The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States. Created in 1913 by the enactment of the Federal Reserve Act, it is a quasi-public (government entity with private components) banking system composed of (1) the presidentially appointed Board of Governors of the Federal Reserve System in Washington, D.C.; (2) the Federal Open Market Committee; (3) twelve regional Federal Reserve Banks located in major cities throughout the nation acting as fiscal agents for the U.S. Treasury, each with its own nine-member board of directors; (4) numerous private U.S. member banks, which subscribe to required amounts of non-transferable stock in their regional Federal Reserve Banks; and (5) various advisory councils. As of February 1, 2006, Ben Bernanke serves as the Chairman of the Board of Governors of the Federal Reserve System.
The first institution with responsibilities of a central bank in the U.S. was the First Bank of the United States, chartered in 1791 by Alexander Hamilton. Its charter was not renewed in 1811. In 1816, the Second Bank of the United States was chartered; its charter was not renewed in 1836, after it became the object of a major attack by president Andrew Jackson. From 1837 to 1862, in the Free Banking Era there was no formal central bank. From 1862 to 1913, a system of national banks was instituted by the 1863 National Banking Act. A series of bank panics, in 1873, 1893, and 1907 provided strong demand for the creation of a centralized banking system.
The Federal Reserve System is the third central banking system in the United States. The first two central banking systems didn't last because there was not adequate support from Congress to keep them in existence. The timeline of central banking in the United States is as follows:
The main motivation for the third central banking system came from the Panic of 1907, which renewed demands for banking and currency reform. During the last quarter of the 19th century and the beginning of the 20th century the United States economy went through a series of financial panics. According to proponents of the Federal Reserve System and many economists, the previous national banking system had two main weaknesses: an "inelastic" currency; and a lack of liquidity. The following year Congress enacted the Aldrich-Vreeland Act which provided for an emergency currency and established the National Monetary Commission to study banking and currency reform.
The chief of the bipartisan National Monetary Commission was financial expert and Senate Republican leader Nelson Aldrich. Aldrich set up two commissions — one to study the American monetary system in depth and the other, headed by Aldrich himself, to study the European central-banking systems and report on them. Aldrich went to Europe opposed to centralized banking, but after viewing Germany's banking system came away believing that a centralized bank was better than the government-issued bond system that he had previously supported. Centralized banking was met with much opposition from politicians, who were suspicious of a central bank and who charged that Aldrich was biased due to his close ties to wealthy bankers such as J.P. Morgan and his daughter's marriage to John D. Rockefeller, Jr.
Aldrich fought for a private bank with little government influence, but conceded that the government should be represented on the Board of Directors. Most Republicans favored the Aldrich Plan, but it lacked enough support in the bipartisan Congress to pass. Progressive Democrats instead favored a reserve system owned and operated by the government and out of control of the "money trust", ending Wall Street's control of American currency supply. Conservative Democrats fought for a privately owned, yet decentralized, reserve system, which would still be free of Wall Street's control. The Federal Reserve Act passed Congress in late 1913 on a mostly partisan basis, with most Democrats in support and most Republicans against it.
In July 1979, Paul Volcker was nominated, by President Carter, as Chairman of the Federal Reserve Board amid roaring inflation. He tightened the money supply, and by 1986 inflation had fallen sharply. In October 1979 the Federal Reserve announced a policy of "targeting" money aggregates and bank reserves in its struggle with double-digit inflation.
In January 1987, with retail inflation at only 1%, the Federal Reserve announced it was no longer going to use money-supply aggregates, such as M2, as guidelines for controlling inflation, even though this method had been in use from 1979, apparently with great success. Before 1980, interest rates were used as guidelines; inflation was severe. The Fed complained that the aggregates were confusing. Volcker was chairman until August 1987, whereupon Alan Greenspan assumed the mantle, seven months after monetary aggregate policy had changed.
The primary motivation for creating the Federal Reserve System was to address banking panics. Other purposes are stated in the Federal Reserve Act, such as "to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes. Before the founding of the Federal Reserve, the United States underwent several financial crises. A particularly severe crisis in 1907 led Congress to enact the Federal Reserve Act in 1913. Today the Fed has broader responsibilities than only ensuring the stability of the financial system.
Current functions of the Federal Reserve System include:
Bank runs occur because banking institutions in the United States usually practice fractional-reserve banking and do not have enough cash in reserves to give to all of their depositors simultaneously. Bank runs can lead to a multitude of social and economic problems. The Federal Reserve was designed as an attempt to prevent or minimize the occurrence of bank runs, and to respond appropriately when they do happen.
Through its discount and credit operations, Reserve Banks provide liquidity to banks to meet short-term needs stemming from seasonal fluctuations in deposits or unexpected withdrawals. Longer term liquidity may also be provided in exceptional circumstances. The rate the Fed charges banks for these loans is the discount rate (officially the primary credit rate).
In making these loans, the Fed serves as a buffer against unexpected day-to-day fluctuations in reserve demand and supply. This contributes to the effective functioning of the banking system, alleviates pressure in the reserves market and reduces the extent of unexpected movements in the interest rates.
For example, on September 16, 2008, the Federal Reserve Board authorized an 85 billion dollar loan to stave off the bankruptcy of international insurance giant American International Group (AIG).
In the current system, private banks are for-profit businesses but government regulation places restrictions on what they can do. The Federal Reserve System is the part of government that regulates the private banks. The balance between privatization and government involvement is also seen in the structure of the system. Private banks elect members of the board of directors at their regional Federal Reserve Bank while the members of the Board of Governors are selected by the President of the United States and confirmed by the Senate. The private banks give input to the government officials about their economic situation and these government officials use this input in Federal Reserve policy decisions. In the end, private banking businesses are able to freely run a profitable business while the U.S. government, through the Federal Reserve System, oversees and regulates the activities of the private banks.
The board of directors of each Federal Reserve Bank District also have regulatory and supervisory responsibilities. For example, a member bank (private bank) is not permitted to give out too many loans to people who cannot pay them back. This is because too many defaults on loans will lead to a bank run. If the board of directors has judged that a member bank is performing or behaving poorly, it will report this to the Board of Governors. This policy is described in United States Code, Title 12, Chapter 3, subchapter 7, section 301:
The punishment for making false statements or reports which overvalue an asset is stated in U.S. Code, Title 18, Part 1, Chapter 47, Section 1014:
These aspects of the Federal Reserve System are the parts intended to prevent or minimize speculative asset bubbles which ultimately lead to severe market corrections.
In passing the Monetary Control Act of 1980, Congress reaffirmed its intention that the Federal Reserve should promote an efficient nationwide payments system. The act subjects all depository institutions, not just member commercial banks, to reserve requirements and grants them equal access to Reserve Bank payment services. It also encourages competition between the Reserve Banks and private-sector providers of payment services by requiring the Reserve Banks to charge fees for certain payments services listed in the act and to recover the costs of providing these services over the long run.
The Federal Reserve plays a vital role in both the nation’s retail and wholesale payments systems, providing a variety of financial services to depository institutions. Retail payments are generally for relatively small-dollar amounts and often involve a depository institution’s retail clients—individuals and smaller businesses. The Reserve Banks’ retail services include distributing currency and coin, collecting checks, and electronically transferring funds through the automated clearinghouse system. By contrast, wholesale payments are generally for large-dollar amounts and often involve a depository institution’s large corporate customers or counterparties, including other financial institutions. The Reserve Banks’ wholesale services include electronically transferring funds through the Fedwire Funds Service and transferring securities issued by the U.S. government, its agencies, and certain other entities through the Fedwire Securities Service. Because of the large amounts of funds that move through the Reserve Banks every day, the System has policies and procedures to limit the risk to the Reserve Banks from a depository institution’s failure to make or settle its payments.
The Federal Reserve Banks began a multi-year restructuring of their check operations in 2003 as part of a long-term strategy to respond to the declining use of checks by consumers and businesses and the greater use of electronics in check processing. The Reserve Banks will have reduced the number of full-service check processing locations from 45 in 2003 to 4 by early 2011.
The Federal Reserve System is an independent government institution that has private aspects. The System is not a private organization and does not operate for the purpose of making a profit. The stocks of the regional federal reserve banks are owned by the banks operating within that region and which are part of the system. The System derives its authority and public purpose from the Federal Reserve Act passed by Congress in 1913. As an independent institution, the Federal Reserve has the authority to act on its own without prior approval from Congress or the President. The members of its Board of Governors are appointed for long, staggered terms, limiting the influence of day-to-day political considerations. The Federal Reserve System's unique structure also provides internal checks and balances, ensuring that its decisions and operations are not dominated by any one part of the system. It also generates revenue independently without need for Congressional funding. Congressional oversight and statutes, which can alter the Fed's responsibilities and control, allow the government to keep the Federal Reserve System in check. Since the System was designed to be independent whilst also remaining within the government of the United States, it is often said to be "independent within the government."
The 12 Federal Reserve banks provide the financial means to operate the Federal Reserve. Each reserve bank is organized much like a private corporation so that it can provide the necessary revenue to cover operational expenses and implement the demands of the board. Member banks are privately owned banks that must buy a certain amount of stock in the Reserve Bank within its region to be a member of the Federal Reserve System. This stock "may not be sold, traded, or pledged as security for a loan" and all member banks receive a 6% annual dividend. These member banks must maintain fractional reserves either as vault cash or on account at its Reserve Bank; member banks earn no interest on either of these. The dividends paid by the Federal Reserve Banks to member banks are considered partial compensation for the lack of interest paid on the required reserves. All profit after expenses is returned to the U.S. Treasury or contributed to the surplus capital of the Federal Reserve Banks (and since shares in ownership of the Federal Reserve Banks are redeemable only at par, the nominal "owners" do not benefit from this surplus capital); the Federal Reserve system contributed over $29 billion to the Treasury in 2006.
The Federal Reserve System as a whole
Board of Governors
Federal Open Market Committee
Federal Reserve Banks
The seven-member Board of Governors is the main governing body of the Federal Reserve System. It is charged with overseeing the 12 District Reserve Banks and with helping implement national monetary policy. Governors are appointed by the President of the United States and confirmed by the Senate., one on Jan. 31 of every even-numbered year, for staggered, 14-year terms. As an independent federal government agency, the Board of Governors does not receive funding from Congress, and the terms of the seven members of the Board span multiple presidential and congressional terms. Once a member of the Board of Governors is appointed by the president, he or she functions mostly independently. The Board is required to make an annual report of operations to the Speaker of the U.S. House of Representatives. It also supervises and regulates the operations of the Federal Reserve Banks, and US banking system in general.
Membership is generally limited to one term. However, if someone is appointed to serve the remainder of another member's uncompleted term, he or she may be reappointed to serve an additional 14-year term. Conversely, a governor may serve the remainder of another governor's term even after he or she has completed a full term. The law provides for the removal of a member of the Board by the President "for cause."
The current members of the Board of Governors are:
All current members of the Board of Governors have taken office during the presidency of George W. Bush.
There are 12 regional Federal Reserve Banks (not to be confused with the "member banks") with 25 branches, which serve as the operating arms of the system. Each Federal Reserve Bank is subject to oversight by a Board of Governors. Each Federal Reserve Bank has a board of directors, whose members work closely with their Reserve Bank president to provide grassroots economic information and input on management and monetary policy decisions. These boards are drawn from the general public and the banking community and oversee the activities of the organization. They also appoint the presidents of the Reserve Banks, subject to the approval of the Board of Governors. Reserve Bank boards consist of nine members: six serving as representatives of nonbanking enterprises and the public (nonbankers) and three as representatives of banking. Each Federal Reserve branch office has its own board of directors, composed of three to seven members, that provides vital information concerning the regional economy.
The Reserve Banks opened for business on November 16, 1914. Federal Reserve Notes were created as part of the legislation, to provide a supply of currency. The notes were to be issued to the Reserve Banks for subsequent transmittal to banking institutions. The various components of the Federal Reserve System have differing legal statuses.
The Federal Reserve Banks have an intermediate status, with some features of private corporations and some features of public federal agencies. Each member bank owns nonnegotiable shares of stock in its regional Federal Reserve Bank—but these shares of stock give the member banks only limited control over the actions of the Federal Reserve Banks, and the charter of each Federal Reserve Bank is established by law and cannot be altered by the member banks. While it is unusual, private individuals and non-bank corporations (with proof of a resolution of the board of directors indicating it intends to do so) may also purchase one or more shares of stock of any of the Federal Reserve Banks. The stock is the same nonnegotiable stock as banks receive, cannot be sold and pays a small dividend. In Lewis v. United States, the United States Court of Appeals for the Ninth Circuit stated that "the Reserve Banks are not federal instrumentalities for purposes of the FTCA [the Federal Tort Claims Act], but are independent, privately owned and locally controlled corporations." The opinion also stated that "the Reserve Banks have properly been held to be federal instrumentalities for some purposes." Another decision is Scott v. Federal Reserve Bank of Kansas City in which the distinction between the Federal Reserve Banks and the Board of Governors is made.
A list of all of the members of the Reserve Banks' boards of directors is published by the Federal Reserve.
|Federal Reserve Bank||Letter||Number||Branches||Website||President|
|Boston||A||1||http://www.bos.frb.org/||Eric S. Rosengren|
|New York City||B||2||Buffalo, New York (will be closing after October 31, 2008)||http://www.newyorkfed.org/||Timothy F. Geithner|
|Philadelphia||C||3||http://www.philadelphiafed.org/||Charles I. Plosser|
|Cleveland||D||4||Cincinnati, Ohio / Pittsburgh, Pennsylvania||http://www.clevelandfed.org/||Sandra Pianalto|
|Richmond||E||5||Baltimore, Maryland / Charlotte, North Carolina||http://www.richmondfed.org/||Jeffrey M. Lacker|
|Atlanta||F||6||Birmingham, Alabama / Jacksonville, Florida / Miami, Florida / Nashville, Tennessee / New Orleans, Louisiana||http://www.frbatlanta.org/||Dennis P. Lockhart|
|Chicago||G||7||Detroit, Michigan||http://www.chicagofed.org/||Charles Evans|
|St Louis||H||8||Little Rock, Arkansas / Louisville, Kentucky / Memphis, Tennessee||http://www.stlouisfed.org/||James B. Bullard|
|Minneapolis||I||9||Helena, Montana||http://www.minneapolisfed.org/||Gary H. Stern|
|Kansas City||J||10||Denver, Colorado / Oklahoma City, Oklahoma / Omaha, Nebraska||http://www.kansascityfed.org/||Thomas M. Hoenig|
|Dallas||K||11||El Paso, Texas / Houston, Texas / San Antonio, Texas||http://www.dallasfed.org/||Richard W. Fisher|
|San Francisco||L||12||Los Angeles, California / Portland, Oregon / Salt Lake City, Utah / Seattle, Washington||http://www.frbsf.org/||Janet L. Yellen|
All nationally chartered banks hold stock in one of the Federal Reserve banks. State-chartered banks may choose to be members (and hold stock in a regional Federal Reserve bank), upon meeting certain standards.
Holding stock in a Federal Reserve bank is not, however, like owning publicly traded stock. The stock cannot be sold or traded. Member banks receive a fixed, 6 percent dividend annually on their stock, and they do not directly control the applicable Federal Reserve bank as a result of owning this stock. They do, however, elect six of the nine members of Reserve banks’ boards of directors. Federal statute provides (in part):
Other banks may elect to become member banks. According to the Federal Reserve Bank of Boston:
For example, as of October 2006 the member banks in New Hampshire included Community Guaranty Savings Bank; The Lancaster National Bank; The Pemigewasset National Bank of Plymouth; and other banks. In California, member banks (as of September 2006) included Bank of America California, National Association; The Bank of New York Trust Company, National Association; Barclays Global Investors, National Association; and many other banks.
Summary of all FDIC insured banks:
|FDIC Insured Institutions|
|Number as of 8/14/2008||8,437|
|Assets as of 3/31/2008||$13,382,783|
|Deposits as of 3/31/2008||$8,569,419|
|(dollar amounts in millions of dollars)|
All FDIC-insured U.S. commercial banks by bank charter type (assets in thousands of dollars, data given by FDIC website as of August 15, 2008):
|charter type||number of banks||total assets|
Each charter type is defined as follows:
The N and SM are members of the system whereas the rest are not. While the OI, SA, and SB categories are not members of the system, they are sometimes treated as if they were members under certain circumstances.
The Federal Reserve Banks also use advisory committees. Of these advisory committees, perhaps the most important are the committees (one for each Reserve Bank) that advise the Banks on matters of agriculture, small business, and labor. Biannually, the Board solicits the views of each of these committees by mail.
A simpler description is described in The Federal Reserve in Plain English:
The Federal Reserve System implements monetary policy largely by targeting the federal funds rate. This is the rate that banks charge each other for overnight loans of federal funds, which are the reserves held by banks at the Fed. This rate is actually determined by the market and is not explicitly mandated by the Fed. The Fed therefore tries to align the effective federal funds rate with the targeted rate by adding or subtracting from the money supply through open market operations. The late economist Milton Friedman consistently criticized this reverse method of controlling inflation by seeking an ideal interest rate and enforcing it through affecting the money supply since nowhere in the widely accepted money supply equation are interest rates found.
The Federal Reserve System also directly sets the "discount rate", which is the interest rate that banks pay the Fed to borrow directly from it. This rate is generally set at a rate close to 100 points above the target federal funds rate. The idea is to encourage banks to seek alternative funding before using the "discount rate" option.
Both of these rates influence the prime rate which is usually about 3 percentage points higher than the federal funds rate.
Lower interest rates stimulate economic activity by lowering the cost of borrowing, making it easier for consumers and businesses to buy and build, but at the cost of promoting the expansion of the money supply and thus greater inflation. Higher interest rates slow the economy by increasing the cost of borrowing. (See monetary policy for a fuller explanation.)
The Federal Reserve System usually adjusts the federal funds rate by 0.25% or 0.50% at a time.
The Federal Reserve System might also attempt to use open market operations to change long-term interest rates, but its "buying power" on the market is significantly smaller than that of private institutions. The Fed can also attempt to "jawbone" the markets into moving towards the Fed's desired rates, but this is not always effective.
Another instrument of monetary policy adjustment employed by the Federal Reserve System is the fractional reserve requirement, also known as the required reserve ratio. The required reserve ratio sets the balance that the Federal Reserve System requires a depository institution to hold in the Federal Reserve Banks, which depository institutions trade in the federal funds market discussed above. The required reserve ratio is set by the Board of Governors of the Federal Reserve System.
|Table: Reserve Requirements in the U.S. Federal Reserve System|
|Type of liability||Requirement|
| ||Percentage of liabilities||Effective date|
|Net transaction accounts|
|$0 to $9.3 million||0||12/20/07|
|More than $9.3 million to $43.9 million||3||12/20/07|
|More than $43.9 million||10||12/20/07|
|Nonpersonal time deposits||0||12/27/90|
In order to address problems related to the subprime mortgage crisis and United States housing bubble, three new tools have been created. The first new tool, called the Term Auction Facility, was added on December 12, 2007. It was first announced as a temporary tool but there have been suggestions that this new tool may remain in place for a prolonged period of time. Creation of the second new tool, called the Term Securities Lending Facility, was announced on March 11, 2008. The main difference between these two facilities is that the Term Auction Facility is used to inject cash into the banking system whereas the Term Securities Lending Facility is used to inject treasury securities into the banking system. Creation of the third tool, called the Primary Dealer Credit Facility (PDCF), was announced on March 16, 2008. The PDCF was a fundamental change in Federal Reserve policy because now the Fed is able to lend directly to primary dealer's, which was previously against Fed policy. The differences between these 3 new facilities is described by the Federal Reserve:
The Term Auction Facility program offers term funding to depository institutions via a bi-weekly auction, for fixed amounts of credit. The Term Securities Lending Facility will be an auction for a fixed amount of lending of Treasury general collateral in exchange for OMO-eligible and AAA/Aaa rated private-label residential mortgage-backed securities. The Primary Dealer Credit Facility now allows eligible primary dealers to borrow at the existing Discount Rate for up to 120 days.
Some of the measures taken by the Federal Reserve to address this mortgage crisis haven't been used since The Great Depression. The Federal Reserve gives a brief summary of what these new facilities are all about:
As the economy has slowed in the last nine months and credit markets have become unstable, the Federal Reserve has taken a number of steps to help address the situation. These steps have included the use of traditional monetary policy tools at the macroeconomic level as well as measures at the level of specific markets to provide additional liquidity.
The Federal Reserve's response has continued to evolve since pressure on credit markets began to surface last summer, but all these measures derive from the Fed's traditional open market operations and discount window tools by extending the term of transactions, the type of collateral, or eligible borrowers.
Total wealth in the United States is published by the Federal Reserve in a report titled, Flow of Funds. At the end of fiscal year 2007, total wealth of all U.S. households and non-profit organizations was $57.718 trillion.
The Federal Reserve ceased publishing M3 statistics in March 2006, explaining that it cost a lot to collect the data but did not provide significantly useful information. The other three money supply measures continue to be provided in detail.
The consumer price index is used as one measure of the value of the money. It is defined as: The data consists of the US city average of consumer prices and can be found at The US Department of Labor—Bureau of Labor Statistics
The CPI taken alone is not a complete measure of the value of money. For example, the monetary value of stocks, real estate, and other goods and services categorized as investment vehicles are not reflected in the CPI. It is difficult to obtain a full picture of value across the full range of the cost of living, so the CPI is typically used as a substitute. The CPI therefore has powerful political ramifications, and Administrations of both parties have been tempted to change the basis for its calculation, progressively underestimating the true rate of decline in purchasing power.
One of the Fed's main roles is to maintain price stability. This means that the change in the consumer price index over time should be as small as possible. The ability to maintain a low inflation rate is a long-term measure of the Fed's success. Although the Fed usually tries to keep the year-on-year change in CPI between 2 and 3 percent, there has been debate among policy makers as to whether or not the Federal Reserve should have a specific inflation targeting policy.
The effects of monetary and price inflation include:
The unemployment rate statistics are collected by the Bureau of Labor Statistics. Since one of the stated goals of monetary policy is maximum employment, the unemployment rate is a sign of the success of the Federal Reserve System.
Like the CPI, the unemployment rate is used as a barometer of the nation's economic health, and thus as a measure of the success of an administration's economic policies. Since 1980, both parties have made progressive changes in the basis for calculating unemployment, so that the numbers now quoted cannot be compared directly to the corresponding rates from earlier administrations, or to the rest of the world.
Below is the balance sheet as of May 15, 2008 (in millions of dollars):
ASSETS: Gold certificate account 11,037 Special drawing rights certificate acct. 2,200 Coin 1,386 Securities, repurchase agreements, term auction credit, and other loans 768,561 Securities held outright 515,656 U.S. Treasury 515,656 Bills 49,610 Notes and bonds 421,816 Repurchase agreements 100,000 Term auction credit 125,000 Other loans 27,905 Items in process of collection 2,282 Bank premises 2,147 Other assets 93,139 Total Assets 880,752 LIABILITIES: Federal Reserve notes outstanding 982,744 Less: notes held by F.R. Banks 201,956 Federal Reserve notes, net 780,789 Reverse repurchase agreements 39,114 Deposits 14,959 Depository institutions 10,574 U.S. Treasury, general account 4,020 Foreign official 97 Other 268 Deferred availability cash items 2,629 Other liabilities and accrued
2,734 Total liabilities 840,224 CAPITAL (AKA Net Equity) Capital paid in 19,861 Surplus 18,479 Other capital 2,189 Total capital 40,528 MEMO (off-balance-sheet items) Marketable securities held in custody for foreign official and international accounts 2,278,674 U.S. Treasury 1,348,648 Federal agency 930,025 Securities lent to dealers 150,541 Overnight facility 12,452 Term facility 138,089
Analyzing the Federal Reserve's Balance Sheet reveals a number of facts:
In addition, the balance sheet also indicates which assets are held as collateral against Federal Reserve Notes.
|Federal Reserve Notes and collateral|
|Federal Reserve notes outstanding||982,744|
|Less: Notes held by F.R. Banks||201,956|
|Federal Reserve notes to be collateralized||780,789|
|Collateral held against Federal Reserve notes||780,789|
|Gold certificate account||11,037|
|Special drawing rights certificate account||2,200|
|U.S. Treasury and agency securities pledged||576,601|
|Other assets pledged||190,951|
A large and varied group of criticisms has been directed against the Federal Reserve System. One critique, typified by the Austrian School, is that the Federal Reserve is an unnecessary and counterproductive interference in the economy. According to this theory, interest rates should be naturally low during times of excessive consumer saving (because lendable money is abundant) and naturally high when high net volumes of consumer credit are extended (because lendable money is scarce). These critics argue that setting a baseline lending rate amounts to centralized economic planning; a hallmark of socialist and communist societies; and inflating the currency amounts to a regressive, incremental redistribution of wealth.
Other critiques include arguments in favor of the gold standard (usually coupled with the charge that the Federal Reserve System is unconstitutional) or beliefs that the centralized banking system is doomed to fail (due to the fractional reserve system's strong resemblance to an unsustainable pyramid scheme). Some critics argue that the Fed lacks accountability and transparency or that there is a culture of secrecy within the Reserve.
At one end of the spectrum are economists from the Austrian School and the Chicago School who want the Federal Reserve System abolished. They criticize the Federal Reserve System’s expansionary monetary policy in the 1920s, arguing that the policy allowed misallocations of capital resources and supported a massive stock price bubble. They also cite politically motivated expansions or tightening of currency in the 1970s and 1980s.
Milton Friedman, leader of the Chicago School, argued that the Federal Reserve System did not cause the Great Depression, but made it worse by contracting the money supply at the very moment that markets needed liquidity. Since its entire existence was predicated on its mission to prevent events like the Great Depression, it had failed in what the 1913 bill tried to enact. Friedman explains his hypothesis on the cause of The Great Depression and the role the Federal Reserve played in it in his book and documentary series Free to Choose. An excerpt of his hypothesis:
This is also the current conventional wisdom on the matter, as both Ben Bernanke and other economists such as the late John Kenneth Galbraith—the latter being an ardent Keynesian—have upheld this reasoning. In an interview with Peter Jaworski (The Journal, Queen's University, March 15, 2002—Issue 37, Volume 129) Friedman also said that ideally he would "prefer to abolish the federal reserve system altogether" rather than try to reform it, because it was a flawed system in the first place. He later said he would like to "abolish the Federal Reserve and replace it with a computer", meaning that it would be a mechanical system in nature that would keep the quantity of money going up at a steady rate. Friedman also believed that, ideally, the issuing power of money should rest with the Government instead of private banks issuing money through fractional reserve lending.
Ben Bernanke agreed that the Fed had made the Great Depression worse, saying in a 2002 speech:
Austrian economists go even further. They argue that in addition to extending the length of the Great Depression, the Federal Reserve System directly caused the Great Depression through monetary inflation in the 1920s. According to the Austrian economic theory of the business cycle, monetary ease results in a boom that becomes a recession or depression, especially quickly when the monetary ease is stopped. Within this theory the Great Depression was simply one of countless booms and busts throughout history that result when the money supply is manipulated. Among other evidence supporting this position is a particularly notorious quote in 1927 from Benjamin Strong, the chairman at the time. Strong said that the American authorities would reduce discount rates as “un petit coup de whisky for the stock exchange.” Austrian economists do not blame unbridled speculators as the primary cause of the roaring twenties, but rather the inflationary monetary policy of the Federal Reserve System.
Milton Friedman alleged that the Fed caused the high inflation of the 1970s. When asked about the greatest economic problem of the day, he said the most pressing was how to get rid of the Federal Reserve. Friedman discusses the high inflation rate of the 1970s and other periods in Free to Choose:
United States Congressman Ron Paul, ranking member of the Subcommittee on Domestic and International Monetary Policy (of the House Banking Committee), has also criticized Federal Reserve policy for creating and downplaying excessive inflation:
Ralph Nader, a consumer activist and presidential candidate in several elections, has criticized the inflation policies of the Federal Reserve for what he says ignores excessive inflation in stock prices and corporate welfare disbursements while showing consistent concern for a rise in ordinary people's wages. In an article he published on his own website in 1999, he stated:
Kucinich has also questioned the idea that the Federal Reserve should be independent. He suggested that it should be "accountable" instead. He was asked, "You mentioned the Federal Reserve. Do you think it should not be independent, that it should be answerable to...", to which he immediately responded:
The Federal Reserve System has also been considered reserved in its relations with the media in an effort to maintain its carefully crafted image and resents any public information that runs contrary to this notion. Maria Bartiromo reported on CNBC that during a conversation at the White House Correspondents’ Dinner in April 2006, Federal Reserve Board Chairman Ben Bernanke stated investors had misinterpreted his recent congressional remarks as an indication the Fed was nearly done raising rates. This triggered a drop in stock prices just when the market was about to close.
In 1993, Rep. Henry Gonzalez confirmed that the Fed did have tapes and transcripts of the meetings and could have complied with the FOIA requests, but had misrepresented the existence of the transcripts and chosen to ignore questions from Congress. After the existence of the transcripts was revealed, the Fed agreed to release the transcripts on a five-year time lag. The time period has been extended, so that for example 1992's transcripts were not released until 1998.
Some critics believe the Fed exacerbated this idea when it decided to stop publishing the M3 aggregate of financial data, which details the total amount of money in circulation at a time. Some of them argue that it is a way the Fed could hide an impending economic disaster from the public if it felt the need. The Fed said that economists did not need M3 when they had M2, despite the fact that the M3 was the only aggregate to contain information regarding the most extravagant monetary exchanges, and therefore would be needed to have a complete understanding of the overall monetary policy in the United States.
Ralph Nader has suggested a solution to the transparency problems through an effort that would "democratize Federal Reserve transparency". He presented a 7-point program that he claims could help to democratize the Federal Reserve System as a whole. He compares the Federal Reserve to other parts of government by stating:
The steps to open government would really be “baby steps” for the Federal Reserve. After all, most of the Federal government must live by “open government” laws and rules, and bureaucrats with a grumble or two – still manage to survive.
Many libertarians also contend that the Federal Reserve Act is unconstitutional. Congressman Ron Paul, for example, argues that:
"The United States Constitution grants to Congress the authority to coin money and regulate the value of the currency. The Constitution does not give Congress the authority to delegate control over monetary policy to a central bank. Furthermore, the Constitution certainly does not empower the federal government to erode the American standard of living via an inflationary monetary policy."
Mr. Chairman, we have in this country one of the most corrupt institutions the world has ever known. I refer to the Federal Reserve Board and the Federal Reserve Banks. The Federal Reserve Board, a Government board, has cheated the Government of the United States and the people of the United States out of enough money to pay the national debt. These twelve private credit monopolies were deceitfully and disloyally foisted upon this country by the bankers who came here from Europe and repaid us for our hospitality by undermining our American institutions...The people have a valid claim against the Federal Reserve Board and the Federal Reserve banks.
Quite a few Congressmen who have been involved in the House and Senate Banking and Currency Committees have been open critics of the Federal Reserve, including Chairmen Wright Patman, Henry Reuss, and Henry Gonzalez. Currently, Congressman Paul is the ranking member of the Monetary Policy Subcommittee and he is a staunch opponent of the Federal Reserve System. During each Congress Paul introduces a bill to abolish the Federal Reserve System (H.R. 2755—110th Congress, H.R. 2778—108th Congress, H.R. 5356—107th Congress, H.R. 1148—106th Congress), although he has yet to have any hearings held on his legislation or to gather any cosponsors. It has often been said that the Federal Reserve is a creature of Congress and it is the fluctuating opinion of that body that it answers to.
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