The Fed: Is the Federal Reserve Still Necessary in the 21st Century?


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Understanding Fed Policy: What Does It Mean?

Booms and busts start — and end — with massive swings in leveraging, on all levels:  governmental, business and personal.

The United States Federal Reserve Board votes on monetary policy on its own schedule – The Fed isn’t accountable to either Congress or the Executive Branch. Image by Gaytan

Monetary Policy: The first bullet point is the one that grabs the headlines. When the Fed initiated its aggressive program of monetary easing to combat the last recession (QE1, 2, 3 and 4 along with “Operation Twist”), its primary goals were to lower interest rates and combat deflationary forces that were wreaking havoc upon the economy, particularly in the housing sector.

Noteworthy with respect to the decision, and its implementation, is that the Federal Reserve is independent from Congress as well as the Executive Branch.

Exhortations from either entity notwithstanding, the Federal Open Market Committee meets eight times a year, with 12 members in attendance:  the seven members of the Board of Governors and five of the 12 Reserve Bank presidents.

The members of the Federal Reserve Board vote to make decisions regarding the Fed’s overall monetary policy after considering various key factors such as GDP growth, unemployment, inflationary pressures, trade, manufacturing and a myriad of other economic data.

The votes are by no means always unanimous, and in recent years there has been significant dissent with respect to monetary easing. Nevertheless, after tallying the votes, the Fed makes its policy decisions, and Bernanke holds a press briefing quarterly to discuss the FOMC’s projections and policy decisions.

Bank Regulation: The second is also straightforward. The Fed supervises and regulates banks and other financial institutions. It is not the primary regulator for all banks and financial institutions, but works in conjunction with the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision (OTS), the Federal Deposit Insurance Corporation (FDIC) as well as state agencies.

Financial Stability: The third is a bit more opaque, but essentially means the Fed is there as a stopgap in the event of significant shocks to the system. For example, after the 9/11 attacks, the Fed provided an unusual amount of liquidity into the system in an attempt to stabilize potential large market swings.

Liquidity: The last role essentially is the Fed’s “day job”, overseeing the nation’s monetary transfers and credit system as a whole. It also lends overnight funds to member banks for their liquidity needs.

Should the Federal Reserve System be Abolished?

This, of course, is a question fraught with subjectivity;  there are supporters as well as detractors of the Federal Reserve, and always will be.

Keeping The Fed: Supporters will argue that someone must provide these services, as the economy cannot function with any degree of stability without a managing entity looking out for long-term interests. As much of a bubble economy as we’ve seen over the past two decades, the highs and lows would be even more pronounced without a non-political agency tapping the brakes as well as the gas pedal as the situation warrants.

This problem, as illustrated by turbulence following major shocks, would be magnified without the Fed’s ability to provide immediate liquidity as well as other emergency measures. Furthermore, even if these abilities were not considered vitally important, the day-to-day functions of the Fed would have to be outsourced, adding risk and uncertainty to something we all take for granted.

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