Why Was the Federal Reserve Created & What Are Its Essential Functions?
- The Federal Reserve Bank of New York explains on its website that the Federal Reserve was founded in 1913 upon Congress's enactment of the Federal Reserve Act. The goal of the act was to provide more oversight of U.S. banking and to provide a more elastic currency. Great financiers of the time including J.P. Morgan and Alfred Rothschild backed and supported the establishment of the Fed. They and other supporters believed the monetary system of the U.S. should be privatized to ensure the free flow of capital through the economy. The financial crises during the late 1800s and early 1900s were one reason for needing greater financial oversight and control. However, three years after the act's passage, President Woodrow Wilson lamented his decision to sign the act. Wilson believed the establishment of the Fed placed the fate of the economy in the hands of only a few men.
- The Federal Reserve's main role is overseeing lending between central banks and consumers. The Federal Reserve Bank of San Francisco's website cites examples of such regulation including non-discrimination in home mortgage lending and electronic funds transfer oversight. Additionally, the Fed loans money to troubled banks in need of a cash infusion in the event of a credit crisis. The Fed also sets interest rates which either contract or expand the money supply. The money supply contracts when nominal interest rates are high and expands when interest rates are low.
- Economic conditions determine the actions of the Federal Reserve. Deflationary periods compel the Federal Reserve to incite rising prices by raising interest rates and selling off government assets to banks. During the 2008 economic crisis, the Federal Reserve loaned trillions of dollars to various banks and companies in an effort to get these institutions lending again. When inflation is high, the Federal Reserve tries spurring deflation by elevating interest rates. The Fed enacts policies in hopes of stabilizing prices, keeping the unemployment rate at a steady level and fueling economic growth.
- The Federal Reserve is a private institution. Some members of Congress believe the monetary supply should be in control of the U.S. government. The argument goes that not having government oversight lends itself to unscrupulous behavior. For example, people who run the Fed might show favoritism toward the financial institutions from which they came. On the other hand, former Federal Reserve chairman Alan Greenspan explained in his book, "The Age of Turbulence," that the Fed must remain out of the influence of politics and elections.