The Fed ’s Entry into Check Clearing Reconsidered

The Federal Reserve’s check clearing business has been a significant part of its operations since its founding and has set the precedent for other payment services offered by the Federal Reserve (Fed) to depository institutions. While there is considerable debate about the proper role for the Fed in the modern payment system, there seems to be much less disagreement concerning the Fed’s entry into check collection. 1 Many scholars believe that when the Fed took on the check payment function during the first decade of the institution’s existence, its entry served to enhance the efficiency of the check payment system. Indeed, Fed documents on its role in the payment system speak of the “breakdown of the check collection system ” around the turn of the century. 2 According to the conventional view, check collection prior to the founding of the Fed was decentralized and defective in a number of ways. By centralizing the system, the Fed was able to eliminate many of the defects. Our purpose in this article is to reexamine the facts concerning the Fed’s entry into check clearing and to evaluate the conventional view in light of those facts. We find that the evidence of inefficiency in the pre-Fed check collection system is inconclusive. Further, inefficiency would imply that there was some form of market failure, yet most discussions of check clearing in the early part of this century are vague or silent on possible sources of market failure. Absent a clearly articulated explanation of why participants in the check collection system failed to achieve efficient results, we find the conventional view to be unconvincing. The authors wish to thank Ned Prescott, John Walter, Alex Wolman, and Tom Humphrey for helpful comments. The views expressed do not necessarily reflect those of the Federal Reserve Bank of Richmond or the Federal Reserve System. The authors remain solely responsible for the contents of this article. 1 See, for example, Benston and Humphrey (1997). 2 Board of Governors of the Federal Reserve System (1990)