Why the Federal Reserve Controls So Much of the Economy | WSJ

Summary

The Federal Reserve, often misunderstood, plays a pivotal role in the US economy. Established in 1913 to stabilize the banking system and prevent bank runs, it has evolved to manage currency circulation and act as a lender of last resort. The Fed's structure, comprising 12 regional banks and a Board of Governors, was designed to distribute power and avoid concentration in one entity. The Great Depression highlighted the need for a centralized authority, leading to the Board's establishment in 1935. The 1970s saw the Fed given a dual mandate to maintain stable prices and maximum employment, leading to politically independent decision-making. The 2008 financial crisis and the COVID-19 pandemic further showcased the Fed's flexibility and willingness to innovate to stabilize the economy, including unprecedented measures like near-zero interest rates and expanded lending. Despite criticism for its power and the unelected nature of its leadership, the Fed remains a crucial institution in the US financial system, acting as an economy chaperone that steps in during times of crisis.

Takeaways

• 🏛️ The Federal Reserve (Fed) is the central banking system of the United States, responsible for distributing and managing the currency in circulation.
• 💵 The Fed has the power to 'print money', which became a popular topic with the 2020 meme 'Money printer go brr', reflecting its role in creating money.
• 📉 The Fed is often seen as the 'economy chaperone', sometimes making unpopular decisions like raising interest rates to maintain economic stability.
• 🏦 The Fed was created in response to financial crises and bank runs in the early 1900s, aiming to provide a more stable banking system.
• 🔄 After the Great Depression, the Fed was restructured in 1935 with a Board of Governors to centralize power and prevent future economic catastrophes.
• 🎓 The Fed's dual mandate, established in 1978, is to focus on stable prices and maximum employment, sometimes requiring trade-offs between the two objectives.
• 📈 High inflation in the 1970s led to political independence for the Fed, which was seen as crucial for better economic outcomes.
• 📊 Paul Volcker's tenure as Fed Chairman in the late 1970s involved raising interest rates significantly, which was unpopular but eventually credited with controlling inflation.
• 🏗️ The 2008 financial crisis saw the Fed take bold, unprecedented measures, including near-zero interest rates and expanding its role in the financial system.
• 📉 The Fed's response to the COVID-19 pandemic mirrored its actions during the Great Recession, with increased money circulation and loans to non-bank entities.
• ⚖️ Despite its essential role, the Fed's power and the fact that it's composed of unelected officials making significant economic decisions are subjects of criticism and debate.

Q & A

What role does the Federal Reserve play in the US economy?

The Federal Reserve plays a crucial role in managing the currency in circulation in the US economy. It is responsible for making decisions that affect interest rates and overall monetary policy.

How did the Federal Reserve originate?

The Federal Reserve was created in 1913 as a response to the need for a central banking system in the United States. It was established to address issues such as bank runs and to provide stability to the financial system.

What were the main motivations behind creating the Federal Reserve?

The main motivations behind creating the Federal Reserve were to prevent bank runs, stabilize the financial system, and provide a central authority for managing monetary policy.

What is the structure of the Federal Reserve System?

The Federal Reserve System consists of 12 separate Federal Reserve Banks located across the country. Each bank represents a different region and operates independently to set policies and interest rates.

What were the consequences of the Federal Reserve's actions during the Great Depression?

Historians widely agree that the Federal Reserve's tight control over the circulation of money and lending exacerbated the Great Depression, making it worse than it might have been otherwise.

How did Congress change the structure of the Federal Reserve in 1935?

In 1935, Congress established the Washington-based Board of Governors to oversee the Federal Reserve System. The Board consists of seven members nominated by the President and confirmed by the Senate.

What dual mandate was given to the Federal Reserve in 1978?

In 1978, Congress gave the Federal Reserve a dual mandate to focus on stable prices and maximum employment. This meant that the Fed had to consider both objectives when making monetary policy decisions.

Why did inflation become a significant concern in the 1970s?

Inflation became a significant concern in the 1970s due to a combination of factors, including bad policies and bad luck, which led to high inflation rates, reaching nearly 15 percent.

How did Paul Volcker address inflation during his tenure as Fed Chairman?

Paul Volcker, appointed by President Jimmy Carter in 1979, raised interest rates dramatically to combat inflation, even reaching nearly 20 percent. This action led to a period of high unemployment but eventually helped control inflation.

What bold measures did the Federal Reserve take during the 2008 financial crisis?

During the 2008 financial crisis, the Federal Reserve took unprecedented measures, including dropping interest rates to near zero, loaning money to non-banks, and purchasing assets like mortgage securities to stimulate the economy.