Oskar Morgenstern, “Developments in the Federal Reserve System” (1930)

Published in the October 1930 Harvard Business Review, Morgenstern’s article examines the institutional conflict behind Federal Reserve discount policy before the 1929 crash. Its scope is deliberately narrower than an explanation of the crash itself: it asks why the System pursued an apparently irrational policy and whether American banking arrangements invalidate established principles of central banking. Morgenstern’s answer distinguishes the Federal Reserve Board’s political calculations from the New York Reserve Bank’s banking judgment. The policy failure exposes a contradiction between statutory authority and an emerging practical organization in which New York necessarily occupies the leading position.

The opening establishes why this institutional question matters internationally. American financial predominance and the interdependence of business cycles make Federal Reserve decisions consequential far beyond the United States. Within America, meanwhile, the relative rarity of direct governmental intervention gives reserve-bank policy exceptional importance. Morgenstern consequently treats the System both as a banking institution and as an instrument exercising powers comparable to European governmental business policy. This perspective makes its internal distribution of authority a question of worldwide economic significance.

The immediate puzzle is the Board’s attempt to restrain stock-market speculation without restricting agricultural and industrial credit. Its warnings and postponed threats of stronger measures appeared to substitute selective admonition for effective monetary restraint. Morgenstern invokes W. R. Burgess’s earlier recognition that stock-exchange lending could not be restricted while farm lending was simultaneously encouraged. Yet he does not simply assume that European banking experience settles the American case. The distinctive organization of American commercial and reserve banking requires an inquiry into whether the apparent irrationality reflects genuinely different institutional conditions.

That inquiry turns on the distinction between legal design and actual operation:

For there is no doubt that the Federal Reserve System, as we find it today in actual practice, and the System which found expression in the Charter, are not the same.

This methodological move carries the argument beyond criticism of particular officials. An adequate explanation must examine working relationships and evolving functions, not merely reconstruct the Federal Reserve Act’s organizational scheme. The original conception combined twelve substantially autonomous reserve banks with a Washington Board charged with coordinating national policy. Governors would express regional interests, while Board-appointed Federal Reserve agents would represent the central authority within the district banks.

In practice, the agents increasingly identified with their district institutions and worked alongside their governors. Direct cooperation among banks developed more readily than cooperation between the banks and Washington, whose distance from daily business coincided with greater exposure to political influence. Appointing especially capable agents did not reverse this tendency:

But the result was the same, for the agents continued to place their district banks uppermost and to relegate the interests of the Board to the background.

Repeated outcomes under competent appointees suggest structural pressures rather than personal disloyalty. Morgenstern interprets these changes as an instance of institutional adaptation: practical responsibilities reshape formal arrangements without necessarily requiring an explicit constitutional rupture. His account values the flexibility of Anglo-American institutions, while insisting that their legal appearance can obscure a substantial redistribution of power.

The second development is New York’s ascendancy, contrary to the founders’ ambition to disperse financial power and reduce regional disparities. Morgenstern rejects the ideal of “keeping the money at home” as a mercantilist misunderstanding of financial concentration. New York’s predominance is not merely an accidental advantage that legislation can redistribute at will:

In any country, even though it be as large as the United States, there is always only one point of contact between its money market and the money centers of foreign countries.

He supports this claim with New York’s share of System reserves and deposits and its decisive importance in foreign exchange. Regional jealousies cannot remove the coordinating function of a central money market. The Board’s own acknowledgment of New York’s leadership thus recognizes a practical necessity while departing from the original institutional plan.

The final substantive section connects these developments to the policy conflict of 1929. Benjamin Strong’s leadership had given the System coherence; his death allowed Washington to reassert itself. From March to August, the Board refused New York’s repeated requests for a higher discount rate, leaving warnings as an ineffective substitute. Treasury assurances of continuing prosperity further undermined those warnings. What appeared to be a single institution’s inconsistent conduct therefore becomes intelligible as a struggle between authorities:

There is accordingly a distinction to be made between the policy of the New York Bank and the policy of the Board.

For Morgenstern, the distinction relocates responsibility: New York sought action consistent with banking experience and economic theory, while the Board’s resistance expressed political calculation. His defense of New York is explicit, although it does not purport to establish that different discount policy alone would have prevented the crash.

The conclusion maintains that ordinary central-banking criteria apply to the Federal Reserve despite its distinctive organization. The essential reform is to resolve the contradiction between Washington’s formal powers and New York’s practical leadership, whether through statutory revision or continued institutional adaptation. Legal form matters less than policy informed by experienced bankers and protected from governmental dependence. The article’s enduring analytical contribution is its separation of an institution’s nominal unity from its competing centers of authority; its normative commitment is to central-bank independence grounded in financial expertise.