Why is the Federal Reserve So Controversial?
The
world’s first central bank offered unprecedented convenience. It gave 17th
century Swedes the option to pay with paper notes rather than 40-pound copper
plates, which were the currency units of the Swedish empire at the time. Historically,
it may have been one of the few actions taken by a central bank that has been
relatively uncontroversial.1
It
seems as though central banking in the United States always has been hotly
debated. Early in our nation’s history, there was tremendous disagreement about
whether a central bank was necessary or even constitutional. In fact,
disagreement on the subject led to political divisions with President George
Washington’s administration and the formation of the Federalist and the
Democratic-Republican parties.2
Today,
the debate has expanded. There are still some who argue the Fed should be
abolished and others who say it is critical to our country’s economic health. However,
the extraordinary monetary policies adopted by the Fed in recent years have
raised questions about its goals, governance, and accountability.3
The First Bank of the
United States, and the Second
Alexander
Hamilton, the first Treasury Secretary, believed the newly formed United States
needed a central bank to help stabilize the country’s currency and retire debt
from the Revolutionary War. He envisioned the bank as “a profit-making
institution, with private shareholders holding four-fifths of its stock and
electing four-fifths of its directors.”2
Despite
its private ownership, the bank would be a repository for federal funds and act
on behalf of the government in financial matters.2 The idea provoked
serious debate:1
“What was it drove our forefathers to this
country?” said James “Left Eye” Jackson, a fiery little congressman from
Georgia. “Was it not the ecclesiastical corporations and perpetual monopolies
of England and Scotland? Shall we suffer the same evils to exist in this
country?...What is the general welfare? Is it the welfare of Philadelphia, New
York, and Boston?”
In
fact, Humanities Magazine reported banking, currency, and finance were topics
that inspired violent political debate during the late 18th and early
19th century. Thomas Jefferson and James Madison were among those
who opposed a central bank; however, in 1791, Congress granted the Bank of the
United States a 20-year charter.2
When
the bank’s charter came up for renewal in 1811, Madison was President and Congress
decided not to extend it. Critics said the bank was too conservative, which was
holding back economic growth. Also, there were concerns British interests held two-thirds
of its stock.4
A
close call with bankruptcy during the War of 1812, when there was no central
bank to provide funding, led President Madison to change his mind about the
value of a central bank. He endorsed the Second Bank of the United States,
which was established in 1816. It was structured similarly to the first bank
and served the same function until 1832 when President Andrew Jackson refused
to extend its charter.2
The Federal Reserve
System
The
Federal Reserve System – a decentralized central bank – was signed in to law in
1913 and began operations in 1914. It was a response to decades of bank panics
and failures.5 Neil Irwin described it like this in his book, The Alchemists: Three Central Bankers and a
World on Fire:1
“Without a central, government-backed bank
able to create money on demand, the American banking system wasn’t able to
provide it. The system wasn’t elastic, meaning there was no way for its supply
of money to adjust with demand. People would try to withdraw more money from
one bank than it had available, the bank would fail, and then people from other
banks would withdraw their funds, creating a vicious cycle that would lead to
widespread bank failures and the contraction of lending across the economy. The
result was economic depression. It happened every few years. One particularly
severe panic in 1873 was so bad that until the 1930s, the 1870s was the decade
known as the “Great Depression.””
Today,
the Fed is deeply ingrained in the economic fabric of the United States. It is
tasked with conducting the nation's monetary policy by influencing money and
credit conditions in pursuit of full employment and stable prices, supervising
and regulating banks, protecting the credit rights of consumers, maintaining
the stability of the financial system, and providing certain financial services
to the U.S. government.6
The
Fed and its leaders are often a source of controversy. While the vast majority
of Fed Chairmen and Chairwomen have been experts in the fields of public
policy, finance, and economics, many have made controversial decisions about
how to influence the U.S. economy. While many of the Fed’s decisions have
proved effective, not all have proved sound.7 The most notable Fed failure
was the Great Depression (1930s) when the Fed’s monetary policies – pushing
rates higher and making less cash available – caused a downturn to become a
depression.8
Fortunately,
economists have learned a fair amount since then. In modern times, Fed leaders
have established a more successful, but no less controversial, record. For
example:
Paul
Volcker
(1979-1987) took over during the early 1980s, when U.S. inflation was 14
percent and unemployment reached 9.7 percent. Volcker unexpectedly raised the
Fed funds rate by 4 percent in a single month, following a secret and
unscheduled Federal Open Market Committee meeting. His policies initially sent
the country into recession. The St. Louis Fed reported "Wanted"
posters targeted Volcker for "killing" so many small businesses. By
the mid-1980s, employment and inflation reached targeted levels.9, 10
Alan
Greenspan
(1987-2006) was in charge through two U.S. recessions, the Asian financial
crisis, and the September 11 terrorist attacks.11 Regardless, he
oversaw the country’s longest peacetime expansion. In the late 1990s, when
financial markets were bubbly, critics suggested, “…Mr. Greenspan’s monetary
policies spawned an era of booms and busts, culminating in the 2008 financial
crisis.”10
Ben
Bernanke
(2006-2014) took the helm of the Fed just before the financial crisis and Great
Recession. When economic growth collapsed in 2007, the Fed lowered rates and
adopted unconventional monetary policy (quantitative easing) in an effort to
stimulate economic growth.10 In 2012, economist Paul Krugman called
Bernanke out in The New York Times,
“…The fact is that the Fed isn’t doing the job many economists expected it to
do, and a result is mass suffering for American workers.”12
Janet Yellen (2014-Present) is
the current Chairwoman of the Fed. Under Yellen’s leadership, after providing
abundant guidance, the Fed raised rates for the first time in seven years. The
International Business Times reported several prominent economists think the
increase was premature, in part, because there are few signs of inflation in
the U.S. economy.13
We
won’t know whether Bernanke and Yellen have made the right choices for many
years, possibly even decades. In the meantime, it seems quite likely the Fed will
remain a controversial institution.
Sources:
1 Book by Neil Irwin: The Alchemists: Three Central Bankers and a
World on Fire (Introduction and Chapter 3)
3 http://www.brookings.edu/~/media/research/files/papers/2014/01/16-federal-reserve-independence-financial-crisis-kohn/16-federal-reserve-independence-financial-crisis-kohn.pdf (or
go to https://s3-us-west-2.amazonaws.com/peakcontent/Peak+Documents/Feb_2016_Brookings-Federal_Reserve_Independence_in_the_Aftermath_of_the_Financial_Crisis-Footnote_3.pdf)
10 http://www.nytimes.com/interactive/2015/12/11/business/economy/fed-interest-rates-history.html?_r=1
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