviews the debate which took place in the congressional hearings on the Strong bill. The hearings indicate that Benjamin Strong's policy was based on his belief that the Fed had the ability to influence the price level by controlling levels of bank reserves. However, the Board of Governors represented by Adolph Miller denied the causal influence of the supply of money on the price level. Miller instead advocated a policy based on the Real Bills Doctrine, according to which the Fed need only be concerned with “speculative” extensions of bank credit. Hetzel points out that an understanding of these fundamental disagreements is essential if one is to appreciate fully the impact that Benjamin Strong’s death and the resulting shift in power from the New York Fed to the Board in Washington had on monetary policy during the Depression.

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