How do governments regulate policy?

Arguments over how much control the U.S. government should exert over the economy have flooded the airwaves with the upcoming inauguration of President-elect Donald Trump. While concerns about a potential government shutdown may be unsettling, learning more about how federal spending works and its impact on the broader economy can provide clarity. To grasp the complexities of monetary policy, it’s helpful to turn back the clock to before World War 2.

Before President Franklin D. Roosevelt assumed command of the executive office in March 1933, the U.S. operated under the gold standard. The standard required every US dollar in circulation to be backed by a specific amount of gold. For example, if the government set the gold price at $100 an ounce, one dollar of currency would be worth 1/100 of an ounce. While the gold provided consumers with reassurances;  stockpiling of gold by American citizens around the time of the great depression made the practice unsustainable. The abandonment of the gold standard led to the adoption of fiat currency, which ties the dollar’s value to the creditworthiness of the government rather than gold. This shift, influenced by Keynesian economics, gave central banks greater control over the money supply, enabling more effective management of inflation and monetary policy.

Fed History

The Federal Reserve, established by the Federal Reserve Act of 1913, served as a response to the financial turmoil of the late 19th and early 20th centuries. Events brought on by a series of bad banking decisions such as the 1907 panic, served as further catalysts for the creation of the Federal Reserve. Even today, the Fed is America's primary defense against future crises and effectively oversees the country's banks.

During the Great Depression of the 1930s, the Federal Reserve faced significant challenges in stabilizing the economy. Its pivotal role during the period was to restore confidence in the financial system and implement policies to mitigate the effects of the economic downturn. 

Structure 

The Federal Reserve System consists of the Board of Governors and 12 regional Federal Reserve Banks. The Board of Governors, located in Washington, D.C., oversees the entire bank and is responsible for making decisions over monetary policy and banking regulations. The 12 regional banks, spread across the country, carry out the Fed's operations and provide essential services to financial institutions and the public.

The Federal Reserve is organized and governed in a way that allows for both centralized decision-making and regional input, reflecting the diverse needs of the U.S. economy.

Functions of the Fed

The Federal Reserve is cross-functional and manages various things from bank operations to policy decisions. Its primary responsibilities include conducting bank stress tests, auditing financial institutions, standardizing regulatory reports, and operating the Federal Reserve payment system.

The Federal Reserve's influence on the economy is far-reaching. Through policy decisions made by the Federal Open Market Committee (FOMC), the Fed influences interest rates, inflation, and overall economic activity. It also plays a vital role in stabilizing the economy during financial crises, as demonstrated by its interventions during the 2008-2009 credit crisis. In addition, Fed actions significantly impact employment levels and the pace of economic growth.

Criticisms of U.S. Federal Reserve 

Despite its significant role, the Federal Reserve has not been immune to criticism and controversy. Some have questioned the effectiveness of its policies and decision-making processes. Additionally, debates about the transparency and accountability of the Fed have sparked controversy and led to calls for greater congressional oversight of its operations.

Understanding the history, structure, functions, and impact of the Federal Reserve is essential for finance enthusiasts. The Fed's role in shaping the financial landscape and its economic influence cannot be overstated. As such, gaining a comprehensive understanding of the Federal Reserve is crucial for anyone looking to understand the complexities of America's financial system.

Citations

Federal Reserve History. "Federal Reserve Structure." Federal Reserve History. 12/20/2024. https://www.federalreservehistory.org/essays/fed-structure.

History.com Editors. "FDR Takes United States Off Gold Standard." History.com. 12/20/2024. https://www.history.com/this-day-in-history/fdr-takes-united-states-off-gold-standard.

Federal Reserve. "The Fed Explained: Payment Systems." Federal Reserve. 12/20/2024. https://www.federalreserve.gov/aboutthefed/fedexplained/payment-systems.htm.

Amadeo, Kimberly. "Who Owns the Federal Reserve?" The Balance. 12/20/2024. https://www.thebalancemoney.com/who-owns-the-federal-reserve-3305974.