The Federal Reserve

Published on Dollars & Sense (also on ZNet), by Arthur MacEwan, August 26, 2012.

Yes, the Federal Reserve, the central banks of the United States, is a powerful institution, important to the operation of the economy. By regulating the supply of money and influencing (if not fully determining) interest rates, the Fed has a major impact on the overall level of production, employment, and inflation. Also, the Fed has a large role (along with some other agencies) in regulating the operations of banks. 

Yet the Fed is structured in a very undemocratic way. Although it derives its authority from Congress, its actions do not have to be approved by Congress, the president or any other segment of the government. Its funding is not set by Congress, and the members of its Board of Governors (the controlling group), though appointed by the president and approved by Congress, have terms that span multiple presidential and congressional terms. Also, while the Fed regulates the banks, bankers have a special role in the operation of the Fed. Some seats on the boards of directors of the twelve regional branches are reserved for bankers, giving them formal capacity to influence the Fed’s policies, including its regulation of the banks.

Not surprisingly, the Fed has exercised its regulation of the banks with “a light hand.” And its overall regulation of the economy—through affecting the money supply and interest rates—has often sacrificed employment to maintain the profitability of business in general and the banks in particular.

The Banks’ Man at the Fed:

To get some useful insight on the undemocratic and pro-business bias of the Fed, consider: … //

… The Fed’s lack of success in promoting economic growth in the current period also results from the fact that private non-financial firms have been reluctant to make new investments, even with low interest rates. So instead of making new loans for productive, job-generating investment, banks have used the low-cost money from the Fed for their own speculative activity—the sort of activity that led to JPMorgan Chase’s multi-billion dollar loss, but which can also make lots of money for the banks.

The Appeal of End the Fed:

Given the Fed’s history of frequently sacrificing employment in the name of preventing inflation, its support of banks and the role of bankers in affecting its operations, its failure to prevent the recent financial crisis, its role in bailing out the banks and the bankers, and its failure to act strongly enough in the current period, there is a good deal of animosity towards the country’s central bank. Ron Paul and others have been able to use this popular animosity to promote a broader agenda of reducing government regulation of the economy. Their call to “end the Fed” is one more effort to push the idea that the economy works best when the government works least. One would think that this is a pretty hard line to swallow in light of recent experience, when the “light hand” of government regulation was a key element in generating our current economic malaise. Yet it seems to have appeal.

In advocating an end to the Fed, Paul has called for a return to the gold standard as a means to regulate the money supply without government involvement. Ironically, at the center of Paul’s right-wing attack on the Fed has been the claim that it has debased our currency and is generating inflation; the gold standard would supposedly prevent this debasement. The argument is ironic because reality has often been the opposite of Paul’s claim—at many times in its history Fed policies have kept inflation in check but generated high unemployment, which tends to keep wages down.

In any case, the problem with the Fed is not the existence of a government authority that regulates the country’s money. Before the Fed started operating in 1914, economic crises had been at least as frequent and severe as in later years. The gold standard (which the U.S. abandoned in steps, especially in the 1930s and ultimately in 1971) certainly did not provide stability and general economic well-being. The problem is the nature of the regulatory authority, run as it is in the interests of the banks and bankers, in particular, and of business, in general. The right’s effort to “end the Fed,” however, would likely throw us into an era of even greater economic instability, having us jump out of the frying pan and into the fire.

What to Do?

So what should be done about the Fed? Unfortunately, the Fed is part of the general economic and political problems of the country, and we should not expect to have a central bank that serves people’s real needs until we have a more democratic society, a society in which money does not dominate politics and in which economic policy is not organized around the idea that maintaining profits is always the first priority.

Still, doing something about the Fed could be one step in doing something about those general problems. To begin a process of change, Dimon and other bankers should be removed from their positions of authority within the Fed. The removal of bankers from their positions of special influence would need to be followed by larger changes in the way members of the boards of directors of the regional Federal Reserve banks are chosen, and ultimately also the way members of the Board of Governors of the Fed are selected. Also, the Fed could be given a stronger mandate to act in ways that would reduce unemployment. Most generally, the goal should be to subject the Fed to democratic control.

At the end of the day, changing the Fed—changing how the U.S. economy is controlled—is a part of the larger struggle to change power in the United States so that it is in the hands of most people instead of the very few. (full text).

(ARTHUR MACEWAN is professor emeritus of economics at the University of Massachusetts-Boston and a Dollars & Sense Associate).

Links:

Mitt’s Tax Havens, Ferguson and Zakaria: The Gospel of Supply Side Jesus, on Dollars and Sense (real world economics), August 28, 2012;

Dear Mr. Dollar, on Dollars and Sense (real world economics), by Arthur MacEwan, archive 2011;

Growing opposition to the Canada-EU trade agreement, on Intrepid Report, by Dana Gabriel, August 30, 012.

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