The Federal Reserve: Purpose, Criticism, and Reform

Introduction

The Federal Reserve was created in 1913 and acts essentially as a central bank. However, its value to the economy is controversial. As Ron Paul (2009) notes, "Part of the public relations game played by the chairman of the Fed is designed to suggest that the Fed is an essential part of our system, one we cannot do without" (p. 10). On the other hand, proponents of the Federal Reserve assert that the Fed serves a necessary role in the stabilization of the economy. This paper examines the good that the Federal Reserve does and provides suggestions on how it might be improved.

What Good Is the Fed?

According to Federal Reserve chairman Ben Bernanke, the Fed is a tool by which the "government can always generate higher spending and hence positive inflation" (Paul, 2009, p. 7). Initially created to deal with the several bank panics of the late nineteenth and early twentieth centuries by rescuing banks over-extended on credit, the Federal Reserve has grown to take on several additional roles. The Federal Reserve's mission statement defines its purpose across "four general areas," which include "influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates; regulating banking institutions…; containing systemic risk…; and providing financial services" to governments and banks throughout the world (Mission, 2009).

While these purposes are broadly delineated, the overall picture of the Fed's powers can be summarized by comparing it to a kind of central bank for the entire world — a bank that is granted the power to oversee the American economy as well as the power to loan and create money for institutions in need.

While these may seem like good and noble purposes to some, they are questioned and attacked by others. The attacks do not necessarily stem from the fact that the Federal Reserve pursues such aims, but rather from dissatisfaction with the way the Fed manages itself. As Paul (2009) states, "People know that this institution has an important job to do in managing the nation's money supply" (p. 10). The problem, critics like Paul identify, is that the extraordinary power granted to the Fed is not one by which inflation may be regulated, but quite the contrary, one by which "the business of generating inflation" is conducted (Paul, p. 12). The Federal Reserve, by its very nature, effects an "artificial increase in the supply of money and credit," and thus causes inflation. What is celebrated as beneficial by those who see lines of bottomless credit as essential to the American economy is viewed as destructive by those who see such lines as harmful.

Criticisms of the Federal Reserve

From such a perspective, the Federal Reserve can be seen as both hero and villain. Depending upon one's orientation, it is either an economic savior or an economic burden. In either case, it has allowed "the largest banks" to "privatize profits and socialize losses," which is a practice antithetical to the free market system, in which both profits and losses are part of normal economic activity (Paul, p. 13). Regardless of one's opinion of the Fed, the fact remains that it wields significant power over economic policy and therefore ought to be regarded with serious scrutiny.

Conclusion

The good that the Federal Reserve does is to monitor economic policy, encourage maximum employment, and promote long-term stability. The way it pursues these goals, however — especially during times of crisis — is highly criticized by economists who do not support the managerial decisions made by Bernanke and others. As Ron Paul argues, the Federal Reserve could improve itself by putting an end to fractional-reserve banking and by allowing institutions burdened with bad debt to collapse rather than continuing to prop them up at taxpayers' expense. Doing so only diminishes the value of the dollar, which the Fed is ostensibly charged with protecting.