FEATURED REPORT

The Federal Reserve

- July 30, 2021
Has it waited too long to curb inflation?
Photo of the Federal Reserve's headquarters in Washington, D.C., on July 24, 2017. (Getty Images/Smith Collection/Gado)
The Federal Reserve, America's central bank, plays an important role in protecting and stabilizing the U.S. economy by controlling inflation, limiting unemployment and regulating financial institutions. In response to the business shutdowns resulting from the COVID-19 pandemic, the Fed undertook a host of aggressive actions to stimulate the economy, including reducing its benchmark interest rate to near zero, establishing massive emergency lending programs and buying large amounts of bonds and other assets. But the economy has revived this year and prices are rising as consumers begin spending again and businesses expand.

What are the principal goals of the Federal Reserve?

How does the Fed seek to achieve these goals? What are the main tools it has to do so?

 
1791–1913A central bank is established in the United States.
1929–1982The Fed's role evolves in the face of depression, war and inflation.
2000–PresentThe Fed wields its authority to stabilize the economy, demonstrating its role and power.
   

Should the Fed consider environmental issues in the development of monetary policy?

Pro

W. Brad Bechtel
Global Head of FX, Jefferies LLC.

Con

As you have previously acknowledged, “society's broad response to climate change is for others to decide — in particular, elected leaders.” We agree with that sentiment but remain concerned that the Federal Reserve … may be preparing to use financial regulation and supervision to further environmental policy objectives. That would be beyond the scope of the Federal Reserve's mission. We urge you to refrain from taking any additional actions with respect to climate-related risks that would impose certain costs for uncertain benefits.

The Federal Reserve's recent actions suggest that [it] may be considering using its financial regulatory authority to play an indirect role in regulating climate change. Last year, the Federal Reserve included climate change in its report on financial stability for the first time, and then announced that it joined the Network of Central Banks and Supervisors for Greening the Financial System. [The Fed also] established a new “Supervision Climate Committee” to further analyze the potential implications of climate change for financial institutions, infrastructure, and markets…. We question both the purpose and efficacy of climate-related banking regulation and scenario analysis, especially because the Federal Reserve lacks jurisdiction over and expertise in environmental matters.

We are also concerned about the value of assessing banks based on inherently uncertain climate models…. [T]here are … substantial methodological challenges associated with assessing climate-related risks that undermine the usefulness of this endeavor. As researchers have noted, current climate models provide little financially meaningful information. Also concerning is the possibility of assessing banks against predictions of what the climate may look like decades in the future — predictions climate scientists have acknowledged are inherently and irreducibly uncertain…. This effort is not grounded in science or economics but is instead a self-fulfilling prophesy: claim there are financial risks with energy exploration and other disfavored investments then use the levers of government — via the unelected bureaucracy — to ban or limit those activities. Such an approach raises serious questions about the relative costs and benefits of climate-related banking regulation….

As you continue to analyze the potential implications of climate change for financial institutions and markets, we urge you to [consider] both the inherent challenges of modeling severe weather events and the limits of the Federal Reserve's statutory authority in this area. Moving forward, we call on the Federal Reserve to be fully transparent with this process and undertake public notice and comment on any contemplated changes to bank regulation or supervision that could result from the Federal Reserve's analysis.

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Discussion Questions

Here are some questions to consider regarding the Federal Reserve:

  • What are the principal goals of the Federal Reserve?

  • How does the Fed seek to achieve these goals? What are the main tools it has to do so?

  • What measures did the Federal Reserve take to buttress the economy during the COVID-19 pandemic?

  • Why do some critics argue that the Fed has waited too long to pull back on its stimulus measures? How do Fed policymakers respond to this criticism?

  • Do you agree with critics that inflation is back and poses a serious threat?

  • In what ways might Federal Reserve policy decisions have an impact on your own community or local economy?

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Chronology

 
1791–1913A central bank is established in the United States.
1791Alexander Hamilton, the first Treasury secretary, leads the formation of America's first national bank, the Bank of the United States, based in Philadelphia.
1811Congress, swayed by some Americans' disapproval of a powerful national bank, refuses to renew the charter of the Bank of the United States.
1816A second national bank is formed, the Second Bank of the United States.
1836President Andrew Jackson persuades Congress not to renew the charter of the Second Bank of the United States, citing what he called the bank's unusual political and economic power and the lack of congressional oversight. The so-called Free Banking Era follows.
1893A banking panic triggers a major economic depression, resulting in the failure of hundreds of banks. Financier J.P. Morgan bails out the banks by leading a syndicate to purchase gold from them.
1907Another major depression hits, caused by the collapse of highly speculative investments. Morgan once again organizes wealthy individuals to bail out banks by providing liquidity.
1913The Federal Reserve is created during Woodrow Wilson's presidency.
1929–1982The Fed's role evolves in the face of depression, war and inflation.
1929On Oct. 28, a stock market crash triggers an economic collapse that becomes the worst depression in U.S. history. By mid-November, the Dow loses approximately half its value and continues to drop until reaching its low point — 89 percent below its peak — during the summer of 1932.
1930-1933Approximately 10,000 banks fail; the money supply drops by 30 percent, leading to deflation, increased debt burdens, reduced consumption and widespread unemployment, forcing banks, companies and families into bankruptcy.
1933-1935Congress passes the Emergency Banking Act, the Glass-Steagall Act, the Gold Reserve Act and the Banking Act of 1935. These measures greatly increase banking regulation, create the Federal Deposit Insurance Corp. (FDIC) to guarantee bank deposits, increase the Fed's powers and separate commercial from investment banking to eliminate conflicts of interest.
1941-1945As the U.S. enters World War II, the Fed focuses on policies to finance the war.
1951-1970The Fed's chair, William McChesney Martin, defends its independence against presidential influence, setting an important precedent.
1965-1982The period of the Great Inflation ensues: Toward its end, prices rise at a rate of up to 1 percent per month and unemployment is rampant. Fed Chair Paul Volker institutes stringent — and unpopular — contractionary policies to curb inflation at the cost of high unemployment and interest rates, stabilizing prices.
2000–PresentThe Fed wields its authority to stabilize the economy, demonstrating its role and power.
2000The “dotcom bubble” — speculative investments in internet and technology stocks — bursts.
2008Subprime mortgage crisis helps to trigger a global financial emergency…. After the financial services firm Lehman Brothers fails, the Fed uses emergency loans to save AIG and other financial institutions.
2009The Fed under Chair Ben Bernanke facilitates mergers of Bank of America and JP Morgan with Merrill Lynch and Bear Stearns, respectively, by guaranteeing bad bank loans. The Fed initiates a bond-buying program known as quantitative easing to stimulate the economy, purchasing over $1.25 trillion in securities and assets.
2010To prevent future destabilizing bank insolvencies, Congress passes the Dodd-Frank Act, empowering the Fed with regulatory and oversight responsibilities.
2020The COVID-19 pandemic causes a global recession. The Fed under Chair Jerome Powell enacts a massive, unprecedented expansionary policy.
2021Vaccine campaigns are successful in some parts of the country, and the economy rebounds. Higher-than-expected inflation sets in, although the Fed and the White House say it is temporary. The Fed revises its policy guidance to signal modest interest rate increases between now and 2023, earlier than originally anticipated.
  

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