[jmherbener]

Power over monetary policy was not centralized in the Board of Governors until the Banking Act of 1935. Benjamin Strong headed the group of Federal Reserve District Bank presidents who, with Board approval, determined rates of discount for commercial paper and open market operations during the 1920s. They engineered a significant monetary inflation and credit expansion in part to re-establish the gold standard, at the pre-War parities and in part to stimulate domestic economic activity.

After the War, the exchange rate of the pound had fallen to $3.20. Britain tried to restore the gold standard at a rate of $4.76. Speculation had driven the rate near $4.70 after 1925, but the fundamentals of underlying purchasing power would not justify it without significant manipulation. That is what the speculators were betting on.

Strong reported to the Board that for the three years 1925-1927, the Fed’s portfolio increased $200 million, the gold stock $18 million, but bank credit had soared by $5 billion. The discount rate was lowered from 6 percent to 4 percent.

The idea was that the pound would appreciate against the dollar if the dollar’s purchasing power was lowered by monetary inflation. The scheme failed because, Britain refused to moderate its own monetary inflation and rising international demand for the dollar prevented the purchasing power of dollar from falling.

The eminent monetary economist, Alan Meltzer, chronicles this story in his landmark book, A History of the Federal Reserve System, Vol. 1.