Essay on THE FEDERAL RESERVE: ROOT OF ALL EVILS
The U.S. Federal Reserve activities cause many questions in the American public since the 2008 crisis, when it was charged that its policies has led to financial collapse. In 2012, the issue of the Federal Reserve is once again at the forefront of public interest in the U.S., primarily because this structure is under constant criticism of Congressman Ron Paul. Paul represents the libertarian wing of the Republican Party and has influence on over a third of its voters. The primary goal of the Fed is to maintain the monetary and financial stability in the US.
However, the recent economic recession reveals the full extent to which the monetary policy of the Fed turn out to be ineffective. More important, the Fed failed to prevent the rise of the economic recession in the US in 2008, while the further policy of the Fed after the recession has broken down proved to be absolutely ineffective, if not to say, dangerous for the US economy because they created conditions for the further steep decline of the US economy. To put it more precisely, the Fed policies failed to prevent the recession but after the outbreak of the economic crisis, the Fed focused on the support of large banks. In such a way, the Fed prevented their bankruptcy but it also failed to help the US economy to recover, while the support of large banks has prolonged the stagnation of large banks and the US economy. In such a situation, the Fed should refuse from the support of large banks and focus on the stimulation of the rise of spending in the US, instead of support of large banks that consumed a considerable part of the public funds but was absolutely pointless to help the US economy to recover.
FED POLICIES AND THEIR BENEFITS
In fact, many specialists (Monetary Policy Report to the Congress, 8) argue that the Fed conducted and still conducts effective policies. They argue that the Fed regulated the monetary policy effectively and the economic recession has started because of the unpredictable crisis in the housing market that provoked the financial crisis that was followed by the outbreak of a large scale recession. In such a situation, the Fed performed its functions properly because it focused on the regulation of the monetary policy and minimized its interference in the US economy. This is why the US economy was booming and proponent of the Fed’s policy (Sheesley, 201) insist that the Fed conducted the right policy of minimal interference and regulation of the financial market along with effective monetary policy.
However, the economic recession has started, regardless of policies of the Fed, which a priori is supposed to protect the US economy from deep crises by means of monetary and financial regulations. The economic recession provoked a bunch of problems, including the steep decline of the housing market, the deep financial crisis, the overall decline of many industries and economy at large. Taking into consideration all of the current problems the US economy has faced, the Federal Reserve has undertaken several steps to prevent the further deterioration in the national economy and revive economic activities in the USA. Firstly, the Federal Reserve has lowered the federal funds rate 325 basis points. Secondly, to support the functioning of commercial paper market in the aftermath of the Lehman Brothers bankruptcy, the Federal Reserve established the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility and the Commercial Paper Funding Facility and Money Market Investor Funding Facility. Thirdly, to support the mortgage and housing market and the economy, the Federal Reserve announced programs to purchase agency-guaranteed mortgage-backed securities and agency debt. Fourthly, the Treasury announced a temporary guarantee of the share prices of money market mutual funds and used authority granted under the Emergency Economic Stabilization Act to purchase preferred shares in large number depository institutions (Monetary Policy Report to the Congress, 2009). In such a way, the Federal Reserve developed policies to support the banking system of the USA, which can revive the national economy. Hence, proponents of Fed’s policy (Monetary Policy Report to the Congress, 9) consider them to be effective.
CRITICISM OF THE FEDERAL RESERVE SYSTEM
However, there are many critics of the Fed, such as Ron Paul, who criticizes the Federal Reserve System (FED) because of unfair practices, which bring harm to the economy and millions of ordinary Americans. Ron Paul once formulated his slogan “End of Fed”. He believes the FED is “dishonest, immoral and unconstitutional” organization. Thus, he has three main claims to the Federal Reserve:
1) Federal reserve produce “dishonest”, “inflated” money, which often referred to as fiat (that is, having a certain rate due to authority of the state, and not due to any economic guarantees), rather than the so-called sound money, which, for example, had a circulation at the time of the gold standard.
2) Unfair practices against members of the free market, while manipulating interest rates and securities.
3) Lack of control, lack of transparency of the FED actions, which are contrary to the economic interests of the country, its citizens and economic entities.
In this regard, Ron Paul requires put the Fed under the control of Congress, because under the Constitution the legislative branch has the exclusive right to conduct inspections and investigations in particularly important cases. And what could be more important than financial stability of the whole country. In the 2012 election Ron Paul goes with the slogan “Audit the Fed”.
The Federal Reserve has always resisted such an audit throughout its history. According to the Federal Reserve Act of 1913, the actions of FED may be limited by laws adopted by Congress, but otherwise acts as an independent shareholder structure. It is necessary to note that such a position of FED often gives rise to theories about the private Central Bank of the United States. As for the President, he has the authority to approve or not approve the Chairman of the Board of Directors of the Federal Reserve, however, director is elected by the internal vote of the Council.
Formally audit of the FED may hold Governmental Accountability Office (GAO), which is a state audit commission and is a part of the legislative branch, but its effectiveness in spite of the extensive self-promotion, is highly questionable. For example, in 2010 GAO presented the Financial Report of the Government of the United States and a press release, stating that the Commission could not give its assessment of the consolidated balance sheet of the Federal Government because of the weak control over the vast material, a significant number of inaccuracies and due to other constraints.
The Federal Reserve according to the official statement has been operating as an independent agency within the government. That basically means that this institution is de facto a separate branch of government. Such a status is confirmed by the words of an official statement: “Federal Reserve … is regarded as an independent central bank because its decisions on monetary policy does not require the approval of the President or anyone else from the executive or judicial branches of government, it receives no funding approved by Congress and the decision of the board of directors includes a large number of conditions set by the President and Congress”. (www.bloomberg.com)
Ron Paul has consistently opposed such a situation and proposed the bill HR 1207, known as the “Law on Transparency of the Federal Reserve.” However, the bill was rejected despite the global financial crisis. Many of its provisions were included in other bills, but Ron Paul and his supporters refused to vote for the “half-solutions”. However, even these solutions (such as bill HR 3996, which in particular removes restrictions of GAO in auditing the Federal Reserve) met strong resistance from the monetary authorities, and as a result President Obama spoke out against it. There were not enough votes to overcome President’s veto, and the law “stuck” in the conciliation committees of the Congress. Opponents of such legislative initiatives say that it was not for the good of the American economy, but simple populism. For example, in 2009, when Paul’s bill was under consideration, Republican Senator Judd Gregg did not hide his anger: “It’s inexcusable to let Congress intervene in monetary policy … One of our strengths is an independent Federal Reserve, and the idea that comes from the House of Representatives is just a populist fever … this is absolutely the wrong decision, and it will bring a fundamental damage to our monetary policy”. (Romm 2009)
So, what we are dealing with: a violation of the Constitution, as says Ron Paul, or violence against the free market or the obvious need for an independent central bank, free from the dictates of populist politicians? There are two important questions that follow the critique of Ron Paul and his supporters: can the Federal Reserve be blamed for the financial crisis? Is it effective enough to prevent crisis or at least mitigate the crisis? Finally, we pose the question more broadly: does the existence of such a powerful structure as the Federal Reserve comply with conditions of economic freedom?
Mark Gertler, an economics professor at New York University, Scientific Adviser of the Federal Reserve Bank of New York, gave his opinion: “It is impossible to imagine the modern global system without a central bank. Central banks were established primarily to maintain the stability of the private banking system. The Fed was created in the early XX century, after the U.S. experienced several economic downturns caused by the collapse of banks. The main task of the Fed in times of crisis is to ensure the continuity of the flow of credit, as happened during the recent crisis”. (bloomberg.com)
Gertler said: “The Fed is independent and objective enough to ensure the stability of the economy. The Fed is really the only institution in the United States free from politics. In my opinion, it is generally the most successful institution in the United States, precisely because it is completely free from politics. If not actions of the Fed, the economic crisis for the U.S. and world economy would have been even worse”. (bloomberg.com)
With the position of Goertler disagreed Alan Reynolds, former head of the Directorate for Economic Research at the Hudson Institute. Paul Reynolds supported the issue of lack of control the Fed and its anti-market nature: “In contrast to the legislative and executive branches of government, the leadership of the Federal Reserve did not really accountable to civilian control. If the White House and Congress from time to time have inspections of the voters from different states, the Supreme Court, and so on, the Fed is free in its actions”. (bloomberg.com)
James Galbraith, professor at the University of Texas, a senior fellow of the Institute of Economic Levy also pointed to the global role of the Fed: “In its present form the Federal Reserve acts as a last instance, which is important to the whole world, not just to the United States. It became obvious at the time of crisis when the U.S. Federal Reserve has released huge amounts of currency to exchange with other major central banks”. (bloomberg.com)
However, the legal status of the Fed, according to Galbraith, has a lot of conflicts: “the Fed in Washington is a state agency, the Federal Reserve regional banks are also government agencies, but they strangely have private influences, endowed with legal status. That is the problematic fact in terms of American Constitution”. (bloomberg.com)
That is, the Fed has recently acted primarily in the interests of major U.S. banks. In a moment of crisis the Fed was completely unable to independently regulate the work of these institutions, although it is the purpose of the Fed. The real cause of the problems with the Fed is not the very existence of such an agency, but the fact that the Fed has become hostage to the interests of the oligarchic banking system – that the problem facing the U.S. today, and this issue that has not been solved yet.
The problem is that the Federal Reserve System has become a multi-functional agency. It not only deals with monetary policy, but does most of the fiscal policy, is engaged in saving banks, which are called “too big to fail”. But if the Fed has focused on domestic politics, it just might be more likely to prevent systemic crises.
However, it proves beyond a doubt that such regulation and monetary policies conducted by the Federal Reserve are very complicated and cannot always be applied effectively. In this respect, it is possible to refer to the recent mortgage crisis, which was followed up by a profound economic recession and a considerable drop of the GDP. In fact, it is obvious that the Federal Reserve has failed to prevent the crisis and the overheating of the national economy resulted in the current economic crisis. In such a situation, the current polices of the Federal Reserve aim at the revival of the national economy through the monetary policies. In this respect, one of the main directions in the current policies of the Federal Reserve is the restriction of the inflation, which started to grow substantially in 2008, but, by the end of the year, the Federal Reserve has managed to decrease the inflation rate, which was negative in the last quarter of the year (Monetary Policy Report to the Congress, 2009).
In addition, the Federal Reserve attempts to maintain the banking system of the USA because many leading banks of the country have faced serious financial problems and suffered from problems concerning liquidity. Moreover, some banks have already run bankrupt. In such a situation, the Federal Reserve attempts to support banks and stimulate them start lending money extensively to stimulate economic activities in the USA.
In fact, the Fed has failed to prevent the economic recession because it has failed to stop speculations in the housing market before the economic recession. After the recession, the Fed focused on the support of large banks which were definitely sinking down. Obviously, such support is a provisional measure that will help large banks to survive for a while but this measure will not improve their performance, while the threat of their bankruptcy persists. Hence, the Fed just prolongs the economic stagnation.
FEDERAL RESERVE SYSTEM AND THE CURRENT ECONOMIC CRISIS
During the history of the FED, there were only two periods when it was able to achieve both stable growth and low inflation. It was in the 1923-1928 years when there was a gold standard, and from 1983 to 2002, when it followed the so-called Taylor rule. But if we speak about the current crisis, the Fed contributed to it, as it kept interest rates too low for too long and also financed the growth of unsecured loans.
The main mistake of the Federal Reserve System is that it has no long-term plans, attention is paid mainly to what happens in a very short period of time. The leaders of the Federal Reserve never ask such important questions: if we do it today, what would be the situation in a year? What will happen in two years, three? For example, the Federal Reserve System has no, despite numerous statements by Chairman Ben Bernanke, coherent explanation of how to get rid of the burden of $ 1.5 trillion of excess reserves.
Thus, the Fed’s policy is absolutely ineffective because its policy focuses on the support of large banks and corporations, while monetary policies are ineffective. The Fed failed to prevent speculations before the recession and the Fed has done nothing to prevent speculations in the future. Therefore, the threat of the new wave of the economic recession persists.
