Fed’s work sparks impassioned reactions

Some see the Fed as absolutely necessary. ... But there also are strong views critical of the central bank.

By Dr. Mike Walden
Business Columnist

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Few institutions generate more mystery and controversy than the Federal Reserve – the “Fed” for short. It already has become a topic in the presidential campaign. Some see the Fed as absolutely necessary to the function and protection of the financial system. They credit the Fed’s strong actions in 2008 and 2009 as preventing another Great Depression.

But there also are strong views critical of the central bank. The Fed is accused of creating inflation and debasing the dollar’s value, prompting speculative investment bubbles and working for the interests of the wealthy. It’s also said that rather than promoting stable growth, the Fed actually causes more volatility in the economy.

So which is the Fed: friend or foe of the economy? Let me answer some questions about the Fed and then you can decide.

What is the Federal Reserve? The Fed is the central bank of the United States, established in 1913. It backstops the financial system and serves as a lender of last resort for banks and other lenders. The Fed is privately funded by member banks. Its charter is controlled by U.S. Congress, and its board of governors are appointed by the president and confirmed by the U.S. Senate.

Why was the Fed created? The Fed was created to provide funds to banks to prevent their closure during bank runs. Furthermore, with depositors knowing they could retrieve their money even during bad economic times, the expectation was that bank runs would be prevented altogether.

What powers does the Fed have? The Fed has three key powers. First, it controls the percentage of deposits that must be kept in bank vaults. Second, it controls two interest rates banks pay to borrow from the Fed or other banks.

It’s the Fed’s third power that is astonishing to many. The Fed can create and destroy money. It creates money by buying investments from banks using new cash and destroys money by doing the reverse.

During the Great Recession, the Fed aggressively used the second two powers, lowering its two key interest rates from more than 5 percent to almost 0 percent and tripling the money supply.

Does the Fed do more harm than good? This is the key question dividing supporters and critics of the Fed. Fed backers say the institution is essential to maintaining stability and confidence in the financial system. They point to the lack of bank runs in recent recessions. Backers say the Great Recession demonstrated the power of the Fed to move rapidly to curtail the free fall of the economy and prevent lending markets from collapsing.

There are two major criticisms of the Fed. With no links to a monetary base such as gold or silver, it is possible for the Fed to create so much money that higher inflation will result.

There’s also the concern that with the Fed alternately stepping on the “money gas” to speed the economy and then on the “money brake” to slow the economy and prevent inflation, the Fed may unwittingly create more instability.

Dr. Mike Walden is a professor and N.C. Cooperative Extension economist in the Department of Agricultural and Resource Economics at N.C. State University.