The Federal Reserve

Introduction

The Federal Reserve's headquarters is in Washington, D.C. The central bank has a mandate to achieve maximum employment and stable prices and to moderate long-term interest rates. (Getty Images/Smith Collection/Gado)

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Overview

John Kermaj has recently been forced to make changes while grocery shopping on Long Island, N.Y., for his family because of higher prices. “We used to buy this stuff for $30. Now it's $60,” he said. He avoids name brand products and often has to forgo higher-priced items such as meat and fresh fish.1

Rising prices are not limited to groceries. The University of Michigan's May consumer sentiment survey found that “record proportions of consumers reported higher prices across a wide range of discretionary purchases, including homes, vehicles and household durables.”2

Keeping inflation under control is part of the mandate of the U.S. government's central bank, the Federal Reserve. But the price increases working their way through the economy have triggered a robust debate about whether the Fed needs to act — or whether it has already missed its moment.

Consumers, such as these shoppers at a Chicago grocery store, are paying higher prices on a wide range of things, from food and gasoline to vehicles and household goods. While some economists see this as temporary, others urge the Fed to be more aggressive in halting inflation. (Getty Images/Scott Olson)

Fed Chairman Jerome Powell, along with a number of prominent economists, say today's rising prices are temporary, an expected and transitory result of the economy's post-COVID rebound. Other experts fear the economy may be entering a period of prolonged inflation, which the Fed has waited too long to effectively mitigate.

The Federal Reserve's legal mandate, set by Congress, is to protect the U.S. economy by using monetary policy to achieve three objectives: maximum employment, stable prices and moderate long-term interest rates. It seeks to fulfill this mandate, in part, by actions that influence the federal funds rate, the interest rate that financial institutions charge each other for loans in the overnight market.3

The Fed has three principal tools at its disposal to accomplish its goals. One is the setting of its discount rate, the rate the Fed charges banks and other financial institutions for loans through its discount window loan process. A second is buying and selling government securities or other financial assets. A third is setting reserve requirements, collateral that must be held by banks against deposits. All these tools have the potential to influence both short-term and long-term interest rates charged by private-sector lenders, and through those rates the pace of economic activity.

When the economy is overheated, growing at such a rapid rate that it causes inflation, the Fed will raise rates to make the cost of borrowing more expensive and slow things down. When the economy is in a recession, the Fed will lower rates to encourage borrowing and spur purchasing.

Economists have long postulated that there is a “natural” rate of employment, which they define as the lowest level of unemployment the economy can bear without causing inflation. This concept guided Fed policy for many years; when unemployment fell below this natural rate, the Fed would raise interest rates to slow the economy.

For example, during the Clinton administration in the 1990s, Fed Chair Alan Greenspan regarded unemployment rates under 5.5 percent to 6 percent to be an inflationary trigger.4 Similarly, as the economy gradually recovered following the global financial crisis of 2008-09, the Fed under Chair Janet Yellen raised rates in 2015 to slow the economy, even though inflation remained quite low. She was acting on the premise that an unemployment rate below 5 percent would bring about potentially destabilizing wage and price increases.5

This policy approach was based on the so-called Phillips Curve, named after economist A.W. Phillips, which used historical data to show an inverse relationship between unemployment and inflation.6

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However, the latest expansion, which began after the financial crisis and lasted until the COVID-19 outbreak, convinced many economists and policymakers that the economy is capable of sustaining a robust job market without triggering inflation. As a result, the Fed determined it would no longer attempt to predict the natural rate of unemployment or institute interest rate changes based on assumptions about such a rate.

“The relationship between the slack in the economy or unemployment and inflation was a strong one 50 years ago … and has gone away,” Powell, the current Fed chair, told the Senate Banking Committee in 2019.7

Last August, at the central bank's annual conference in Jackson Hole, Wyo., Powell announced a further change in monetary policy strategy. He said the Fed would aim for an average inflation rate of 2 percent over time — rather than treating 2 percent as a cap, as has been the practice historically. Under this new paradigm, the Fed will tolerate inflation above 2 percent “for some time” after periods of low inflation. Powell referred to this strategy as a “flexible form of average inflation targeting,” or “FAIT.” Although Powell did not specify the period over which the average would be calculated, he signaled the Fed's intention to move toward longer-term goals.8

The pandemic caused massive shutdowns of the economy last year and led to tens of millions of Americans losing their jobs. Initially, the stock market fell 40 percent and lending tightened.9 In response, the Fed under Powell cut its benchmark interest rate to near zero and announced a plan to buy $700 billion in Treasury bonds and other assets, a maneuver known as quantitative easing.10

Unemployed residents wait in Frankfort, Ky., for help with their jobless claims in June 2020. Tens of millions of Americans lost their jobs last year as the pandemic caused massive shutdowns in the economy, spurring the Fed to take actions to counteract the downturn. (Getty Images/John Sommers II)

Many economic observers credited these actions with restoring investor confidence in the economy, keeping interest rates on mortgages and credit cards low and ameliorating pandemic-related job losses. Another result was a rebound in the stock market. The Dow Jones Industrial Average hit a low of 18,214 on March 23, 2020, but recovered to reach 30,000 for the first time ever on Dec. 4.11

The Fed under Powell also enacted unprecedented new lending facilities to stabilize the economy during the COVID lockdowns, expanding its lending to state and local governments, large corporations and small and medium-sized business. Recently, Republican lawmakers have sought to curtail the Fed's pandemic lending programs, allowing them to expire without renewal, and to obstruct the Fed's ability to develop new emergency lending programs, saying Congress intended these measures to be temporary.

Most economists assert that keeping the Fed independent from lawmakers is critical to developing sound long-term monetary policy, unbiased by short-term partisan political goals. These economists argue that elected officials have a strong incentive to evaluate policies from a short-term perspective, with a bias toward decisions that will generate favorable approval ratings for them. As a result, elected officials generally favor expansionary policies that will put more money in constituents' pockets but are not always necessarily ideal for creating sustained growth. Mindful of their constituents, politicians are also hesitant to enact policies that will slow or contract the economy. Independence ensures the Fed's ability to institute unpopular policies for the greater good over the long term.

“Careful empirical studies support the view that more-independent central banks tend to deliver better inflation outcomes than less-independent central banks, without compromising economic growth,” then-Fed Chair Ben Bernanke said in a 2010 speech.12

Mark Thoma, an economics professor at the University of Oregon, said the Fed's success in taming inflation in the early 1980s “cemented the idea that an independent Fed could do what elected officials could not.”13

However, some economists voice a counterargument: In a democratic society, elected officials, and not appointed bureaucrats, should set economic policies. Adam Tooze, a Columbia University economic historian, wrote that Congress' enactment of potent stimulus bills to boost the economy during the pandemic was an important affirmation of this principle: “For all the failures and weaknesses of American democracy over recent months, this is a dramatic demonstration of democracy's power to act.”14

It seems clear that the pandemic-related shutdowns and the spending measures adopted to combat them represented a significant departure from Washington's response to previous recessions, which relied more heavily on less visible actions taken by the Fed.

“This is an enduring regime shift,” said Paul McCulley, who teaches at Georgetown's McDonough School of Business. “Having the tools of economic stabilization work a whole lot more through the fiscal channel and a whole lot less through the monetary channel is a profound, pro-democracy policy mix.”15

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One criticism of a reliance on monetary policy measures enacted by the Fed to promote economic expansion is that such actions increase the wealth gap. Lower interest rates may spur economic activity, but they also make stocks and other financial assets more attractive to investors, and thus increase their value. And that favors the already affluent investors who own most of those assets.

Now, with inflation growing at the most rapid pace since 2008, Fed officials are facing greater scrutiny about their policy decisions.16

As economists, policymakers, investors and consumers survey the economic landscape, here are some of the questions they are debating:

Has the Federal Reserve been too slow to counteract new inflationary pressures?

Americans are growing concerned about their diminishing purchasing power in an increasingly inflationary environment.

In the first six months of 2021, the consumer price index, one commonly used measure of inflation, rose at an annual rate of 5.4 percent. Used car and truck prices rose 32 percent over the last six months, and the average national price of gasoline reached a seven-year high of $3.13 a gallon. Housing prices have surged as low mortgage rates and the prevalence of working from home have fueled demand. The S&P CoreLogic Case-Shiller 20 metro-house price index reported a 14.6 percent annual gain in the cost of housing in April, the highest reading in more than 30 years of that index's data.17

Many economists and policymakers, including Fed Chair Powell, contend that a temporary increase in prices is to be expected as the post-pandemic economy reopens and consumers are armed with extra cash for discretionary spending in the form of pandemic savings and stimulus checks. Currently, U.S. households have $2.3 trillion in excess savings. COVID vaccinations and easing government restrictions have released pent-up demand for many goods and services, including travel. This is buoying demand and driving price increases as companies struggle to meet the surge. Powell argues that as supply catches up, prices will stabilize over the medium to long term.18

According to the U.S. Bureau of Labor Statistics, rents heavily influence inflation, contributing nearly 33 percent of the overall consumer price index. Rents rise as the labor market tightens because the demand for rental properties grows. Rental rates are rising and vacancies are falling in all market segments, most drastically in moderate- to low-quality rentals.19

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The U.S. unemployment rate, which peaked at 14.8 percent in April 2020 at the height of the pandemic-related shutdowns, has since then fallen to 5.9 percent in June. While that was still above the prepandemic level of 3.5 percent, employers in many industries say they are experiencing persistent labor shortages; for example, a June survey conducted by the National Federation of Independent Business found that 46 percent of small business owners reported job openings they have not been able to fill.20

The Biden administration says it is watching the situation carefully but does not see a serious problem as yet. “We certainly don't see a level of wage pressures that would be consistent with a very deep supply constraint,” said Jared Bernstein, a member of the White House Council of Economic Advisers. “But, that said, we expect there to be some wage pressure as the labor market tightens up.”21

Companies, already stressed to meet burgeoning demand, will pay higher wages to keep and attract employees — and these increased wage costs will be passed on to consumers as businesses increase prices to maintain profitability. Another response is to cut back on product size — reducing the number of paper towels, for example, or the amount of cat food in a can, while maintaining prices, increasing unit cost.22 Confronted with higher prices, workers will demand to be paid more to maintain purchasing power, creating a snowball effect that could result in runaway inflation without the Fed's intervention.

Some economists are not convinced that today's inflation is temporary, because investor and consumer expectations of inflation tend to be self-fulfilling. If workers believe higher prices and rents are here to stay, they will demand higher wages to maintain purchasing power, setting off a wage-price spiral. Some experts believe this is already happening.

“The economy is overheating and companies, even though we have a high unemployment rate, cannot get the labor they need to meet demand and they are being forced to raise wages,” said Jonathan Golub, chief U.S. equity strategist at the global banking firm Credit Suisse.23

For the Fed, managing the inflation expectations of the financial markets is perhaps even more important than managing consumers' expectations. When investors anticipate inflation, they will demand higher interest rates, or yields, on bonds, and bond prices will fall. Already in 2021, the market is showing signs of investor concerns over inflation in the form of higher yields for U.S. Treasuries due to expectations of rising interest rates. The five-year breakeven rate, a closely watched measure of expected inflation, reached 2.7 percent in May, its highest level since just before the 2008-09 financial crisis.24

Although the economy is rebounding, Powell has said it still has a way to go to reach prepandemic levels.25 The Fed has repeatedly announced its intention to keep its benchmark rate near zero until 2023 and to continue its crisis-level bond purchase program of $120 billion per month to support the economy.

In testimony given July 14 on Capitol Hill, Powell reiterated that it would be an error to adopt a tighter monetary policy now. “Honestly, it would be a mistake to do it at a time when virtually all forecasters believe that these things will come down on their own accord,” he told House lawmakers. “It would be a mistake to act prematurely.”26

Federal Reserve Board Chairman Jerome Powell told members of Congress in June that it would be a mistake to fight inflation by raising interest rates because price increases on consumer goods will soon start to abate. (Getty Images/Graeme Jennings)

But Powell also acknowledged that the price runups surprised him and other Fed policymakers — and that they might have to change course if the situation persists. “The challenge we're confronting is how to react to this inflation, which is larger than we had expected — or that anybody had expected,” he told a Senate committee on July 15. “And to the extent it is temporary, it wouldn't be appropriate to react to it. But to the extent it gets longer and longer, we'll have to re-evaluate the risks.”27

The sensitivity of the subject was vividly illustrated by the financial markets' reaction to comments by Yellen, who is now Treasury secretary, in May. “It may be that interest rates will have to rise somewhat to make sure our economy does not overheat, even though the additional spending is relatively small relative to the size of the economy,” Yellen told The Atlantic. “It could cause some very modest increases in interest rates to get that reallocation.”

In response to her remarks, the stock market briefly dipped over concerns of inflation and rate increases. Yellen tempered her statement later that day, stating, “I don't think there's going to be an inflationary problem, but if there is, the Fed can be counted on to address them.”28

Other experts have their doubts. One of them is Lawrence Summers, who served as Treasury secretary under President Bill Clinton and as a key adviser to President Barack Obama at the start of the financial crisis.

Despite this Democratic pedigree, Summers has repeatedly warned that President Biden's latest stimulus package would overheat the economy and argued that the current price surge is likely not transitory.

“There is much clearer evidence of labor shortage, there are more and more pervasive supply bottlenecks, commodities and future commodities prices are rising,” he said. “Housing is on fire, and market inflation expectations are trending upwards. None of these are inherently transitory factors, so to my mind, grounds for concern are increasing.”29

Despite Summers' warnings, Biden on May 28 announced a $6 trillion budget proposal for fiscal 2022, about a third of which would be funded through debt. Summers said in response that monetary and fiscal policymakers had “underestimated the risks, very substantially.”

“Policymakers at the Fed and in the White House need to recognize that the risk of a Vietnam inflation scenario is now greater than the deflation risks on which they were originally focused,” he told CNN. “Whatever was the case a few months ago, it should now be clear that overheating — not excess slack — is the dominant economic risk facing the US over the next year or two.”30

Former Fed Governor Kevin Warsh has written that the central bank under Powell has effectively forsaken efforts to pre-empt harmful developments, such as excessive inflation, in favor of a more reactive approach. The problem, he wrote in The Wall Street Journal, is that changes in economic policy can take a long time to have an impact on the economy — and by then it may be too late. “The Fed says it has the tools to stop an inflationary surge, but its new regime promises a tardy response,” Warsh wrote. “Late by design, the Fed would have to tighten policy more to stop an inflationary surge.”31

The disagreement is unsurprising, given the unprecedented situation brought about by the pandemic. Financial factors cause most recessions. The economic effects of COVID-19 are more like those of a natural disaster. Under these unique circumstances, it is difficult to make predictions. “We've never had anything like it — a collapse and then a boom-like pickup,” said Allen Sinai, chief global economist and strategist at Decision Economics, Inc., a research and consulting firm. “It is without historical parallel.”32

Are some Federal Reserve policies increasing the wealth gap in the United States?

Income and wealth inequality have worsened steadily since the 1980s. Currently, one quarter of Americans have zero or negative savings, while the top 10 percent of Americans own 70 percent of the wealth in the United States. Over the last 40 years, income of those in the bottom 10 percent has risen only 20 percent, while income of those in the top 10 percent has increased 66 percent.33

Automation, demand for college-educated workers, a cheap worldwide labor pool and globalized commerce have all exacerbated wealth inequality. And some economists cite the Federal Reserve's monetary policies as a factor, arguing that they disproportionately aid the wealthy.34

An expansionary monetary policy — keeping interest rates low to stimulate economic growth — should hold benefits for Americans of modest means. An analysis by the Federal Reserve Bank of New York found that, over a recent five-year period, expansionary monetary policy led to greater employment and income gains for lower-income people. In theory, expansionary policies would also help narrow the wealth gap — if a portion of the additional income was saved. But such policies have another effect: They increase the value of stocks and other assets, and that mostly benefits the affluent.35

Most owners of stocks are upper middle class or wealthy. The wealthiest 10 percent own 89 percent of stocks and mutual fund shares. The top 1 percent own 53 percent of stock market shares. Most middle- and low-income families do not possess large stock holdings because they have limited savings, cannot tolerate the risks of the stock market or lack the knowledge and access to invest. As a result, most middle- and lower-income Americans have failed to benefit from the multi-trillion-dollar increase in stock market values that resulted from the Fed's expansionary policies.36

This disparity led Chris Gaffney, the president of world markets at TIAA Bank, to call Fed Chair Powell the “head of state for Wall Street.”37

Home prices have also benefited from the Fed's policy of keeping interest rates low, with values rising approximately $1.3 trillion from March 2020 through the end of the December, according to the Fed. And 45 percent of U.S. real estate is owned by the wealthiest Americans.

While middle-income Americans have also benefited, the rise in home values has been far less dramatic than the $22.4 trillion increase in the stock market. Olivier Blanchard, former chief economist for the International Monetary Fund, said that changes in interest rates have “major, major distribution effects between borrowers and lenders, between asset holders and not.”38

Wealth disparities, and the policies that may produce them, have drawn increased scrutiny in the heightened debate about racial and social equity sparked by the police killing of George Floyd last year and similar incidents. Floyd's killing in Minneapolis led to protests in more than 50 countries.39 The demonstrations created “a watershed moment,” says Alex Braly James, a diversity consultant who advises companies on issues of racial justice. She says that since Floyd's death, the number of diversity trainings her consulting firm has performed has increased two to three times.

Former Fed Chair Bernanke acknowledged in 2017 that, “all else [being] equal, higher stock prices mean greater inequality of wealth.” But he added that “whatever effects monetary policy has on inequality are likely to be transient, in contrast to the secular forces of technology and globalization that have contributed to the multi-decade rise in inequality in the United States.”40

In any case, Bernanke said in 2015, the “distributional impact of monetary policy should not prevent the Fed from pursuing its mandate to achieve maximum employment and price stability, thereby providing broad benefits to the economy.” Donald L. Kohn, who served as Fed vice chairman under Bernanke, offered a similar viewpoint. “It would be wrong for the Federal Reserve to say that we are going to take longer” to stabilize the economy due to equality concerns, Kohn said.41

Powell, the current chair, offered a similar defense at a congressional hearing in February. “We can't affect wealth inequality,” he said. “We can indirectly affect income equality by doing what we can to support job creation at the lower end of the market.” When pressed by Sen. Elizabeth Warren, D-Mass., a longtime advocate of government action to reduce income inequality, to discuss how monetary policy affects inequality, Powell demurred. “Those are really fiscal policy issues,” he said.42

Warren wants to make them monetary issues as well. Warren, Rep. Maxine Waters, D-Calif., and Sen. Kirsten Gillibrand, D-N.Y., have introduced legislation that would make social justice a part of the Fed's formal mandate. While passage in the current Congress will be an uphill effort, given the lack of any Republican cosponsors, Warren hopes to use the proposal to focus attention on the issue. “Systemic racism and inequality is not something that happens on its own — it is a result of specific policy choices and the Fed must take deliberate action to fix it,” Warren said.43

Should Congress curtail the Federal Reserve's independence?

Most economic experts believe that insulating the Federal Reserve from political pressures is essential. Only an independent central bank, they say, can have the latitude to set monetary policies that are in the best long-term interests of the economy, even if they may conflict with the short-term interests of presidents or lawmakers.

The Fed's necessary role as the adult in the economic house was memorably summed up back in 1955 by then-Chair William McChesney Martin, who said the bank should act as if it were “the chaperone who has ordered the punch bowl removed just when the party was really warming up.”44

But that has not stopped politicians from trying to exert influence on the Fed. They have done so through two principal means, according to Jerry Jordan, former president of the Federal Reserve Bank of Cleveland, and William Luther, an economics professor at Florida Atlantic University. One is the president's legal authority to appoint, with Senate consent, the seven members of the Fed's Board of Governors, who form the core of the bank's Federal Open Market Committee that sets the Fed's benchmark interest rate. The second is congressional oversight, exercised primarily through the Senate and House committees that have jurisdiction over the Fed.45

In a study published last year, Jordan and Luther concluded that Fed independence was more illusory than real — and that some of the bank's own policy decisions in recent years had inadvertently increased its exposure to political pressures. They compared the Fed to other central banks in scores of countries and concluded that, in terms of independence, it ranked only in the bottom one-fourth. “The Fed is not independent — and it is not even close,” they wrote.46

The most recent attempt to impose significant restrictions on the Fed came at the end of last year. First, then-Treasury Secretary Steve Mnuchin announced in November that he would not extend funding for a lending program adopted by the Fed to help businesses and state governments cope with the economic effects of the pandemic. In addition, Mnuchin demanded that all unused funds for the program — $455 billion out of a total of $500 billion originally appropriated — be returned to the Treasury. Many Democrats saw this as a Republican maneuver to hamstring the incoming Biden administration.47

Sen. Pat Toomey, R-Pa., introduced a legislative measure last year that would have barred the Fed or Treasury from creating any new lending programs, an effort many Democrats said was intended to hamstring the incoming Biden administration. While most economists say an independent Fed is essential, some experts say it is far from autonomous. (Getty Images/Drew Angerer)

Then, one month later, as Congress was nearing final passage of a $900 billion COVID-19 relief measure, Republican Sen. Pat Toomey of Pennsylvania demanded that the bill contain a provision barring the Fed or the Treasury from creating any new lending programs. Toomey argued that his proposal was simply intended to codify in law the original intent of the earlier act that had authorized the Fed's lending. But Democrats asserted that it went further — and, once again, said it was aimed at weakening the new administration. The impasse was resolved by a compromise that barred the Fed only from reviving a lending program that was identical to the previous effort.48

Toomey said that his effort, far from trying to politicize the Fed, was actually aimed at insulating the central bank from politics. “These are unprecedented, extraordinary powers, and they're only justifiable in a real emergency,” he said. “My concern was there would be tremendous political pressure to misuse these, to morph these liquidity facilities that had successfully restored market liquidity and turn them into an instrument of fiscal policy, which is a terrible idea.”49

Charles Plosser, the former president of the Federal Reserve Bank of Philadelphia, shares this concern. He noted that, because of new monetary policy instruments developed to address the global financial crisis, the Fed now has the ability to substantially increase its balance sheet without necessarily causing inflation.

“A large balance sheet unconstrained by monetary policy is ripe for abuse,” Plosser wrote last year. “Congress and an administration would be tempted to look to the balance sheet for their own purposes, including credit policy and off-budget fiscal policy.”50

Powell, for his part, has insisted that the Fed pays no attention to politics. “We never take into account political considerations,” he said in 2019, in denying that a decision to lower interest rates had come in response to pressure from President Donald Trump. “There's no place in our discussions for that. We also don't conduct monetary policy in order to prove our independence.”51

But economic experts note that Congress created the Fed through the Federal Reserve Act of 1913 and has the ability to alter the Fed's powers, something Fed officials can hardly ignore. Over its lifetime, the Federal Reserve Act has been amended more than 200 times — to impose new responsibilities on the Fed, to increase its transparency or to limit its powers.52

If the Fed's policies vastly deviate from the wishes of Congress, the bank runs the risk of a reduction in independence. In fact, the Fed in the past has adjusted its policy decisions under threat of bills that would curb its authority. In the 1970s, for example, the Fed lowered the federal funds rate below the target rate proposed by economic models in response to proposed bills that threatened its powers.53

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Background

A Tale of Two Banks

Alexander Hamilton, the first Treasury secretary, led the formation of America's first national bank, the Bank of the United States, based in Philadelphia, in 1791. Hamilton believed a national bank would improve government finances and enhance the nation's credit internationally. The Bank of the United States did not enact monetary policy, but was the only bank permitted to have branches in multiple states and to lend to the government. Many Americans, primarily in the agrarian South, disapproved of the idea of a single large and powerful bank, preferring instead to deal with their local state banks. When the Bank of the United States' charter expired in 1811, 20 years after its creation, Congress blocked its renewal — by just one vote.54

In 1816, Congress approved the Second Bank of the United States. However, when populist Andrew Jackson became president in 1829, he was determined to dismantle it. His warnings about bankers holding too much power resonated with the public. When the Second Bank's charter expired in 1836, it was not renewed.55

Andrew Jackson, the seventh president of the United States, opposed a national bank, saying it gave bankers too much power. When the charter of the Second Bank of the United States expired in 1836, Congress did not renew it, ushering in a period known as the Free Banking Era. (Getty Images/Universal History Archive/Universal Images Group)

The period that ensued was known as the Free Banking Era. State-chartered and wholly unchartered banks proliferated, issuing their own notes backed by government securities, but the notes were unregulated and offered at different rates in different regions. Bank runs and financial panics were common.56

In 1893, a banking panic triggered the worst U.S. depression to date. Hundreds of banks closed and unemployment reached 25 percent. Financier J.P. Morgan bailed out the banking system by organizing a syndicate to purchase gold from U.S. banks to provide liquidity. This triggered awareness among politicians about the necessity for banking reform. Between 1893 and 1907, politicians, bankers and businessmen repeatedly proposed such reforms to Congress, but no action was agreed upon.57

In 1907, another depression occurred due to the collapse of highly speculative investments and lack of government control of the money supply. It led to a mass run on the banks and plummeting stock values. Morgan again stepped in and persuaded fellow financiers, including John D. Rockefeller, and Treasury Secretary George Cortelyou, to join him in providing bailout liquidity to Wall Street banks and other financial institutions.58

Realizing the perils of relying on wealthy citizens to ensure economic stability, Congress passed the Aldrich-Vreeland Act in 1908. The act established the National Monetary Commission, which was charged with devising laws to safeguard the banking system. But Democrats and populists were wary of allowing bankers to have too much power over the national financial markets. As a result, it took three years and multiple proposals before lawmakers reached agreement on a more permanent solution.

President Woodrow Wilson signed the Federal Reserve Act in 1913. A system of 12 regional banks was formed and a Federal Reserve Board was established in Washington.59

The Fed primarily focused on war finance at the expense of inflation during World War I. It pushed war bonds by lending at a discount to banks when the proceeds were being used to purchase war bonds or treasuries. The low lending rates stimulated the economy but also led to inflation. The Fed could have raised rates to curb inflation, but did not, seeking instead to limit the Treasury's cost of debt in financing the war. “Independence was sacrificed to maintain interest rates that lowered the Treasury's cost of debt finance,” economist Alan Meltzer wrote in his book, A History of the Federal Reserve. 60

The war established the U.S. dollar as a global currency. U.S. gold holdings increased, as $1.3 billion worth of gold flowed from Europe to pay for American exports such as food and munitions. As the Fed's coffers grew, it was able to purchase more government securities, which would become an important monetary tool after the war. In addition, European currencies became unstable during the war, making the dollar a preferred currency for international trade. Credit was also hard to obtain in wartime Europe, which further increased international use of the dollar.61

Depression

On Oct. 28, 1929, the Dow Jones Industrial Average fell 13 percent. The next day, it dropped an additional 12 percent. By mid-November, the Dow had lost approximately half its value. It continued to fall until the summer of 1932, when it reached its low point of 89 percent below its peak. The market crash triggered a financial crisis in which almost 10,000 U.S. banks failed between 1930 and 1933. The worst economic collapse in U.S. history — the Great Depression — followed.62

Leading up to the crash, the Fed had been wary of the market's exuberance. The Fed board believed speculative investments diverted resources from real products and services. The board asserted that the “Federal Reserve Act does not … contemplate the use of the resources of the Federal Reserve Banks for the creation or extension of speculative credit.”63

The Fed sought to curb speculative investments by educating people about the dangers of speculation. After the crash, it denied requests for loans from reserve banks to private banks that loaned to speculative investors.64 The Fed also raised interest rates with the goal of dissuading risky investments; but this had the unintended consequence of further slowing the U.S. economy. It also helped spread the economic slowdown to other countries.65

The Fed's board of governors disagreed on the best course of action. Some governors argued for loaning funds to solvent financial institutions at high rates. Others favored a policy of cutting back on lending and allowing weak financial institutions to fail.66 The Depression-era Fed was unable to come to consensus quickly and lagged behind events.

Due to this indecision, the Fed failed to adequately prop up the money supply. From 1930 to 1933, the U.S. money supply dropped by 30 percent, which led to deflation, increased debt burdens, reduced consumption and more unemployment. It forced many banks, companies and families into bankruptcy.67

In reaction to the Depression, Congress reformed the Fed and much of the financial system. The 1933 Glass-Steagall Act legally separated commercial and investment banking and established the Federal Deposit Insurance Corp. (FDIC) to guarantee bank deposits. The Gold Reserve Act of 1934 transferred all gold ownership to the Treasury. The Banking Act of 1935 changed the Fed's structure by establishing the Federal Open Market Committee to set rates and removed the Treasury secretary from the Fed's board of governors, granting the Fed enhanced independence.68

War and Postwar

When the United States entered World War II after the Japanese attack on Pearl Harbor in 1941, the Federal Reserve declared that it was “prepared to use its powers to assure at all times an ample supply of funds for financing the war effort.”69 That became the Fed's primary objective.

The Treasury and the Fed collaborated on a plan to finance military expenditures through a combination of taxation and domestic borrowing. The Fed created Victory Fund committees to market a wide variety of war bonds to investors, from small savers to corporations with large reserves. To encourage the war bond effort, the Fed reduced the discount rate to 1 percent — well below the 3 percent to 7 percent rates of the preceding decade.70

To prevent wartime inflation, Congress introduced bills to regulate prices and rationing of scarce items. Congress also enabled the Fed to purchase securities directly from the Treasury and exempted war loan deposits from banks' reserve requirements during wartime.71

Americans line up in 1942 to buy rationed sugar. To prevent inflation during World War II, the federal government regulated prices for many commodities and rationed scarce goods. (Getty Images/Smith Collection/Gado)

The Fed grew during the war from 11,000 employees in 1939 to a high of 24,000 by 1944. The majority of this expanded workforce worked with the Treasury on war loan drives. Most of the bonds were in small denominations of $25 or less, necessitating a large workforce.72

From 1951 to 1970, the Fed was run by Martin, who became the longest-serving chairman in the bank's history. Martin, who previously served as the president of the New York Stock Exchange, was especially wary of inflation — leading to his “take away the punch bowl” comment.73

During the Johnson administration in the 1960s, massive spending was required to fund the Vietnam War and the Great Society anti-poverty programs. Not wanting to raise taxes, President Lyndon B. Johnson pressured the Fed to lower rates to make borrowing easier, particularly for defense companies. Martin refused to comply, asserting the Fed's independence to set rates free of political pressure. Nonetheless, inflation began to rise at the end of his chairmanship, in part because his Fed prioritized fighting unemployment over price stabilization.

The Great Inflation

The runup of inflation that began in the 1960s and extended into the early 1980s seriously damaged the U.S. economy. During this so-called Great Inflation, the economy suffered four recessions, two energy crises and an unprecedented imposition of peacetime wage and price controls. The consequences included lost economic growth, a damaged stock market, rising unemployment and volatility of the U.S. dollar abroad. Jeremy Siegel, a finance professor at the University of Pennsylvania, called it “the greatest failure of American macroeconomic policy in the postwar period.”74

Inflation rose from 1 percent in 1965 to above 15 percent by 1979. During the period from 1969 to 1982, unemployment rose from 3.5 percent to 9.7 percent. When President Jimmy Carter appointed Paul Volcker as Fed chair in the summer of 1979, inflation was rising at a rate of 1 percent per month.75

Volcker's predecessor, Arthur Burns, had declared that it was “illusory to expect central banks to put an end to inflation.” President Richard Nixon had commanded Burns to make sure there was no recession, and he capitulated. Volcker had other ideas.76

The new Fed chair made controlling inflation his first priority. Inflation was worsening, seemingly uncontrollably, due in part to the oil shocks of 1973 and 1979. Volcker announced that instead of directly targeting rates, he would target the amount of bank reserves and allow the federal funds rate to go as high as necessary to organically reduce reserves. He was well aware his plan would result in skyrocketing interest rates and higher unemployment, which would be painful and unpopular. At the start of Volcker's stint as chair, the fed funds rate was at 11 percent. By June 1981, it was over 19 percent. The prime rate, which private banks made available to customers with the best credit, soared to a high of 21.5 percent. Business activity slowed and by the end of 1982 unemployment reached 10.8 percent.77

A weary-looking Federal Reserve Chair Paul Volcker explains in 1982 why curbing inflation requires allowing interest rates and unemployment to rise. (Getty Images/Bettmann/Contributor)

Volcker was reviled by many business people, members of Congress and ordinary Americans whose mortgage rates skyrocketed to 18 percent. Despite his unpopularity, Volcker stayed the course, asserting that a recession was an acceptable price to pay for ending runaway inflation. By 1985, inflation began to decline significantly and Volcker finally eased monetary policy. In 1987, his final year as chair, average annual inflation was just 3.6 percent.78

Greenspan and Beyond

Greenspan succeeded Volcker as Fed chair during the Reagan administration. Greenspan was opposed to rigid regulation, believing in the efficacy of free markets. During his 18-year tenure, which ended in 2006, inflation remained tame and employment was high, in large part due to the development of the internet and e-commerce.

In 2008, the global financial crisis, triggered by widespread failures of so-called subprime mortgage loans made to borrowers with weak credit ratings, crushed markets across the globe. Some critics have blamed Greenspan's easy-money policies for causing or exacerbating the crisis. For example, the “Greenspan put” was a highly criticized policy that created moral hazard — a lack of incentive to protect against risk of loss — for sophisticated investors.79 Because of the widespread belief that the Fed would take steps such as reducing the fed funds rate to limit investor losses, some were emboldened to take excessive risks.

In retrospect, Greenspan acknowledged during a congressional hearing in October 2008 that his anti-regulatory stance related to derivatives and subprime mortgages and reliance on the self-correcting mechanism of the markets were flawed. “Those of us who have looked to the self-interest of lending institutions to protect shareholders' equity, myself included, are in a state of shocked disbelief,” he said. “This crisis has turned out to be much broader than anything I could have imagined. It has morphed from one gripped by liquidity restraints to one in which fears of insolvency are now paramount.”80

Bernanke, a Princeton economics professor, succeeded Greenspan. Bernanke led the Fed's response to the global financial crisis by slashing rates to zero and implementing quantitative easing, an innovative program in which the Fed purchased billions of dollars of mortgage-backed securities and long-term Treasuries to stimulate economic growth.81 Because the Fed purchased these securities in large blocks, demand for them increased, which in turn caused prices to rise and interest rates to fall, which stimulated production and job creation.

Many economic observers credit Bernanke with saving the U.S. financial system and forestalling another Great Depression by bailing out large financial companies, such as AIG, on the theory that the aftermath of a potential bankruptcy for such companies would be a worse outcome for the economy. Bernanke also encouraged Bank of America to merge with Merrill Lynch and JP Morgan Chase to merge with Bear Stearns by guaranteeing the bad loans of the troubled institutions. While these bailouts generated fierce resentment among many Americans, especially those who lost their homes due to mortgage foreclosure during the crisis, Obama credited Bernanke's crisis policy, courage and creativity with preventing a depression. Bernanke, in his book, The Courage to Act, wrote that the global financial markets nearly collapsed in 2008, necessitating extreme measures.82

Bernanke's successor, Yellen, was the first woman to serve as Fed chair. She was appointed by Obama after serving as vice chair during the Clinton administration. In contrast to Greenspan's philosophy, Yellen believed that markets require government regulation. During her term, she tightened financial and banking regulations. She began to sell off Treasury and mortgage bonds the Fed had purchased under quantitative easing. Under her leadership, unemployment fell from 6.7 percent to 4.1 percent, the greatest decline of any Fed chair term, while inflation remained below 2 percent.83

“If we judge the Fed by its capacity and its performance in hitting the mandates or the objectives that Congress gives it — price stability, maximizing employment — the record of the economy under her chair has been just shy of stellar,” Sarah Binder, a senior fellow at the Brookings Institution, a centrist think tank, said of Yellen.84

Nonetheless, Trump did not reappoint Yellen, and she became the first chair in over 40 years to only serve one term. Trump nominated Powell to replace her.

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Current Situation

Inflation Fears

The Fed and the White House's continued coordinated message, reassuring Americans that inflation is transitory, is attracting growing skepticism. The 5.4 percent increase of the consumer price index in June was higher than anticipated by most economists and was the biggest surge in prices since 2008.85

In an appearance before the House Financial Services Committee on July 14, Powell said most of the price increases were centered in a small group of goods and services in parts of the economy that were reopening after being shuttered by the pandemic. He said long-run inflation expectations remained stable, while adding that the Fed was prepared to take action through monetary policy changes if the price increases proved to be persistent.86

Earlier, on June 16, Powell announced that Fed officials now anticipate making two interest rate increases by the end of 2023, a departure from their previous stance in which they promised to keep rates at zero through the end of 2023. Powell said he expected the benchmark rate to be at 0.6 percent by the end of 2023. The Fed also increased its 2021 inflation forecast to 3.4 percent, up from 2.4 percent, and its GDP growth forecast to 7 percent, up from 6.5 percent. In response to the news, the stock market dropped. In anticipation of higher rates, 10-year Treasury yields rose to 1.56 percent.87

After its July 28 meeting, the Fed said in a statement that the economy “has made progress” toward achieving the goals of maximum employment and price stability. Observers called it an indication that the Fed might start scaling back the pace of its monthly bond purchases later this year. But Powell, speaking to reporters after the meeting, said the economy still had “some ground to cover on the labor market side.”88

Meanwhile, Republicans remain skeptical and blame Biden's spending plans for the greater-than-expected inflation. Sen. Rick Scott, R-Fla., called on Biden to “realize that reckless spending has consequences, inflation is real and America's debt crisis is growing.” Republicans hope the issue will have political resonance; Rep. Jim Banks, R-Ind., said his party should “tie inflation to the Biden economic agenda and explain to voters how inflation is Democrats' hidden tax” on the middle class.89

A 2019 agreement suspending the legal limit on how much debt the federal government can incur expires on Aug. 1. Republicans aim to leverage the renegotiation on federal debt to push for spending cuts. Republicans are negotiating from a position of strength, because failure to reach an agreement on the debt ceiling would cause the federal government to default on its debt obligations and could trigger a stock market crash.

“Given the worsening fiscal outlook for the federal government and at least three and a half more years of President Biden proposing trillions and trillions of dollars of deficit-financed spending, it is more important than ever for conservatives to reclaim the debt limit as a tool to highlight and force action on our nation's spending problem,” Banks said.90

The U.S. Chamber of Commerce agrees with the GOP's stance. “For the most part, the administration can't do a lot about inflation. But what they can do is not make it worse by having huge spending bills,” said Curtis Dubay, senior economist at the chamber.

The Business Roundtable, comprised of prominent CEOs, also doubts that inflation is temporary. “The hope of the Fed is that this is transitory. The question is, how long is transitory? Is it six months? Is it 12 months? Or have we gotten into what would unfortunately be an inflationary cycle where wage growth follows wage growth follows wage growth, which means it's not transitory,” said Gregory Hayes, CEO of defense contractor Raytheon Technologies.91

The answer relies upon consumer and investor expectations. “In the next few months, we'll have very high inflation numbers,” said Randall Kroszner, a former Fed governor. “It's unlikely to persist, but it's a real risk that it does. That risk is higher now than it has been for decades. Will consumers accept it as temporary? We really don't know. In some ways, this is faith-based monetary policy.”92

Job Market

The U.S. economy added 850,000 jobs in June, more than experts had predicted, after two months of gains that had fallen short of expectations. There is an imbalance between the number of unemployed workers and millions of vacant job openings. The Labor Department reported in July that there were 9.2 million job openings, the most since 2000. Despite this, 9.3 million are unemployed.93

The pandemic has changed work culture in many industries, perhaps forever. The consulting firm McKinsey & Company's Global Institute predicts that approximately a quarter of workers are likely to work at least three to five days a week from home going forward.94 Workers seeking better work-life balance are better positioned to demand better circumstances and benefits, given the tight job market.

A Popeyes restaurant in Miami advertises for workers in February. There is a disconnect between the number of unemployed workers and abundant job vacancies, with the Labor Department reporting nearly 9.2 million positions open and 9.3 million people out of work. (Getty Images/Joe Raedle)

The pandemic has also served as a wake-up call to many Americans who are either changing careers or taking advantage of retirement portfolio gains and retiring. A Pew Research Center survey this year found that 66 percent of the unemployed had “seriously considered” changing their field of work. Four million people quit their jobs in April, the highest ever. New business applications increased 24 percent in 2020, the largest increase ever recorded.95

Workers are empowered to be selective about job choices in this environment. A U.S. Chamber of Commerce survey in May showed 61 percent of unemployed people were in no hurry to return to work. Three in 10 said they did not expect to resume working this year. Many continue to collect unemployment benefits and are emboldened to try for something new or wait for the right opportunity. There are a plethora of restaurant and hospitality jobs to fall back on. For instance, Indeed.com has job openings for line cooks paying up to $35 an hour.96

When companies cannot fill job openings, they raise wages. The average hourly rate in the hospitality sector is up $1 from before the pandemic. But competition for labor is fierce. Warehouses have increased wages even more, now offering $26 an hour on average, significantly higher than the average hourly rate of $18 per hour in hospitality. Overall average hourly earnings have risen 2 percent since last year, pointing to more inflation as companies pass on higher labor costs to consumers.97

Rising housing prices are also pushing wages and prices up. National home values are up 15 percent since last year.98 Some experts believe the United States may be approaching a rental crisis. A federal government moratorium on many evictions expires at the end of July and rents are already up 9.2 percent in the first half of 2021, according to the online marketplace Apartment List.99 As rents rise, inflation is likely to result.

Social Justice

Issues such as social justice and climate change mitigation are not part of the Fed's official mandate. However, some Democrats, such as Sen. Warren and Rep. Waters, would like the Fed to address them. Critics are calling this “mandate creep” and warn that pursuing policy integrating social goals could lead to unfair lending practices.

As a presidential candidate, Biden in July 2020 urged the Fed to “aggressively target persistent racial gaps in jobs, wages and wealth.” A month later, Democrats proposed legislation that would expand the Fed's mission to include reducing racial inequality in the economy. The Federal Reserve Racial and Economic Equity Act would require the Fed “to minimize and eliminate racial disparities in employment, wages, wealth, and access to affordable credit.” Proponents of the measure cited the fact that the unemployment rate for Black Americans has been twice that for white Americans for decades and that the average white family's net worth was 11 times higher than that of a Black family as of 2016.100

Ron Feldman, first vice president at the Federal Reserve Bank of Minneapolis, said that racial inequality should be a primary focus for all banking regulators. “Are there things around credit, through the allocation of credit that are critical in ensuring that, in fact, there is more racial equality going forward than there are today? I do think that is a very important area to look [at],” he said.101

The Federal Reserve Bank of San Francisco published a “Racial Equity Primer” last year. That drew a sharp retort from Sen. Toomey. “The Federal Reserve's independence and careful adherence to nonpartisanship has allowed it to avoid being seen as a politicized body,” he wrote in a letter to Mary C. Daly, the president of the San Francisco bank. “The Federal Reserve may pursue mission creep or welcome itself to political capture. But such activities are inconsistent with its statutory responsibilities; only Congress has the authority to reform the Federal Reserve or modify its mission.”102

Toomey is not alone in arguing that socializing monetary policy risks eroding the Fed's credibility. Peter Conti-Brown, a Fed historian at the University of Pennsylvania, warned that if the central bank seems too much like a “Democratic institution” it could lose bipartisan support.103

Fed Chair Powell has acknowledged inequalities, especially in how lower-income Black and Hispanic women were disproportionately affected financially by the pandemic. Powell has placed greater focus on maximizing employment, particularly among low-income workers and minorities, than on controlling inflation. But he argued that Congress should lead social justice initiatives, because the Fed does not “really have the tools that can address distributional disparate outcomes as well as fiscal policy.”104

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Outlook

Unique Time

There is uncertainty in the financial markets regarding inflation and monetary policy going forward. New vaccine-resistant variants of the coronavirus, uncertainty around Biden's fiscal plan and the impact of bottlenecks in the supply chain are all unknown quantities.

“This particular inflation is just unique in history,” Powell told lawmakers on July 15. “We don't have another example of the last time we reopened a $20 trillion economy with lots of fiscal and monetary support. We are humble about what we understand.”105

For a time, the Fed was providing firm forward guidance that rates would remain near zero until the end of 2023. Since the Fed changed its tune in June, due to concerns that inflation will last longer than previously expected, investor and consumer sentiment are likely to have changed in response.

Some analysts say Powell's memory of the 2013 “taper tantrum” may make him wary about being too specific about the Fed's intentions on monetary policy. In that incident, then-Chair Bernanke was quite specific in public comments about the conditions under which the Fed would pare back its bond purchases. The price of 10-year Treasury notes fell dramatically in reaction.106

Powell's ambiguity was on display in June as he answered a question about cutting back on bond purchases.

“You can think of this meeting as the ‘talking about talking about’ meeting, if you like,” he said. “The economy has clearly made progress, although we are still a ways from our goal of substantial further progress. Assuming that is the case, it will be appropriate to consider announcing a plan for reducing our asset purchases at a future meeting.”107

Federal Reserve Bank of St. Louis President James Bullard told CNBC, “I put us starting in late 2022” at raising rates, while recent guidance pointed to 2023 before rate increases were expected.108

Powell revised his inflation expectations to be approximately 3.4 percent this year. Given the Fed's new stance of targeting average 2 percent inflation over time, it is very likely inflation will be above 2 percent for a continued period. While there are good reasons to expect inflation in the near to medium term, the long-term outlook is less clear.

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Pro/Con

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

Pro W. Brad Bechtel Global Head of FX, Jefferies LLC. Written for CQ Researcher, July 2021 (The views expressed herein are those of the author and not necessarily those of his employer.) The mandate of the Federal Reserve is to foster economic conditions that achieve both stable prices and maximum sustainable employment. The Fed also has a mandate for the financial system that includes regulation and supervision of banks and their affiliates. Concurrent with these broad powers, financial stability is necessary for the Fed to be able to achieve its mandate. No better example of this can be found than the financial crisis of 2008-09 and the COVID-19 crisis of 2020. In both instances it was necessary for the Fed to implement extraordinary measures to ensure financial stability and achieve its broader mandates. Climate change will be no different and will require no less from the Fed. While climate change is a cumulative impact that will be difficult to quantify or measure on a day-to-day basis, its effect could be no less severe than what we have seen in the last two major financial crises. The physical impact associated with tornadoes, hurricanes, or rising sea levels can have a sudden and devastating impact on a regional economy. Transition-related effects associated with changing climates may leave large areas of land unusable and require immediate and long-lasting levels of economic support. Such disruptions could lead to widespread financial instability at a local, regional, national or global level depending upon the timing, depth, and severity of the impact. It is essential for the Federal Reserve to waste no time in building out its capability for modeling and forecasting climate change in order to ensure financial stability when climate-related crises emerge. Including climate change as part of the financial stability responsibility of the Fed, in association with its existing responsibilities under the Financial Stability Oversight Council, is essential in ensuring the proper implementation of the Fed's dual mandate as we navigate climate change and its impact on our economies. Failure to include the Federal Reserve in climate change initiatives will leave its member banks and those financial institutions it regulates without a leader on climate change. Such a failure will also isolate the Fed on the global stage as other central banks race to integrate climate change into their purview. Keeping the Federal Reserve integrated into the broader climate change initiative is essential for ensuring the financial stability of the United States as we navigate this enormous challenge. Failure to do so will isolate a key player on the global stage and further alienate the United States on the road to sustainability.

Con Excerpted from a March 18, 2021 Letter to Federal Reserve Chair Jerome Powell from Republican Members of the U.S. Senate Banking Committee, led by Sen. Pat Toomey. 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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Short Features

Fed and Other Regulators Want to Increase Cryptocurrencies Scrutiny

One of the key attractions of bitcoin and other cryptocurrencies is the lack of regulation over them. That may change if government regulators have their way.

Cryptocurrencies are digital forms of currency that exist virtually and are not backed by physical assets, such as dollars or gold, or by any government. There are currently more than 11,000 cryptocurrencies, according to CoinMarketCap.com, a market research website.1 They are used for secure online transactions, typically without a financial intermediary such as a bank. And cryptocurrencies tend to be highly volatile: The value of one bitcoin, for example, reached a record $65,000 in April, but by the end of June was trading at $28,911.2

Despite these swings, cryptocurrency is a rapidly growing asset class, with a collective market capitalization of around $1.4 trillion as of July.3

The fact that cryptocurrencies are untethered to any government or central bank insulates them from government monetary control. Only a fraction of cryptocurrency exchanges, for example, require ID verification and proof of address to conduct a transaction. No cryptocurrency exchange is currently regulated by the Securities and Exchange Commission (SEC).4 And because of their anonymous nature, cryptocurrencies are attractive for money laundering, ransomware attacks, illegal drugs, human traffickers, black market transactions and a host of other illegal ventures, according to critics.

“Cryptocurrencies play almost no role in normal economic activity,” economist and New York Times columnist Paul Krugman wrote. “Almost the only time we hear about them being used as a means of payment — as opposed to speculative trading — is in association with illegal activity, like money laundering or the bitcoin ransom Colonial Pipeline paid to hackers who shut it down.”5

Bitcoin, shown here in a smartphone display, is one of the most well-known cryptocurrencies — digital forms of money that exist virtually and are not backed by any physical assets or governments. Cryptocurrencies are attracting increasing scrutiny from regulators. (Getty Images/SOPA Images/LightRocket/Avishek Das)

Because of the dubious uses to which cryptocurrencies can be put, government regulators are taking a hard look at them. Federal Reserve Chair Jerome Powell said in May that the Fed will pay greater attention to “the appropriate regulatory and oversight framework” for cryptocurrencies. This scrutiny will include “private-sector payments innovators who are currently not within the traditional regulatory arrangements applied to banks, investment firms, and other financial intermediaries.”

Powell said the Fed would publish a working paper on the issue at the end of the summer. “We're going to address digital payments broadly,” he said, adding that “we're really at a critical point in terms of appropriate regulation.”6

SEC Chair Gary Gensler also has said he favors greater regulation of cryptocurrency exchanges. “This is a quite volatile, one might say highly volatile, asset class, and the investing public would benefit from more investor protection on the crypto exchanges,” he said.7

Only limited regulations are in place to protect cryptocurrency users against fraud and market manipulation. Sen. Elizabeth Warren, D-Mass., said this lack of regulatory scrutiny at a time of rising demand for cryptocurrencies “has left ordinary investors at the mercy of manipulators and fraudsters.”8

Reported crypto scams totaled $82 million in the fourth quarter of 2020 and the first quarter of 2021, according to the Federal Trade Commission. Many of the scams used social media to target small investors, the commission said. Estimated losses from fraud and theft associated with cryptocurrencies exceeded $4.4 billion in 2019.9

Gensler, who taught courses on digital assets when he was a professor at the Massachusetts Institute of Technology, said the SEC is “trying to bring the similar protections to the exchanges where you trade crypto assets, as you might expect on the New York Stock Exchange or Nasdaq.”10

“When you go into one of these [crypto] exchanges, you don't know whether the order book is accurately reporting the bids and the offers,” he said. “You don't know whether some of the trading that is reported is real or fake.”11

The Treasury has also highlighted cryptocurrency fraud risks, including opportunities for wealthy individuals to move assets into the crypto sector to avoid taxation. “Cryptocurrency already poses a significant detection problem by facilitating illegal activity broadly, including tax evasion,” the Treasury said.12

The Biden administration recently announced its American Families Plan Tax Compliance Agenda, a set of tax compliance initiatives. It identified cryptocurrency as “an enforcement priority.” Already in 2020, the IRS added a cryptocurrency transaction question to individual tax returns. The Biden proposal would require businesses to report cryptocurrency transactions of $10,000 or more to the IRS. It would also require crypto exchanges and custodians to report accounts with inflows or outflows of $600 per year or more.13

The proposal is part of an administration push to recoup lost tax revenues. The U.S. “tax gap” — the difference between taxes owed and taxes collected by the IRS — was estimated at $584 billion in 2019. The Treasury said its proposal would shrink the tax gap by approximately 10 percent, raising an estimated $700 billion over the next decade.14

Some lawmakers have expressed concerns about one aspect of the push for greater government scrutiny: proposals to regulate so-called self-hosted wallets, which are repositories for digital currency that exist only on a user's computer. Financial crime watchdogs say such wallets are the main conduits for illegal activity. But three Republican members of Congress warned then-Treasury Secretary Steve Mnuchin in December that increased regulation of self-hosted wallets raised privacy concerns, could put Americans “at a significant disadvantage to our global competitors” and could even be counterproductive for law enforcement.15

Rep. Jim Himes, D-Conn., who chairs a subcommittee of the House Financial Services panel, predicted that Congress will not pass cryptocurrency legislation anytime soon, due to lawmakers' lack of knowledge about the subject. “Most of my colleagues don't have a deep understanding of cryptocurrencies, what they can do, what the dangers are,” he said.16

Nevertheless, uncertainty about forthcoming crypto regulations has made some investors hesitant. Investment adviser and former fund manager David Tice warned that the recent “uproar from central bankers” makes cryptocurrencies “very dangerous to hold today.”17

— Patricia Pan Connor

[1] Kendall Little, “You Have Cryptocurrency Questions. We have Answers,” NextAdvisor, July 15, 2021, https://tinyurl.com/5cx9swyy.

[2] Ryan Browne, “Bitcoin had a wildly volatile first half. Here are the 5 biggest risks ahead,” CNBC, July 1, 2021, https://tinyurl.com/3dwexd36.

[3] “Today's Cryptocurrency Prices by Market Cap,” CoinMarketCap, accessed July 19, 2021, https://tinyurl.com/2m925tun.

[4] Matt Novak, “Sen. Warren wants SEC to finally regulate crypto markets,” Gizmodo, July 9, 2021, https://tinyurl.com/b3fvkxc.

[5] Paul Krugman, “Technobabble, Libertarian Derp and Bitcoin,” The New York Times, May 20, 2021, https://tinyurl.com/ycd4v3nc.

[6] Little, op. cit.

[7] David Lawder and Howard Schneider, “U.S. regulators signal stronger risk, tax oversight for cryptocurrencies,” Reuters, May 20, 2021, https://tinyurl.com/6ka6p6cp.

[8] Novak, op. cit.

[9] Dave Michaels and Andrew Ackerman, “Bitcoin Fraud Concerns Draw Scrutiny from Regulators,” The Wall Street Journal, July 6, 2021, https://tinyurl.com/nk3v67tr; Lael Brainard, “Update on Digital Currencies, Stablecoins, and the Challenges Ahead,” Dec. 18, 2019, https://tinyurl.com/yw9kv222.

[10] Chris Matthews, “SEC Chairman says Americans need a ‘cop on the beat’ to protect investors from crypto fraud,” MarketWatch, May 26, 2021, https://tinyurl.com/fdnbdzey.

[11] Michaels and Ackerman, op. cit.

[12] Lawder and Schneider, op. cit.; “The American Families Tax Plan Compliance Agenda,” Department of the Treasury, May 2021, https://tinyurl.com/2854s2em.

[13] Ibid.; MacKenzie Sigalos, “How the IRS is trying to nail crypto tax dodgers,” CNBC, July 14, 2021, https://tinyurl.com/3djehu48.

[14] David Lawder, “U.S. Treasury seeks reporting of cryptocurrency transfers, doubling of IRS workforce,” Reuters, May 20, 2021, https://tinyurl.com/mvuj4ath.

[15] Kevin Helms, “US Lawmakers Caution Against Regulations Restricting Use of Self-Hosted Crypto Wallets,” Bitcoin News, Dec. 12, 2020, https://tinyurl.com/5yenm9hr.

[16] Kevin Helm, “US Congress Will Not Pass Cryptocurrency Legislation Anytime Soon, Says Lawmaker,” Bitcoin News, May 24, 2021, https://tinyurl.com/8a6p28r8.

[17] Kevin Helms, “Investment Advisor Says Bitcoin Is Very Dangerous to Hold Today Citing Warnings by Regulators,” Bitcoin News, July 19, 2021, https://tinyurl.com/yxs7se8a.

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Fed Studying Feasibility of a Digital Currency

Several countries, including China and Sweden, are trying out a digital currency — a form of digital money that has no physical presence but exists on decentralized computer networks through a ledger-based system. The United States may someday join the sovereign crypto party.18

Federal Reserve Chair Jerome Powell announced in May that the Fed intends to analyze the cryptocurrency market and publish a working paper this summer, with a focus on the possibility of issuing a U.S. central bank digital currency (CBDC) for use by the public.19

One reason for doing so would be to help “unbanked” citizens — those who lack access to banking services, primarily lower-income Americans. One of the barriers such people encounter is banks' minimum balance requirements to open and maintain fee-free checking accounts. A 2019 survey by the Federal Deposit Insurance Corp. (FDIC) found that 48.9 percent of unbanked households cited their inability to meet minimum deposits as a reason for being unbanked, while 29 percent reported it as the main reason. High bank fees were also cited by 34.2 percent as another barrier.20

The COVID-19 pandemic made it even harder for such individuals to participate fully in economic activity because many businesses moved to all-electronic transactions, to avoid the spread of the virus through the exchange of paper money. In addition, federal pandemic relief checks were delayed and frequently subject to fees for those recipients without bank accounts when cashed.

Federal Reserve Governor Lael Brainard is a strong proponent of a Fed-backed cryptocurrency. “The pandemic led to an acceleration of the migration to digital payments,” Brainard said. “There was a pronounced shift by consumers and businesses to contactless transactions facilitated by electronic payments.” Because electronic transactions are growing rapidly, Brainard said, “introducing safe central bank money that is accessible to households and businesses in digital payments systems … would reduce counterparty risk and the associated consumer protection and financial stability risks.”21

Federal Reserve Governor Lael Brainard supports the creation of a Fed-backed digital currency, viewing it as a tool for greater financial inclusion, particularly for lower-income Americans who often lack access to conventional banking services. (AFP/Getty Images/Eric Baradat)

More broadly, Brainard and other advocates view a digital currency as a tool for greater financial inclusion, allowing unbanked individuals immediate and fee-free access to relief checks, Social Security payments and childcare credits.

However, the ranks of the unbanked are declining. In 2019, the unbanked represented 7.1 million out of 124 million U.S. households, the lowest percentage since the FDIC began tracking it, suggesting that the problem is improving on its own.

Powell said a Fed digital currency could have broader applications, including use by the general public.22

One likely objection to widespread usage of government-backed digital currency is the potential for invasion of privacy. Privacy advocates often view government tracking of private transactions as an infringement of citizens' rights, just as the passage of the anti-terrorist Patriot Act after the Sept. 11, 2001, attacks led to hot debates on the issue.

Privacy, which is not a protected right in China, is not a relevant concern in that communist nation. On the contrary, the authoritarian government's surveillance of its citizens is made easier with digital money. In fact, Chinese officials have cited digital currency as a means of “enforcing party discipline.”23

In the United States, there are legitimate reasons for confidential transactions, including political organizing, expenses related to confidential business ideas or proprietary inventions, purchases that may reveal a person's high net worth status and activities that are legal but potentially embarrassing.

One of the defining advantages of the U.S. dollar is that it is protected by a long-established body of law, including privacy statutes and the Constitution's Fourth Amendment protection against unwarranted search and seizure. The development of a governmental digital currency would require a host of legal, security and regulatory laws, which may take years to fully develop.

Privacy advocates with concerns about a digital currency may recall how the IRS was accused in 2013 of improperly targeting taxpayers associated with the tea party movement, and in 2014 settled a lawsuit filed over allegations that it disclosed the donor list of an organization that opposed same-sex marriage.24

A recent U.S. Supreme Court case, Americans for Prosperity v. Bonta, revealed multiple data breaches by California state officials that Justice Samuel Alito described as “grossly negligent.” The California attorney general's office requires all nonprofit organization to disclose their largest donors, saying the disclosure is necessary to prevent fraud. While the attorney general is required to keep this information confidential, some information regarding donors to two conservative groups, the Americans for Prosperity Foundation and Thomas More Law Center, was made public.25

Just this year, the investigative journalism website ProPublica published the private tax return information of billionaires Jeff Bezos, Warren Buffett, Bill Gates, Rupert Murdoch, Mark Zuckerberg and others in an exposé about how the wealthiest avoid paying income taxes.26

According to Fed Chair Powell, one of the strongest arguments to develop a Fed-backed digital currency is that it could decrease the need for private cryptocurrencies, which are currently unregulated and can present significant risks to investors.

“You wouldn't need cryptocurrencies if you had a digital U.S. currency,” he said. But Powell also said he is in no hurry to keep pace with China or Sweden. “I think it's way more important to get it right than it is to get it fast,” he said.27

— Patricia Pan Connor

[18] Jamie Crawley, “Sweden's Central Bank to Test Digital Currency with Handelsbanken,” CoinDesk, May 28, 2021, https://tinyurl.com/34ja3wfn.

[19] “Federal Reserve Chair Jerome H. Powell outlines the Federal Reserve's response to technological advances driving rapid change in the global payments landscape,” Board of Governors of the Federal Reserve System, May 20, 2021, https://tinyurl.com/y3xmrft3.

[20] “How America Banks: Household Use of Banking and Financial Services,” Federal Deposit Insurance Corp., 2019, https://tinyurl.com/2k7b7tvv.

[21] Jeff Cox, “Fed's Lael Brainard pushes digital dollar as central bank currency race heats up,” CNBC, May 24, 2021, https://tinyurl.com/46mcdkew.

[22] Jeff Cox, “The Fed this summer will take another step ahead in developing a digital currency,” CNBC, May 20, 2021, https://tinyurl.com/4fvt6kkm.

[23] Yaya J. Fanusie and Emily Jin, “China's Digital Currency — Adding Financial Data to Digital Authoritarianism,” Center for a New American Security, January 2021, https://tinyurl.com/ycskv3sn.

[24] Gregory Korte, “Q&A: The Tea Party Scandal Explained,” USA Today, May 13, 2013, https://tinyurl.com/26zzz7pu; Mackenzie Weinger, “IRS pays $50K in confidentiality suit,” Politico, June 24, 2014, https://tinyurl.com/vs7ch8as.

[25] Amy Howe, “Justices doubtful on California donor-disclosure requirement,” SCOTUSblog, https://tinyurl.com/2bnv74d3; Adam Liptak, “Supreme Court Backs Donor Privacy for California Charities,” The New York Times, July 1, 2021, https://tinyurl.com/5ycz7sp8.

[26] Jesse Eisinger, Jeff Ernsthausen and Paul Kiel, “The Secret IRS Files: Trove of Never-Before-Seen Records Reveal How the Wealthiest Avoid Income Tax,” ProPublica, June 8, 2021, https://tinyurl.com/ympyhjbd.

[27] Kevin Helms, “Fed Chair Jerome Powell Says You Wouldn't Need Cryptocurrency if You Had a US Digital Currency,” Bitcoin.com, July 15, 2021, https://tinyurl.com/twfzjr3m.

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Bibliography

Books

Bernanke, Ben S., The Courage to Act, W.W. Norton, 2015. The former Federal Reserve chair recounts the events of the financial crisis of 2008 and the Fed's actions to stabilize the markets.

Eichengreen, Barry, Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, Oxford University Press, 2011. A professor of economics and political science at the University of California, Berkeley, examines the U.S. dollar's dominance from the post-World War II period to its precarious medium-term prospects today, due to emerging economies such as China.

Meltzer, Allan H., A History of the Federal Reserve, Volume 1: 1913-1951, University of Chicago Press, 2003. A professor of political economy at Carnegie Mellon's Tepper School of Business provided a comprehensive history of the Federal Reserve from its founding in 1913 to the Treasury-Federal Reserve Accord of 1951, which marked a fundamental restructuring.

Articles

Appelbaum, Binyamin, and Robert D. Hershey, “Paul A. Volcker, Fed Chairman Who Waged War on Inflation, Is Dead at 92,” The New York Times, Dec. 9, 2019, https://tinyurl.com/46xzypsa. An obituary describes the life and notable actions of the former Fed chair.

Barro, Josh, “The World's Best Bureaucrat,” New York Magazine, Oct. 27, 2020, https://tinyurl.com/3zwmrm82. A financial reporter provides a positive review of the Fed's response to the COVID-19 pandemic under Jerome Powell's leadership.

Cox, Jeff, “The Fed keeps expanding its powers, and that's making some people nervous,” CNBC, May 27, 2021, https://tinyurl.com/43xvz5j3. The Federal Reserve is stirring controversy by unofficially expanding its mandate to consider the impact of its policies on social justice and climate concerns.

Elis, Niv, “Toomey hits Fed over ‘obsession with race,’” The Hill, May 24, 2021, https://tinyurl.com/9brdtpuf. Sen. Pat Toomey, a Republican from Pennsylvania, criticizes the Fed for “mandate creep” due to resources spent analyzing racial inequity.

Gebeloff, Robert, “Who Owns Stocks? Explaining the Rise of Inequality During the Pandemic,” The New York Times, Jan. 1, 2021, https://tinyurl.com/2jvt96z7. A reporter specializing in data analysis provides commentary regarding the fairness of how stock values have risen due to monetary actions during the pandemic, disproportionately benefitting the affluent.

Irwin, Neil, “Move Over Nerds. It's the Politicians' Economy Now,” The New York Times, March 9, 2021, https://tinyurl.com/u859rk. Politicians increasingly are reacting to economic upheaval through government spending programs, taking some of the responsibility for the current economic situation that was previously borne exclusively by the Fed.

Levitz, Eric “In Historic Move, Fed Will No Longer Kill Jobs to Fight Phantom Inflation,” New York Magazine, Aug. 27, 2020, https://tinyurl.com/pspv65pp. The Fed says it will no longer attempt to predict and adjust rates according to the “natural” rate of employment.

Salter, Alexander William, “The Federal Reserve is Both Too Politicized and Too Powerful,” Foundation for Economic Education, July 28, 2020, https://tinyurl.com/yphrrm32. A libertarian think tank says congressional power over the Fed weakens the institution's independence.

Sloan, Allan, and Cezary Podkul, “How The Federal Reserve is Increasing Wealth Inequality,” ProPublica, April 27, 2021, https://tinyurl.com/448vvtws. Two journalists examine how monetary policy makes the rich richer through asset appreciation but does not help the poor nearly as much.

Warsh, Kevin, “The Fed's Risky Fill-the-Punch-Bowl Strategy,” The Wall Street Journal, June 7, 2021, https://tinyurl.com/3awe94e8. A former Fed governor warns that the Fed's new strategy of flexible average inflation targeting will not address inflation on a timely basis and ultimately will damage the economy.

Reports and Studies

“Distribution of Household Wealth in the U.S. since 1989,” Board of Governors of the Federal Reserve System, last updated June 21, 2021, https://tinyurl.com/mxzukvwu. A report on the distribution of wealth in America, sorted by demographic groups.

“June 2021 Report: Labor Shortage Remains a Challenge for Small Businesses as Inflation Increases,” NFIB, accessed July 21, 2021, https://tinyurl.com/49rknnyc. A report shows that despite the high unemployment rate, small businesses are struggling to hire employees.

Jordan, Jerry L., and William J. Luther, “Central Bank Independence and The Federal Reserve's New Operating Regime,” AIER Sound Money Project Working Paper Series, Oct. 2, 2020, https://tinyurl.com/52zytxvk. A paper highlights the ways in which the Federal Reserve lacks independence due to various political influences.

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The Next Step

Inflation

Egan, Matt, “Inflation is here. The Delta variant could make it worse,” CNN, July 21, 2021, https://tinyurl.com/nn6hacxa. The spread of the Delta variant of COVID-19 in the United States could slow inflation in the short term but worsen it in the long term, as more restrictions make it harder for supply chains to meet demand.

Idzelis, Christine, “U.S. investors expect inflation to pick up, prompting these portfolio changes, a UBS survey finds,” MarketWatch, July 21, 2021, https://tinyurl.com/vrnpesp8. Fifty-seven percent of U.S. investors expect inflation will accelerate over the next 12 months and are planning to adjust their stock portfolios accordingly.

Rockerman, Olivia, and Peyton Forte, “Inflation Drumbeat Reverberates on Latest U.S. Earnings Calls,” Bloomberg, July 21, 2021, https://tinyurl.com/4vd64c4a. Multiple companies, including Coca-Cola, said unexpected rising costs of materials and wages could lead them to raise prices.

Job Market

Caminiti, Susan, “Chipotle, Target use TikTok to find the workers they need in tight job market,” CNBC, July 18, 2021, https://tinyurl.com/h3rxcwb3. As finding workers becomes harder, Chipotle, Target, Shopify and other companies are turning to TikTok Resumes, a pilot program that lets job applicants submit video résumés on the social platform.

Cox, Jeff, “U.S. jobless claims show surprise gain, well above expectations,” CNBC, July 22, 2021, https://tinyurl.com/amndh3mx. Weekly jobless claims rose to 419,000 for the week that ended July 17, the highest since mid-May, despite an improving labor market.

Thompson, Derek, “What Quitters Understand About the Job Market,” The Atlantic, June 21, 2021, https://tinyurl.com/r3pv2te5. More Americans, feeling optimistic about other potential opportunities, are quitting their jobs, and employers may turn to artificial intelligence and innovation in response.

Spending and Debt Ceiling

Emma, Caitlin, and Jennifer Scholtes, “Democrats slam McConnell over debt limit timebomb,” Politico, July 21, 2021, https://tinyurl.com/pvc39fyf. Democrats accused Senate Minority Leader Mitch McConnell, R-Ky., of holding the economy hostage after he said he does not expect any Republican senator to vote in favor of raising the debt ceiling.

Everett, Burgess, “Manchin says Dems ‘need to pay for’ their multitrillion-dollar spending plans,” Politico, July 13, 2021, https://tinyurl.com/953h28wc. Sen. Joe Manchin, D-W.Va., said he wants Democrats to identify funding sources for all of the new spending in their upcoming $3.5 trillion package to avoid adding to the national debt.

Ewall-Wice, Sarah, “Debt ceiling deadline: Here's when the government will no longer be able to pay its bills,” CBS News, July 21, 2021, https://tinyurl.com/jrxkw3un. The Congressional Budget Office projected that the U.S. government will run out of cash to pay its bills in October or November unless the debt ceiling is raised.

Stock Market

Likos, Paulina, “How Fed Decisions Impact the Stock Market,” U.S. News & World Report, July 16, 2021, https://tinyurl.com/rkrra38a. Interest rate hikes and other actions by the Federal Reserve will likely affect new investors' portfolios.

Schneider, Howard, “What, me worry? Fed chief's emotional tone can drive markets, study suggests,” Reuters, July 21, 2021, https://tinyurl.com/2yjch85x. Voice analytics tools suggest Federal Reserve Chairman Jerome Powell strikes a more negative tone than his predecessors in his public comments about the economic outlook, which can send the stock market tumbling.

Smith, Elliot, “Top investment strategist David Roche warns the Fed could burst a market ‘bubble,’” CNBC, June 29, 2021, https://tinyurl.com/3ec5dc83. A veteran investor expressed concern that inflationary pressures may lead the Federal Reserve to scale back its unprecedented COVID-era stimulus program sooner than expected.

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Contacts

American Institute for Economic Research
250 Division St., Great Barrington, MA 01230
888-528-1216
aier.org
Nonprofit promoting education about personal freedom, free enterprise, property rights and limited government.

Archival Economic Data
Federal Reserve Bank of St. Louis, One Federal Bank Plaza, St. Louis, MO, 63102
314-444-8444
alfred.stlouisfed.org
Comprehensive collection of historical economic data.

Bureau of Labor Statistics
2 Massachusetts Ave., N.E., Washington DC, 20212
202-691-5200
bls.gov
Official website of the U.S. Department of Labor, providing data on employment, inflation and other economic metrics.

Department of the Treasury
1500 Pennsylvania Ave., N.W., Washington, D.C. 20220
202-622-2000
home.treasury.gov/
Official webpage where Treasury Department reports, statistics, press releases and documents are available.

Economic Policy Institute
1333 H St., N.W., East Tower, Washington DC 20005
202-775-8810
epi.org
Liberal think tank that provides analysis of economic policy.

Federal Reserve History
federalreservehistory.org
A comprehensive collection of essays about the history of the Fed.

Federal Reserve System
20th Street and Constitution Avenue, N.W., Washington DC 20551
202-452-3000
federalreserve.gov
Official website where Federal Reserve reports, working papers, press releases and working papers are available.

House Committee on Financial Services
2129 Rayburn House Office Building, Washington, D.C. 20515
202-225-4247
financialservices.house.gov/
House committee with jurisdiction over banking, economic stabilization, insurance, international finance, money and credit.

Senate Committee on Banking, Housing, and Urban Affairs
534 Dirksen Senate Office Building, Washington, D.C. 20510
202-224-7391
banking.senate.gov
Senate committee responsible for overseeing banking, insurance, financial markets, economic policy, securities, international trade and finance.

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Footnotes

[1] Ben Popkin, “Get ready for higher grocery bills for the rest of the year,” NBC News, April 13, 2021, https://tinyurl.com/59pb598u.

[2] Anneken Tappe, “Surging prices: Key inflation metric just hit a 29-year high,” CNN Business, May 28, 2021, https://tinyurl.com/h2k36wxb.

[3] “What is the Fed: Monetary Policy,” Federal Reserve Bank of San Francisco, 2021, https://tinyurl.com/7svncwcx.

[4] Jeff Faux, “The Politically Talented Mr. Greenspan,” Economic Policy Institute, March 4, 2002, https://tinyurl.com/c8ckdpu2.

[5] Eric Levitz, “America's Finest Economists Have Been Needlessly Undermining Growth, Study Confirms,” New York Magazine, June 23, 2019, https://tinyurl.com/nzrd5psk; Eric Levitz, “In Historic Move, Fed Will No Longer Kill Jobs to Fight Phantom Inflation,” New York Magazine, Aug. 27, 2020, https://tinyurl.com/2e8en33z.

[6] “Phillips Curve,” Investopedia, updated April 30, 2021, https://tinyurl.com/53hyr5dw.

[7] Yun Li, “The Fed chairman says the relationship between inflation and unemployment is gone,” CNBC, July 11, 2019, https://tinyurl.com/4kutshvc.

[8] Tyler Powell and David Wessel, “What do changes in the Fed's longer-run goals and monetary strategy statement mean?” Brookings Institution, Sept. 2, 2020, https://tinyurl.com/w8bpnryy.

[9] Josh Barro, “The World's Best Bureaucrat,” New York Magazine, Oct. 27, 2020, https://tinyurl.com/32cr4n3b.

[10] Steve Liesman, “Federal reserve cuts rates to zero and launches massive $700 billion quantitative easing program,” CNBC, March 15, 2020, https://tinyurl.com/r8ywtxb3.

[11] Peter King, “Business Week Ahead, Dec 28-Jan 1, 2021,” Newsday, Dec. 22, 2020, https://tinyurl.com/cwuvkdks.

[12] Ben S. Bernanke (May 25, 2010), “Central Bank Independence, Transparency, and Accountability,” Institute for Monetary and Economic Studies International Conference, Bank of Japan, Tokyo, https://tinyurl.com/bszymvft.

[13] Mark Thoma, “Federal Reserve Independence: The Never-Ending Story,” Milken Institute Review, Oct. 20, 2017, https://tinyurl.com/cen84bup.

[14] Neil Irwin, “Move Over Nerds. It's the Politicians' Economy Now,” The New York Times, March 9, 2021, https://tinyurl.com/ykhuuy58.

[15] Ibid.

[16] Gwynn Guilford, “Inflation Accelerates Again in June as Economic Recovery Continues,” The Wall Street Journal, July 13, 2021, https://tinyurl.com/beu8n657.

[17] Jeff Cox, “Inflation climbs higher than expected in June as price index rises 5.4%,” CNBC, July 13, 2021, https://tinyurl.com/55ucks8p; Jeffry Bartash, “Why used car prices are driving inflation higher — and why it won't last,” MarketWatch, July 17, 2021, https://tinyurl.com/4h9umzdc; Kyle Hicks, “AAA: National average gas price on track to exceed $3.24 a gallon, highest in 7 years,” The Denver Channel, July 7, 2021, https://tinyurl.com/3metns9h; and “S&P CoreLogic Case-Shiller Index Shows Annual Home Price Gains Surged to 14.6% in April,” S&P Dow Jones Indices, June 29, 2021, https://tinyurl.com/4bdenjbw.

[18] Lucia Mutikani, “Pent-up demand, shortages fuel U.S. economy,” Reuters, May 28, 2021, https://tinyurl.com/4cartye9; Christopher Rugaber, “Fed's Powell says high inflation temporary, will ‘wane,’” The Associated Press, June 22, 2021, https://tinyurl.com/7h7t8ey.

[19] Dias, Daniel A. and Duarte, Joao B. “Monetary Policy, Housing Rents, and Inflation Dynamics.” International Finance Discussion Papers, Board of Governors of the Federal Reserve System, Federalreserve.org, May 2019, https://tinyurl.com/ejzpyvac; Gord Collins, “The US Rental Property Market Outlook,” ManageCasa, June 23, 2021, https://tinyurl.com/3f7wpz23.

[20] “Civilian Unemployment Rate,” U.S. Bureau of Labor Statistics, accessed July 21, 2021, https://tinyurl.com/ytjcd6s8; “June 2021 Report: Labor Shortage Remains a Challenge for Small Businesses as Inflation Increases,” NFIB, accessed July 21, 2021, https://tinyurl.com/8pneuwyv.

[21] Jeff Stein and Tyler Pager, “White House grapples with reports of labor shortage, inflation as recovery picks up steam,” The Washington Post, May 5, 2021, https://tinyurl.com/87y37b9v.

[22] Abha Bhattarai, “One way companies are concealing higher prices: Smaller packages,” The Washington Post, June 1, 2021, https://tinyurl.com/pm3vwrxf.

[23] “Wage-Price Spiral,” Economicshelp.org, https://tinyurl.com/wk8tnr73; Patti Domm, “Workers' wages are rising at the fastest pace in years. Companies' profits could take a hit,” CNBC, May 22, 2021, https://tinyurl.com/hvbabm7h.

[24] Vivien Lou Chen, “Traders Push Inflation Gauge to 13-Year High as Debate Rages,” Bloomberg, May 5, 2021, https://tinyurl.com/2pah3buv.

[25] Rachel Siegel, “Biden says Fed should take ‘whatever steps it deems necessary’ to respond to inflation,” The Washington Post, July 19, 2021, https://tinyurl.com/r6pr38we.

[26] Nick Timiraos, “Powell Says Fed Still Expects Inflation to Ease,” The Wall Street Journal, July 14, 2021, https://tinyurl.com/3a6kea2p.

[27] Nick Timiraos, “Fed's Powell Concedes Anxiety About Higher Inflation but Resists Policy Shift,” The Wall Street Journal, July 15, 2021, https://tinyurl.com/4uhhprdb.

[28] Jeff Stein, “Yellen's comments on inflation spark confusion, clarification as White House tries to navigate economic pressures,” The Washington Post, May 4, 2021, https://tinyurl.com/3vhwp3f3.

[29] Stein and Pager, op. cit.

[30] John Harwood, “Biden spoke with prominent critic Larry Summers on economy after inflation warnings,” CNN, June 3, 2021, https://tinyurl.com/24ttdcby; Andrea Shalal, Jarrett Renshaw and Jeff Mason, “Money is cheap, let's spend it — White House $6 trillion budget message,” Reuters, May 28, 2021, https://tinyurl.com/422cju5y.

[31] Kevin Warsh, “The Fed's Risky Fill-the-Punch-Bowl Strategy,” The Wall Street Journal, June 7, 2021, https://tinyurl.com/32zzc35c.

[32] Gwynn Guilford and Sarah Chaney Cambon, “The Economic Recovery is Here. It's Unlike Anything You've Ever Seen,” The Wall Street Journal, June 2, 2021, https://tinyurl.com/yw3wty66.

[33] Mary C. Daly, “Is the Federal Reserve Contributing to Economic Inequality?” Economic Letter, The Federal Reserve Bank of San Francisco, Oct. 19, 2020, https://tinyurl.com/2rw6v4w6.

[34] “Changes in U.S. Family Finances from 2016 to 2019: Evidence from the Survey of Consumer Finances,” Federal Reserve Bulletin, September 2020 Vol. 106, No. 5, https://tinyurl.com/2uf2cs92; “DFA Distribution Financial Accounts,” Federal Reserve, last updated June 21, 2021, https://tinyurl.com/97dxuweh; and Jessica Semega et al., “Income and Poverty in the United States: 2019,” United States Census Bureau, Sept. 15, 2020, https://tinyurl.com/2c5d94vh.

[35] Alina K. Bartscher et al., “Monetary Policy and Racial Inequality,” Staff Reports No. 959, Federal Reserve Bank of New York, January 2021, https://tinyurl.com/fra7vkz4.

[36] “Distribution of Household Wealth in the U.S. since 1989,” Board of Governors of the Federal Reserve System, last updated June 21, 2021, https://tinyurl.com/3fnwr4a9; Robert Gebeloff, “Who Owns Stocks? Explaining the Rise of Inequality During the Pandemic,” The New York Times, Jan. 26, 2021, https://tinyurl.com/2jvt96z7.

[37] Katherine Greifield, Lu Wang and Vildana Hajric, “Stocks Show Jerome Powell is Still Wall Street's Head of State,” Bloomberg, Nov. 6, 2020, https://tinyurl.com/yrtb56vs.

[38] Allan Sloan and Cezary Podkul, “How the Federal Reserve is Increasing Wealth Inequality,” ProPublica, April 27, 2021, https://tinyurl.com/448vvtws.

[39] Amy Gunia et al., “The Racial Reckoning Went Global Last Year. Here's How Activists in 8 Countries Are Fighting for Justice,” Time, May 11, 2021, https://tinyurl.com/yekdhj4w.

[40] Ben Bernanke, “Monetary Policy in a New Era,” Brookings Institution, Oct. 2, 2017, https://tinyurl.com/kh3seaew.

[41] Binyamin Applebaum, “Ben Bernanke Says Fed Can't Get Caught Up in Inequality Debate,” The New York Times, June 1, 2015, https://tinyurl.com/utz7m337.

[42] Sloan and Podkul, op. cit.; “Sen. Elizabeth Warren questions Fed's Jerome Powell on how inequality affects economy,” CNBC, Feb. 23, 2021, https://tinyurl.com/h3weu9mw.

[43] “Warren, Waters, Gillibrand Reintroduce Their Bill Requiring the Fed to Close Racial Employment and Wage Gaps,” News Release, Office of Sen. Elizabeth Warren, April 21, 2021, https://tinyurl.com/8whub28.

[44] Timothy Taylor, “The Punch Bowl Speech: William McChesney Martin,” Conversable Economist, June 24, 2013, https://tinyurl.com/2u9y72m7.

[45] Jerry L. Jordan and William J. Luther, “Central Bank Independence and The Federal Reserve's New Operating Regime,” AIER Sound Money Project Working Paper Series, Oct. 2, 2020, https://tinyurl.com/52zytxvk.

[46] Alexander William Salter, “The Federal Reserve is Both Too Politicized and Too Powerful,” American Institute for Economic Research, July 30, 2020, https://tinyurl.com/a2t6pfuw.

[47] Steven T. Mnuchin, letter to Fed Chair Jerome Powell, Nov. 19, 2020, https://tinyurl.com/4mcsjnnz; Niv Elis, “Mnuchin to put $455B in COVID-19 relief funds beyond successor's reach,” The Hill, Nov. 25, 2020, https://tinyurl.com/dh7nbydj.

[48] Jim Saksa, “Toomey digs in on ‘redundant’ Fed facilities provision,” Roll Call, Dec. 18, 2020, https://tinyurl.com/yat2ewp2; Emily Cochrane and Jeanna Smialek, “Lawmakers Resolve Fed Dispute as they Race to Close Stimulus Deal,” The New York Times, Dec. 19, 2020, https://tinyurl.com/yw3x6afv.

[49] Kevin Stankiewicz, “GOP Sen. Pat Toomey explains why he fought to end emergency Fed lending programs in Covid bill,” CNBC, Dec. 21, 2020, https://tinyurl.com/pzvj3phr.

[50] Alexander William Salter, “The Federal Reserve is Both Too Politicized and Too Powerful,” Foundation for Economic Education, July 28, 2020, https://tinyurl.com/yphrrm32.

[51] Yun Li, “Powell says Fed will never move rates because of political factors or to prove its independence,” CNBC, July 31, 2019, https://tinyurl.com/33pkzxyn.

[52] Campbell R. Harvey, “The Federal Reserve Act of 1913,” The Free Financial Dictionary, https://tinyurl.com/8d4ep6s.

[53] Gregory D. Hess and Cameron A. Shelton, “Congress and the Federal Reserve,” Wiley Online Library, May 17, 2016, https://tinyurl.com/fwm889ch.

[54] Andrew T Hill, “The First Bank of the United States,” Federal Reserve History, Dec. 4, 2015, https://tinyurl.com/bhsj8r9d; “History of the Federal Reserve,” Federal Reserve Education.org, https://tinyurl.com/2aaynw5n.

[55] History of the Federal Reserve,” ibid.

[56] Ibid.

[57] Greg Iacurci, “Unemployment is nearing Great Depression levels. Here's how the eras are similar — and different,” CNBC, June 10, 2020, https://tinyurl.com/2r7b8t24; Gary Richardson and Tim Sablik, “Banking Panics of the Gilded Age,” Federal Reserve History, Dec. 4, 2015, https://tinyurl.com/9w5wh9dc.

[58] Jon R. Moen and Ellis W. Tallman, “The Panic of 1907,” Federal Reserve History, Dec. 4, 2015, https://tinyurl.com/2jy72ar8; Jon Moen, “The Panic of 1907,” EH.net, https://tinyurl.com/2ffkm8ky.

[59] Federal Reserve Bank of Kansas City Staff, “Federal Reserve Act Signed into Law,” Federal Reserve History, Nov. 22, 2013, https://tinyurl.com/2uka8bec.

[60] Phil Davies, “Federal Reserve's Role During WWI,” Federal Reserve History, Nov. 22, 2013, https://tinyurl.com/ac8dmdwu.

[61] Barry Eichengreen, Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System (2011).

[62] “History of the Federal Reserve,” Federal Reserve Education, https://tinyurl.com/35h88ncm.

[63] Gary Richardson, Alejandro Komai, Michael Gou, and Daniel Park, “Stock Market Crash of 1929,” Federal Reserve History, Nov. 22, 2013, https://tinyurl.com/4k66u4zf.

[64] Ibid.

[65] Ibid.

[66] Gary Richardson, “The Great Depression,” Federal Reserve History, Nov. 22, 2013, https://tinyurl.com/ydevvcfs.

[67] Ibid.

[68] Ibid.; Julia Maues, “Banking Act of 1933 (Glass-Steagall),” Federal Reserve History, Nov. 22, 2013, https://tinyurl.com/yd3dyrfp; Gary Richardson, Alejandro Komai and Michael Gou, “Gold Reserve Act of 1934,” Federal Reserve History, Nov. 22, 2013, https://tinyurl.com/2u77jdyp; and Gary Richardson, Alejandro Komai and Michael Gou, “Banking Act of 1935,” Federal Reserve History, Nov. 22, 2013, https://tinyurl.com/27dharvz.

[69] “Thirtieth Annual Report of the Board of Governors of the Federal Reserve System Covering Operations for the Year 1943,” Board of Governors of the Federal Reserve System, 1943, https://tinyurl.com/9as7cbj9.

[70] Gary Richardson, “The Federal Reserve's Role During WWII,” Federal Reserve History, Nov. 22, 2013, https://tinyurl.com/47863uv3.

[71] Ibid.

[72] Ibid.

[73] N. Gregory Mankiw, “How to Avoid Recession? Let the Fed Work,” The New York Times, Dec. 23, 2007, https://tinyurl.com/pbhef5st.

[74] Michael Bryan, “The Great Inflation,” Federal Reserve History, Nov. 22, 2013, https://tinyurl.com/z9txcaf4.

[75] Binyamin Appelbaum and Robert D. Hershey Jr., “Paul A. Volcker, Fed Chairman Who Waged War on Inflation, Is Dead at 92,” The New York Times, Dec. 9, 2019, https://tinyurl.com/d8fkawbv.

[76] Roger Lowenstein, “How Paul Volcker beat inflation and saved an independent Fed,” The Washington Post, Dec. 10, 2019, https://tinyurl.com/vredhwfr.

[77] Ibid., Appelbaum and Hershey, op. cit.

[78] Appelbaum and Hershey, ibid.; Matthew Boesler, “How Paul Volcker Paved the Way for Today's Low Rates,” Bloomberg News, Dec. 11, 2019, https://tinyurl.com/s78vcn7w.

[79] James Chen, “Alan Greenspan,” Investopedia, June 14, 2021, https://tinyurl.com/k56k8fc7.

[80] Edmund L. Andrews, “Greenspan Concedes Error on Regulation,” The New York Times, Oct. 23, 2008, https://tinyurl.com/4d2zn64.

[81] “Ben Bernanke,” Federal Reserve History, https://tinyurl.com/23zrrnzj.

[82] Jon Hilsenrath, Elizabeth Williamson and Jonathan Weisman, “Calm in Crisis Won Fed Job,” The Wall Street Journal, Aug. 26, 2009, https://tinyurl.com/4krr8ks8; Ylan Q. Mui, “Ben Bernanke on why he was right about the economy,” The Washington Post, Oct. 14, 2015, https://tinyurl.com/xexmbfzw.

[83] Heather Long, “Janet L. Yellen, America's first female Fed chair, finishes to ‘standing ovation,’” The Washington Post, Dec. 13, 2017, https://tinyurl.com/2edhsuj3; Don Lee and Jim Puzzanghera, “Yellen's legacy as Fed chief: Full employment but unfinished business,” Los Angeles Times, Jan. 25, 2018, https://tinyurl.com/dvpfk529.

[84] Emily Stewart, “Janet Yellen, the first woman Fed chair, proved the skeptics wrong and got fired anyway,” Vox, Jan. 24, 2018, https://tinyurl.com/b4ceyc73.

[85] Cox, op. cit.

[86] Jeanna Smialek, “Fed Chair Powell Sees Months of Inflation, but Then Moderation,” The New York Times, July 14, 2021, https://tinyurl.com/f9jyhuwm.

[87] Jeff Cox, “The Fed moves up its timeline for rate hikes as inflation rises,” CNBC, June 17, 2021, https://tinyurl.com/jwkfmu8u; Damian J. Troise, “Stocks slide, yields rise as Fed sees hikes as soon as 2023,” USA Today, June 16, 2021, https://tinyurl.com/yr6n6syj.

[88] Jeanna Smialek, “Federal Reserve Keeps Rates Unchanged but Cites ‘Progress’ Toward Its Goals,” The New York Times, July 28, 2021, https://tinyurl.com/rf7fmehw.

[89] Will Weissert and Josh Boak, “Republicans Point to Inflation in Bid to Retake Congress,” ABC News, The Associated Press, June 18, 2021, https://tinyurl.com/ykp5cec4.

[90] Alex Gangitano and Sylvan Lane, “Inflation Concerns Spark New Political Fights,” The Hill, June 18, 2021, https://tinyurl.com/ysc32n36.

[91] Ibid.

[92] Heather Long, “The economy isn't going back to February 2020. Fundamental shifts have occurred,” The Washington Post, June 20, 2021, https://tinyurl.com/aj27ekpb.

[93] Patricia Cohen, “U.S. Added 850,000 jobs in June, and Wages Rose,” The New York Times, July 2, 2021, https://tinyurl.com/4fpf9dkm; Bryan Mena, “U.S. Job Openings Held at Record Level Headed into Summer,” The Wall Street Journal, July 7, 2021, https://tinyurl.com/w9v4se8s.

[94] Susan Lund et al., “The future of work after Covid-19,” McKinsey Global Institute, Feb. 18, 2021, https://tinyurl.com/jrkknkjy.

[95] Heather Long, “It's not a ‘labor shortage.’ It's a great reassessment of work in America,” The Washington Post, May 7, 2021, https://tinyurl.com/xjpwyph7.

[96] “Poll: The COVID-19 Unemployed,” U.S. Chamber of Commerce, June 3, 2021, https://tinyurl.com/2ez3t58u.

[97] Lucia Mutikani, “U.S. job growth picks up, desperate employers boost wages to attract workers,” Reuters, June 4, 2021, https://tinyurl.com/94873tz8.

[98] Thomas Wade, “Understanding the National Increase in House Prices,” American Action Forum, July 20, 2021, https://tinyurl.com/59mdjfp6.

[99] Alex Tanzi, “Soaring rental rates, inflation in U.S. have staying power,” Northwest Arkansas Democrat Gazette, July 11, 2021, https://tinyurl.com/34jes337.

[100] Heather Long, “Democrats introduce bill to give the Federal Reserve a new mission: Ending racial inequality,” The Washington Post, Aug. 5, 2020, https://tinyurl.com/2epcm4ku; Jennifer Epstein, “Biden Urges Diverse Fed to Fight Racial Inequality,” Bloomberg, The Washington Post, July 29, 2020, https://tinyurl.com/4vdztrhe; and Heather Long and Andrew Van Dam, “The black-white economic divide is as wide as it was in 1968,” The Washington Post, June 4, 2020, https://tinyurl.com/36vhdxvv.

[101] Neil Haggerty, “Does Fed already have the power to tackle racial inequality?” American Banker, Aug. 23, 2020, https://tinyurl.com/tfc83aj5.

[102] “Racial Equity Primer,” Federal Reserve Bank of San Francisco, June 12, 2020, https://tinyurl.com/3mwe5nrp; Sen. Patrick Toomey, letter to Mary C. Daly, United States Senate Committee on Banking, Housing and Urban Affairs, March 29, 2021, https://tinyurl.com/p9xd8cs.

[103] Jeanna Smialek, “The Fed Faces Criticism as it Wades into Climate and Equity Issues,” The New York Times, April 19, 2021, https://tinyurl.com/57cmrj3j.

[104] Haggerty, op. cit.; Long, op. cit.

[105] Sylvan Lane, “Fed's uncertain future casts shadow over Senate hearing,” The Hill, July 15, 2021, https://tinyurl.com/yudupsuc.

[106] Mark DeCambre, “Federal Reserve Chairman Jerome Powell's stock market record is poor,” MarketWatch, June 16, 2021, https://tinyurl.com/emkat46p.

[107] Jerome Powell, “Transcript of Chair Powell's Press Conference,” Federal Reserve, June 16, 2021, https://tinyurl.com/74va8d7s.

[108] Michael S Derby, “Fed's Bullard Pencils in Rate Increase in 2022,” The Wall Street Journal, June 18, 2021, https://tinyurl.com/3frnb36p.

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About the Author

Patricia Pan Connor is a freelance writer and investor. Formerly, she was an investment banker and private equity investor, based in New York City. Patricia graduated from Brown University with a B.A. in economics and currently resides in Montecito, Calif.

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