The International Origins of the Federal Reserve System. By Lawrence Broz. Ithaca, NY and London: Cornell University Press, 1997. Pp. xiii, 269. $35.00.

First things first. If you have an interest in central bank theory, get this book. If you have an interest in macroeconomic history, get this book. If you an interest in the origin and evolution of political institutions, get this book. Lawrence Broz presents an original and thought-provoking account of the origins of the Fed that is a must read for students of central bank theory, history, and policy analysis.

Broz's punch line is that a deep understanding of the founding of the Federal Reserve System requires analysis at two levels. The first level is a general one that entails addressing the question: "What are the social benefits of establishing a central bank?" The answer is to provide financial stability; in the early nineteenth century U.S. banking system this stability was to be achieved by reforming the payments system, which importantly would provide broad-based benefits spread over the entire economy.

These social benefits pose a dilemma leading to the second stage of analysis. The problem is that broad-based benefits are unlikely to spur political action because of free riding. Broz develops a joint-products explanation to resolve the dilemma. The task the founders faced was to come up with a central banking proposal that would tie-in the social benefits of financial stability with private benefits to a politically powerful interest group. In securing the private benefits, the special interest group would automatically be providing the social benefits.

What were these private benefits and who were the privileged groups? Broz argues that the founding of the Fed made the dollar an international currency with New York bankers and U.S. exporters and importers differentially benefiting. Significant benefits would accrue to these special groups once the amount of international trade in the United States hit a critical mass. Broz documents that U.S. international trade rose significantly in the 1890s mobilizing political forces and triggering the founding of the Fed. Much of Broz's analysis is a descriptive political history of winners and losers.

Broz sheds new light on the "origins" issue. His approach is appealing because it encourages the reader to wear two hats: that of the monetary theorist and that of the economic historian. As theorist, Broz builds the case that the creation of a U.S. central bank in 1914 was a positive sum game. Of course, this is a case that has been made by many a modern theorist; more importantly, this is a case that could have been, and indeed certainly was made, well before the Fed's founding.

The economic historian faces a fundamentally different task. Given that there are these welfare gains, there are numerous ways they could be split. The particular way that emerges depends on the existing political institutions. Unlike the task facing the theorist, it is highly unlikely that a student of central banking in 1890, 1900, or even 1907 could, with any accuracy, have identified the particular provisions of the Federal Reserve Act and the winners and losers. This is an exercise in history that by its very nature requires hindsight.

How does Broz fare as theoretician and historian? If I can be so presumptuous, my grade for economic history would be a solid "A." Broz does a thorough job of identifying the winning and losing coalitions. I would mark Broz down, however, on the theory grade. I would suggest that the economic-history explanation is consistent with a number of different stories about the conjectured positive-sum nature of the game. I do not find Broz's account to be completely satisfying.

My quarrel is one that I think Broz himself might acknowledge. There were a variety of reforms that would have led to greater financial stability. At the most fundamental level, the problem with the nineteenth-century banking system was the legal restrictions that discouraged financial institutions from issuing currency. The most direct solution would have been to simply eliminate the restrictions. Alternatively, the government might have given a monopoly privilege to one of the existing financial institutions. Finally, the government could have founded the Fed. Any of these institutional changes could have enhanced financial stability and in so doing would have increased the size of the welfare pie. Moreover, it is reasonable to conjecture that political entrepreneurs would have been clever enough to devise a pie-cutting technique that would have secured political victory for any one of these solutions.

Other readers may well disagree with my critique of Broz as economic theoretician. The bottom line is that The International Origins of the Federal Reserve System is as close as possible to an academic "can't-put-it-down" book. For those whose interest is sparked by the title, you will not be disappointed by this highly readable and original work.