How the Fed Manages to Keep Its Independence
How exactly does the Federal Reserve operate, and who are its shareholders? The Federal Reserve is made up of a central board that is selected by the government as well as 12 regional banks. Because the Federal Reserve Board is an autonomous institution within the United States government, the President, Congress, and any other elected person are not required to provide their consent to any of the Board’s decisions.
The Federal Reserve is answerable to both the public and to Congress. The Federal Reserve receives its funding from investments. The fundamental responsibility of the Federal Reserve is to control inflation.
The United States’ primary financial institution is known as the Federal Reserve. The decisions it makes have an impact on the economy of the United States and, by extension, the global economy. Because of its position, it is the most powerful actor in the global economy. It is neither a private business nor a government department.
It is not subject to voters or shareholders, many people view it as highly suspect due to the fact that its leader is not an elected official. This makes it appear as though the organization is trying to hide something from them.
Find out how the Federal Reserve actually operates, who the owners are, and how they are held accountable for their actions.
Who Exactly Is in Charge of the Federal Reserve?
The Federal Reserve Act of 1913 established the Federal Reserve as a separate entity from other financial institutions.
At the time, President Woodrow Wilson advocated for a central board that was nominated by the government, but Congress advocated for the Federal Reserve to have 12 regional banks that would represent the various areas of the United States. Because of the deal, the Fed now possesses both.
The Federal Reserve and Congress
To serve on the Board of Governors of the Federal Reserve, candidates must first receive approval from both the president and Congress. However, the tenure of board members is not intended to coincide with that of elected politicians.
The chair of the Federal Reserve is presently held by Jerome Powell, who was appointed by the president. The appointment of the president requires the consent of Congress. The chair of the Federal Reserve is required to report to Congress on the activities of the Fed.
The statutes that regulate the Fed can be changed by Congress at any time. The Dodd-Frank Wall Street Reform and Consumer Protection Act, for instance, placed restrictions on the Federal Reserve’s authority. It was essential that the Federal Reserve conduct an audit of the emergency loans that it made during the 2008 financial crisis through the Government Accountability Office (GAO).
In addition to this, it mandated that the Federal Reserve must disclose the identities of any financial institutions that have been awarded emergency loans or TARP money. Before granting any emergency loans, the Fed is required to acquire approval from the Treasury Department, just like it did with Bear Stearns and AIG5.
The Federal Reserve Board is an independent agency within the federal government of the United States. This means that the president, elected officials, or lawmakers do not have to agree with what the Federal Reserve Board does.
It is also vital to note that the Federal Reserve does not get its financing from Congress. Instead, its finances are supported by the returns on its investments. The United States Treasury Notes that it purchases through open market operations and pays it interest on a regular basis.
It does so by earning interest on the investments it has made in other currencies. Its financial institutions are compensated monetarily for the services they render to commercial banks. Among these are the processing of checks, the transfer of payments, and the tasks that automated clearinghouses do.
Additionally, the Fed is compensated with interest for loans that it provides to member banks. It subsequently transfers any “profit” to the United States Treasury Department after using this money to settle its financial obligations.
The structure of the 12 regional Federal Reserve banks is very comparable to that of private banks. They are responsible for the custody of currency, the processing of checks, and the provision of loans to private banks operating within the territory under their supervision. These financial institutions are also participants in the banking system operated by the Federal Reserve.
As a consequence of this, they are required to keep reserve requirements. In exchange, they are able to borrow money from one another whenever necessary at the fed funds rate. They also have the option of borrowing money from the discount window of the Fed at the discount rate if all else fails.
Commercial banks are required to have stock ownership in one of the 12 regional Federal Reserve banks in order to be considered a member of the Federal Reserve System. However, holding stock in the Federal Reserve Bank is entirely different from holding stock in a private corporation. It is not possible to trade it, and the member banks do not receive any voting rights in exchange for it.
These stocks have a dividend payout rate of 6%, which is required by law. However, the banks are obligated to give the United States Treasury all of their profits once they have paid their expenses.
The Reasons Why the Fed Ought to Keep Its Independence
If it is not subject to political pressure in the short term, the Federal Reserve’s monetary policy will be able to perform its duties more effectively. The ability to set expectations, particularly with regard to inflation, must be unrestricted. It is unable to do so so long as its leaders live in fear of being removed from their positions by an elected official.
Fed chairs are typically highly-respected academic economists in their respective fields. They are particularly knowledgeable in matters pertaining to public policy, finance, and central banking. They are appreciated not for their charisma, enormous fan bases, or abilities in public speaking; rather, they are valued for the expertise they possess. They are used to being in an environment where ideas are challenged, looked at, and talked about.
How Accountability Is Achieved Regarding the Fed
Despite its autonomy, the Federal Reserve is nonetheless answerable to both the American people and their elected representatives in Congress. If the Fed is open and honest about the activities it is undertaking, it will be in the best position to moderate expectations. Also, it has to explain its actions in a clear and concise way.
The Fed communicates with the public by releasing reports on a regular and comprehensive basis. First, the chair of the Federal Reserve and other members of the board regularly provide testimony before Congress. Second, the Federal Reserve provides Congress with a comprehensive Monetary Policy Report on a semiannual basis.
Third, following each meeting, the Federal Open Market Committee (FOMC) issues a statement for public consumption. Additionally, it delivers comprehensive meeting minutes three weeks after the fact. After a period of five years, verbatim transcripts are made public.
The inner workings of the Fed
The Federal Reserve’s principal responsibility has always been to control inflation. It is equipped with a wide range of tools to carry out its functions.
During the global financial crisis of 2008, it developed cutting-edge methods to forestall the onset of a slump. Since the beginning of the recession, it has also made a commitment to lower unemployment and boost economic growth.
Monetary Policy Tools
The Federal Reserve achieves its goals by employing the instruments of monetary policy.
The practice of keeping interest rates at historically low levels is known as “expansionary monetary policy.” This results in a quicker expansion of the economy. When the economy expands at an excessive rate, it leads to price increases.
The process of pushing interest rates higher is referred to as “contractionary monetary policy.” It does this by increasing the cost of loans and other types of credit, which in turn inhibits economic growth. Because of this, there will be less money available.
Prices are lowered by firms in response to falling demand. This results in a decrease in inflation. This results in a further decrease in demand since customers postpone purchases in the hope that prices will continue to decline.
How exactly does the Federal Reserve lowers interest rates? This results in a reduction in the target for the federal funds rate. In most cases, banks will follow the lead of the Federal Reserve and reduce benchmark rates, such as the prime rate.
The Federal Reserve can also make use of its other instruments, such as reducing the discount rate that banks must pay in order to borrow money directly through the discount window of the Federal Reserve.
The Federal Reserve got inventive in order to fight the financial crisis that occurred in 2008. As a method of injecting more liquidity into the banking system, it made direct purchases of mortgage-backed securities from various banks. Additionally, it began purchasing Treasury bonds. The term “quantitative easing” was coined to describe both of these purchases.
Some people were concerned that the Federal Reserve’s practices might lead to hyperinflation. They maintained that the Federal Reserve was doing nothing more than printing money. However, banks were not making loans, which meant that there was not enough growth in the money supply to produce inflation. Instead, they stocked up on cash in order to cover the cost of a never-ending flood of home foreclosures. The situation didn’t improve until 2011. At that point, the Fed had already begun to scale back its quantitative easing.
Questions That Are Typically Asked (FAQs)
Who served as the chair of the Federal Reserve in 2009 when Time magazine honored him or her as “Person of the Year?”
In 2009, the Chairman of the Federal Reserve, Ben Bernanke, received the “Person of the Year” award from Time magazine.
What exactly is the Federal Reserve responsible for?
The Federal Reserve is the nation’s central bank, and one of its primary responsibilities is to ensure that the economy of the United States functions efficiently. Monetary policy, the supervision of the safety of financial institutions, the facilitation of payment and settlement systems, as well as the promotion of risk management, consumer protection, and community development are all ways that the central bank accomplishes this goal.