What is a Central Bank and Why Do We Have One?

It's become very fashionable in the US (I guess it's always been fashionable in reality but it seems to have been amplified since 2007) to criticise the Fed - that's the US central bank system.

There's been a recent discussion between Tyler Cowen and Alex Tabarrok, with a bit extra from Brian Caplan, about this.

Tabarrok, along with some of the research he cites, goes a little further than perhaps many of us in the UK might even begin to think: He talks about what would have happened had the Fed never existed. In 1903 the Federal Reserve system was established, whereas the Bank of England has been existence much longer (although not necessarily in its current form).

This is a much stronger position than just assessing the performance of an institution, but it does beg the question: What would happen instead? What exactly does a central bank do? Reportedly the Fed was given the mandate to stabilise the economy and hence conduct monetary policy.

So the research Tabarrok considers looks at pre- and post-Fed and looks at how the economy fared. It finds that post-Fed, things went a bit messy: Great Depression and all that.

But the big problem here is: Can we really rewind the clock and carry out this comparison? We don't know what the US, post-1913, would have looked like without the Fed in place so the comparison is a little false. We can try and control for all of the other factors which might explain economic outcomes, but this is an imperfect science.

So we're basically left with economic theory; what does economic theory tell us about the functions of a central bank? Come back next term for lectures, and we'll find out!