Criticism of the Federal Reserve
Encyclopedia
The Federal Reserve System
, known colloquially as "the Fed", has faced various criticisms since its conception in 1913. The system was created as a third attempt at central banking in the United States
. The Federal Reserve Act
, which began the Fed, was a hotly debated issue in its own right, and passed primarily on party lines—and that was only after considerable political manipulation of Congressmen by Woodrow Wilson
.
The earliest debates on central banking in the United States centered on its constitutionality, private ownership, and the degree to which an economy should be centrally planned. Some of the most prominent early critics were Thomas Jefferson
, James Madison
, and Andrew Jackson
, although Madison ultimately renounced his earlier objections. As the effects of central banking, and the Federal Reserve System in particular, became more apparent, new criticisms began to emerge.
Intense criticism among the general public was a major feature of the 2010 midterm elections. Critics reached a wide audience that reacted against the Troubled Asset Relief Program of 2008-9 and the bailout of major banks, insurance and mortgage companies, as well as the industrial companies General Motors
and Chrysler
. Longtime critics of the Fed gained new audiences as New York Times columnist Frank Rich
noted, "Ron Paul
and Jim DeMint
, political heroes of the tea party right
, and Bernie Sanders
and Alan Grayson
, similarly revered on the left, have found a common cause in vilifying the Federal Reserve Bank
and its chairman, Ben Bernanke."
Many Congressmen who have been involved in the House and Senate Banking and Currency Committees have been open critics of the Federal Reserve, including Chairmen Wright Patman
, Henry Reuss, and Henry B. Gonzalez
. Congressman Ron Paul
, the current Chairman of the Monetary Policy Subcommittee, is a staunch opponent of the Federal Reserve System, and routinely introduces bills to abolish the Federal Reserve System, although these have been unsuccessful, garnering neither cosponsors nor hearings. Paul, however, rallied more success with the Federal Reserve Transparency Act of 2009. Although this bill was not passed, certain parts were included in the Dodd–Frank Wall Street Reform and Consumer Protection Act. This resulted in a partial audit of the emergency loan programs authorized by the Board of Governors
. In a report was submitted by the Government Accountability Office
, on the 21st of July 2011, called the Federal Reserve System: Opportunities Exist to Strengthen Policies and Processes for Managing Emergency Assistance, discovered that in the 3 years prior to the audit that some 16 trillion dollars had been given in the form of loans and bailouts to U.S. banks, corporations, as well as, to foreign banks in France, Scotland, Germany, U.K., Switzerland, and Belgium.
It has often been said that the Federal Reserve is a creature of Congress and it is the fluctuating opinion of that body to which it answers.
, believe that monetary policy is often too tight. They argue that lower interest rates would be more advantageous to the United States economy; lower rates lead to higher employment, it is argued, because demand for goods is increased.
According to this argument, the possible accompanying inflation
would in fact be positive. Inflation decreases the real value of both foreign and domestic debt, as well as decreases real interest rates for entities that have borrowed money at a fixed nominal rate. In addition, Paul Krugman
argues that a lower dollar—which may very well accompany higher inflation—is good for U.S. exporters, thereby helping to make the transition away from huge trade deficits to a more sustainable international position.
A rough guideline of how the Fed currently sets the federal funds rate
is a special case of the so called "Taylor rule
". The rule can be written as follows:
where
is the federal funds rate, 
is the rate of inflation, 
is the target rate of inflation, 
is the logarithm of real GDP
, and
is the logarithm of potential output
.
(FOMC), while other regional banks rotate in two- and three-year intervals. The FOMC, under law, determines its own internal organization but, by tradition, elects the president of the Federal Reserve Bank of New York
as its vice chairman. A working paper written for the Federal Reserve Bank of Atlanta
in 2003 said:
Perhaps the most widely-accepted criticism of the Fed was first proposed by Milton Friedman
and Anna Schwartz
– that the Fed exacerbated the 1929 recession, sparking the Great Depression
. After the stock market crashed in 1929, the Fed continued to contract the money supply
and refused to save banks that were struggling due to bank runs. This mistake, critics charge, allowed what might have been a relatively mild recession to explode into catastrophe. Friedman and Schwartz believed that the depression was “a tragic testimonial to the importance of monetary forces.”
Before the 1913 establishment of the Federal Reserve
, the banking system had dealt with periodic crises (such as in the Panic of 1907
) by suspending the convertibility of deposits into currency. The system nearly collapsed in 1907 and there was an extraordinary intervention by an ad-hoc coalition assembled by J. P. Morgan
. The bankers demanded in 1910-1913 a central bank to address this structural weakness. Friedman suggests, however, that if a policy similar to 1907 had been followed during the banking panic at the end of 1930, it might have stopped the vicious circle of the forced liquidation of assets at depressed prices, just as suspension of convertibility in 1893 and 1907 had quickly ended the liquidity crises at the time.
Essentially, in the monetarist view, the Great Depression was caused by the fall of the money supply. Friedman and Schwartz note that "[f]rom the cyclical peak in August 1929 to a cyclical trough in March 1933, the stock of money fell by over a third." The result was what Friedman calls the "Great Contraction"—a period of falling income, prices, and employment caused by the choking effects of a restricted money supply. The mechanism suggested by Friedman and Schwartz was that people wanted to hold more money than the Federal Reserve was supplying. People thus hoarded money by consuming less. This, in turn, caused a contraction in employment and production, since prices were not flexible enough to immediately fall. The Fed's failure was in not realizing what was happening and not taking corrective action.
Many have since agreed with Friedman and Schwartz's theory, including current Chairman Ben S. Bernanke, who said in a 2002 speech:
In a 2002 interview with Peter Jaworski (The Journal, Queen's University, March 15, 2002—Issue 37, Volume 129) Friedman said that ideally he would "prefer to abolish the federal reserve system altogether" rather than try to reform it, because it was a flawed system in the first place. He would prefer to replace the organization with a mechanical system that would increase the money supply at some fixed rate, and thought that "leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement."
. They claim that the Fed kept interest rates too low following the 2001 recession, and that this in turn prompted borrowers to be reckless. The housing bubble then led to the credit crunch. Then-Chairman Alan Greenspan
disputes this interpretation. He points out that the Fed's control over the long-term interest rates critics have in mind is only indirect. The Fed did raise the short term interest rate over which it has control (i.e. the federal funds rate), but the long term interest rate (which usually follows the former) did not increase.
The Federal Reserve's role as a supervisor and regulator has been criticized as being ineffective. Former U.S. Senator Chris Dodd, then-chairman of the United States Senate Committee on Banking, Housing, and Urban Affairs
, remarked about the Fed's role in the present economic crisis, "We saw over the last number of years when they took on consumer protection responsibilities and the regulation of bank holding companies, it was an abysmal failure."
In the 2010 midterm elections, the Tea Party movement
made criticism of the Federal Reserve a major talking point, picked up by conservative Republican candidates across the country. In Utah, GOP Senate candidate Mike Lee has campaigned against the Fed, accusing it of trying to “monetize the debt” by printing money to buy government bonds. Fed officials have hotly denied that. GOP Senate candidate Ken Buck
in Colorado says Congress should be "shining a light on the Federal Reserve" because it is too cozy with private interests. GOP Senate candidate Rand Paul
in Kentucky, whose father Congressman Ron Paul
has long attacked the Fed, argues that the Fed is hurting the economy by lowering the dollar and by its easy money policies that cause booms and busts. Polls indicate that the Fed's critics will have a much stronger voice in the next Congress.
Austrian School
, is that the Federal Reserve's control of interest rates is an unnecessary and counterproductive interference in the economy. According to this theory, rates should be naturally low during times of excessive consumer saving (because lendable money is abundant) and naturally high when high net volumes of consumer credit are extended (because lendable money is scarce). These critics argue that setting a baseline lending rate amounts to centralized economic planning, and inflating the currency amounts to a regressive, incremental redistribution of wealth. While these viewpoints remain a minority position, many Austrians credit themselves with correctly predicting the Financial crisis of 2007–2010, most notably investment banker Peter Schiff
for his many appearances on popular US cable news channels.
. This is seen as a failure of the Fed to comply with its legislatively mandated duty, as specified by the Federal Reserve Act
. Critics focus particularly on inflation's effects on wages and savings. They point out that wages, as adjusted for inflation, i.e. real wage
s, have sometimes gone down (e.g. at the end of 2004). Additionally, critics point out that there has been a decline of over 95% in the purchasing power of the U.S. dollar since the Federal Reserve's inception, which can be seen as a failure in its mission as well.
Milton Friedman alleged that the Fed caused the high inflation of the 1970s. When asked about the greatest economic problem of the day, he said the most pressing was how to get rid of the Federal Reserve. In April 2009 former Fed Chairman Paul Volcker
criticized the Fed's notion that an inflation rate of two percent is consistent with promotion of price stability, noting that a two percent inflation rate will wipe out half of a consumer's purchasing power within a generation.
, argues that:
Another argument – that the power to "coin" money precludes issuance of paper money, and that the government must redeem paper money with "precious metal" – was dismissed as frivolous
in Milam v. United States, citing the Legal Tender Cases.
Member banks ("[a]bout 38 percent of the nation's more than 8,000 banks") are required to own capital stock in their regional banks, and the regional banks pay a set 6% dividend on the member banks' paid-in capital stock (not the regional banks' profits) each year, returning the rest to the US Treasury Department. The Fed has noted that this has created "some confusion about 'ownership'":
In response to a Bloomberg request for information under the Freedom of Information Act against the Board of Governors of the Federal Reserve System, the Board objected to the request by stating that the records were housed at the Federal Reserve Bank of New York, which was "not an agency" of the government and therefore not subject to the Act.
Some have criticized this quasi-private arrangement, claiming that the Federal Reserve System is a private bank. For example, Charles August Lindbergh
objected to the private ownership of the Federal Reserve banks, complaining that the financial system "has been turned over to the Federal Reserve Board ... [which] administers the finance system by authority of a purely profiteering group. The system is Private, conducted for the sole purpose of obtaining the greatest possible profits from the use of other people's money."
By contrast, one commentator has stated:
In his textbook, Monetary Policy and the Financial System, Paul M. Horvitz, the former Director of Research for the Federal Deposit Insurance Corporation
, states:
Also, the Fed sponsors much of the monetary economics research in the United States. Some believe this makes it less likely for researchers to publish findings challenging the status quo that is the Federal Reserve.
Federal Reserve System
The Federal Reserve System is the central banking system of the United States. It was created on December 23, 1913 with the enactment of the Federal Reserve Act, largely in response to a series of financial panics, particularly a severe panic in 1907...
, known colloquially as "the Fed", has faced various criticisms since its conception in 1913. The system was created as a third attempt at central banking in the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
. The Federal Reserve Act
Federal Reserve Act
The Federal Reserve Act is an Act of Congress that created and set up the Federal Reserve System, the central banking system of the United States of America, and granted it the legal authority to issue Federal Reserve Notes and Federal Reserve Bank Notes as legal tender...
, which began the Fed, was a hotly debated issue in its own right, and passed primarily on party lines—and that was only after considerable political manipulation of Congressmen by Woodrow Wilson
Woodrow Wilson
Thomas Woodrow Wilson was the 28th President of the United States, from 1913 to 1921. A leader of the Progressive Movement, he served as President of Princeton University from 1902 to 1910, and then as the Governor of New Jersey from 1911 to 1913...
.
The earliest debates on central banking in the United States centered on its constitutionality, private ownership, and the degree to which an economy should be centrally planned. Some of the most prominent early critics were Thomas Jefferson
Thomas Jefferson
Thomas Jefferson was the principal author of the United States Declaration of Independence and the Statute of Virginia for Religious Freedom , the third President of the United States and founder of the University of Virginia...
, James Madison
James Madison
James Madison, Jr. was an American statesman and political theorist. He was the fourth President of the United States and is hailed as the “Father of the Constitution” for being the primary author of the United States Constitution and at first an opponent of, and then a key author of the United...
, and Andrew Jackson
Andrew Jackson
Andrew Jackson was the seventh President of the United States . Based in frontier Tennessee, Jackson was a politician and army general who defeated the Creek Indians at the Battle of Horseshoe Bend , and the British at the Battle of New Orleans...
, although Madison ultimately renounced his earlier objections. As the effects of central banking, and the Federal Reserve System in particular, became more apparent, new criticisms began to emerge.
Intense criticism among the general public was a major feature of the 2010 midterm elections. Critics reached a wide audience that reacted against the Troubled Asset Relief Program of 2008-9 and the bailout of major banks, insurance and mortgage companies, as well as the industrial companies General Motors
General Motors
General Motors Company , commonly known as GM, formerly incorporated as General Motors Corporation, is an American multinational automotive corporation headquartered in Detroit, Michigan and the world's second-largest automaker in 2010...
and Chrysler
Chrysler
Chrysler Group LLC is a multinational automaker headquartered in Auburn Hills, Michigan, USA. Chrysler was first organized as the Chrysler Corporation in 1925....
. Longtime critics of the Fed gained new audiences as New York Times columnist Frank Rich
Frank Rich
Frank Rich is an American essayist and op-ed columnist who wrote for The New York Times from 1980, when he was appointed its chief theatre critic, until 2011...
noted, "Ron Paul
Ron Paul
Ronald Ernest "Ron" Paul is an American physician, author and United States Congressman who is seeking to be the Republican Party candidate in the 2012 presidential election. Paul represents Texas's 14th congressional district, which covers an area south and southwest of Houston that includes...
and Jim DeMint
Jim DeMint
James Warren "Jim" DeMint is the junior U.S. Senator from South Carolina, serving since 2005. He is a member of the Republican Party and a leader in the Tea Party movement. He previously served as the U.S. Representative for from 1999 to 2005.-Early life and education:DeMint was born in...
, political heroes of the tea party right
Tea Party movement
The Tea Party movement is an American populist political movement that is generally recognized as conservative and libertarian, and has sponsored protests and supported political candidates since 2009...
, and Bernie Sanders
Bernie Sanders
Bernard "Bernie" Sanders is the junior United States Senator from Vermont. He previously represented Vermont's at-large district in the United States House of Representatives...
and Alan Grayson
Alan Grayson
Alan Mark Grayson is a former U.S. Representative for , serving from 2009 until 2011. He is a member of the Democratic Party and loves cookies. After losing the election he moved to Austin to start stand-up comedy and a cookie business. The district Grayson represented lies in central Florida...
, similarly revered on the left, have found a common cause in vilifying the Federal Reserve Bank
Federal Reserve Bank
The twelve Federal Reserve Banks form a major part of the Federal Reserve System, the central banking system of the United States. The twelve federal reserve banks together divide the nation into twelve Federal Reserve Districts, the twelve banking districts created by the Federal Reserve Act of...
and its chairman, Ben Bernanke."
Congress
Congressman Louis T. McFadden, Chairman of the House Committee on Banking and Currency from 1920–31, accused the Federal Reserve of deliberately causing the Great Depression. In several speeches made shortly after he lost the chairmanship of the committee, McFadden claimed that the Federal Reserve was run by Wall Street banks and their affiliated European banking houses.Many Congressmen who have been involved in the House and Senate Banking and Currency Committees have been open critics of the Federal Reserve, including Chairmen Wright Patman
Wright Patman
John William Wright Patman was a U.S. Congressman from Texas in Texas's 1st congressional district and chair of the United States House Committee on Banking and Currency .-Early life:...
, Henry Reuss, and Henry B. Gonzalez
Henry B. Gonzalez
Henry Barbosa González was a Democratic politician from the state of Texas. He represented Texas's 20th congressional district from 1961 to 1999.-Background:...
. Congressman Ron Paul
Ron Paul
Ronald Ernest "Ron" Paul is an American physician, author and United States Congressman who is seeking to be the Republican Party candidate in the 2012 presidential election. Paul represents Texas's 14th congressional district, which covers an area south and southwest of Houston that includes...
, the current Chairman of the Monetary Policy Subcommittee, is a staunch opponent of the Federal Reserve System, and routinely introduces bills to abolish the Federal Reserve System, although these have been unsuccessful, garnering neither cosponsors nor hearings. Paul, however, rallied more success with the Federal Reserve Transparency Act of 2009. Although this bill was not passed, certain parts were included in the Dodd–Frank Wall Street Reform and Consumer Protection Act. This resulted in a partial audit of the emergency loan programs authorized by the Board of Governors
Board of governors
Board of governors is a term sometimes applied to the board of directors of a public entity or non-profit organization.Many public institutions, such as public universities, are government-owned corporations. The British Broadcasting Corporation was managed by a board of governors, though this role...
. In a report was submitted by the Government Accountability Office
Government Accountability Office
The Government Accountability Office is the audit, evaluation, and investigative arm of the United States Congress. It is located in the legislative branch of the United States government.-History:...
, on the 21st of July 2011, called the Federal Reserve System: Opportunities Exist to Strengthen Policies and Processes for Managing Emergency Assistance, discovered that in the 3 years prior to the audit that some 16 trillion dollars had been given in the form of loans and bailouts to U.S. banks, corporations, as well as, to foreign banks in France, Scotland, Germany, U.K., Switzerland, and Belgium.
It has often been said that the Federal Reserve is a creature of Congress and it is the fluctuating opinion of that body to which it answers.
Employment
Some critics of the Federal Reserve, such as Peter TeminPeter Temin
Dr. Peter Temin is a widely cited economist and economic historian, currently Gray Professor Emeritus of Economics, MIT and former head of the Economics Department....
, believe that monetary policy is often too tight. They argue that lower interest rates would be more advantageous to the United States economy; lower rates lead to higher employment, it is argued, because demand for goods is increased.
According to this argument, the possible accompanying inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
would in fact be positive. Inflation decreases the real value of both foreign and domestic debt, as well as decreases real interest rates for entities that have borrowed money at a fixed nominal rate. In addition, Paul Krugman
Paul Krugman
Paul Robin Krugman is an American economist, professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University, Centenary Professor at the London School of Economics, and an op-ed columnist for The New York Times...
argues that a lower dollar—which may very well accompany higher inflation—is good for U.S. exporters, thereby helping to make the transition away from huge trade deficits to a more sustainable international position.
A rough guideline of how the Fed currently sets the federal funds rate
Federal funds rate
In the United States, the federal funds rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis. Institutions with surplus balances in their accounts lend...
is a special case of the so called "Taylor rule
Taylor rule
In economics, a Taylor rule is a monetary-policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions. In particular, the rule stipulates that for each one-percent increase in inflation, the...
". The rule can be written as follows:
where
is the federal funds rate, is the rate of inflation, is the target rate of inflation, is the logarithm of real GDPGross domestic product
Gross domestic product refers to the market value of all final goods and services produced within a country in a given period. GDP per capita is often considered an indicator of a country's standard of living....
, and
is the logarithm of potential outputPotential output
In economics, potential output refers to the highest level of real Gross Domestic Product output that can be sustained over the long term. The existence of a limit is due to natural and institutional constraints...
.
Excessive New York City influence
Many people have complained that New York City's financial sector has too much influence on banking in the United States. The New York Federal Reserve Bank representative is the only permanent member of the Federal Open Market CommitteeFederal Open Market Committee
The Federal Open Market Committee , a committee within the Federal Reserve System, is charged under United States law with overseeing the nation's open market operations . It is the Federal Reserve committee that makes key decisions about interest rates and the growth of the United States money...
(FOMC), while other regional banks rotate in two- and three-year intervals. The FOMC, under law, determines its own internal organization but, by tradition, elects the president of the Federal Reserve Bank of New York
Federal Reserve Bank of New York
The Federal Reserve Bank of New York is one of the 12 Federal Reserve Banks of the United States. It is located at 33 Liberty Street, New York, NY. It is responsible for the Second District of the Federal Reserve System, which encompasses New York state, the 12 northern counties of New Jersey,...
as its vice chairman. A working paper written for the Federal Reserve Bank of Atlanta
Federal Reserve Bank of Atlanta
The Federal Reserve Bank of Atlanta is responsible for the sixth district, which covers the states of Alabama, Florida, and Georgia, 74 counties in the eastern two-thirds of...
in 2003 said:
The Great Depression 1929
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...
and Anna Schwartz
Anna Schwartz
Anna Jacobson Schwartz is an economist at the National Bureau of Economic Research in New York City, and according to Paul Krugman "one of the world's greatest monetary scholars"...
– that the Fed exacerbated the 1929 recession, sparking the Great Depression
Great Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
. After the stock market crashed in 1929, the Fed continued to contract the money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
and refused to save banks that were struggling due to bank runs. This mistake, critics charge, allowed what might have been a relatively mild recession to explode into catastrophe. Friedman and Schwartz believed that the depression was “a tragic testimonial to the importance of monetary forces.”
Before the 1913 establishment of the Federal Reserve
Federal Reserve Act
The Federal Reserve Act is an Act of Congress that created and set up the Federal Reserve System, the central banking system of the United States of America, and granted it the legal authority to issue Federal Reserve Notes and Federal Reserve Bank Notes as legal tender...
, the banking system had dealt with periodic crises (such as in the Panic of 1907
Panic of 1907
The Panic of 1907, also known as the 1907 Bankers' Panic, was a financial crisis that occurred in the United States when the New York Stock Exchange fell almost 50% from its peak the previous year. Panic occurred, as this was during a time of economic recession, and there were numerous runs on...
) by suspending the convertibility of deposits into currency. The system nearly collapsed in 1907 and there was an extraordinary intervention by an ad-hoc coalition assembled by J. P. Morgan
J. P. Morgan
John Pierpont Morgan was an American financier, banker and art collector who dominated corporate finance and industrial consolidation during his time. In 1892 Morgan arranged the merger of Edison General Electric and Thomson-Houston Electric Company to form General Electric...
. The bankers demanded in 1910-1913 a central bank to address this structural weakness. Friedman suggests, however, that if a policy similar to 1907 had been followed during the banking panic at the end of 1930, it might have stopped the vicious circle of the forced liquidation of assets at depressed prices, just as suspension of convertibility in 1893 and 1907 had quickly ended the liquidity crises at the time.
Essentially, in the monetarist view, the Great Depression was caused by the fall of the money supply. Friedman and Schwartz note that "[f]rom the cyclical peak in August 1929 to a cyclical trough in March 1933, the stock of money fell by over a third." The result was what Friedman calls the "Great Contraction"—a period of falling income, prices, and employment caused by the choking effects of a restricted money supply. The mechanism suggested by Friedman and Schwartz was that people wanted to hold more money than the Federal Reserve was supplying. People thus hoarded money by consuming less. This, in turn, caused a contraction in employment and production, since prices were not flexible enough to immediately fall. The Fed's failure was in not realizing what was happening and not taking corrective action.
Many have since agreed with Friedman and Schwartz's theory, including current Chairman Ben S. Bernanke, who said in a 2002 speech:
Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.
In a 2002 interview with Peter Jaworski (The Journal, Queen's University, March 15, 2002—Issue 37, Volume 129) Friedman said that ideally he would "prefer to abolish the federal reserve system altogether" rather than try to reform it, because it was a flawed system in the first place. He would prefer to replace the organization with a mechanical system that would increase the money supply at some fixed rate, and thought that "leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement."
Global financial crisis
Some economists, such as John Taylor, have asserted that the Fed was responsible, or at least partially responsible, for the United States housing bubbleUnited States housing bubble
The United States housing bubble is an economic bubble affecting many parts of the United States housing market in over half of American states. Housing prices peaked in early 2006, started to decline in 2006 and 2007, and may not yet have hit bottom as of 2011. On December 30, 2008 the...
. They claim that the Fed kept interest rates too low following the 2001 recession, and that this in turn prompted borrowers to be reckless. The housing bubble then led to the credit crunch. Then-Chairman Alan Greenspan
Alan Greenspan
Alan Greenspan is an American economist who served as Chairman of the Federal Reserve of the United States from 1987 to 2006. He currently works as a private advisor and provides consulting for firms through his company, Greenspan Associates LLC...
disputes this interpretation. He points out that the Fed's control over the long-term interest rates critics have in mind is only indirect. The Fed did raise the short term interest rate over which it has control (i.e. the federal funds rate), but the long term interest rate (which usually follows the former) did not increase.
The Federal Reserve's role as a supervisor and regulator has been criticized as being ineffective. Former U.S. Senator Chris Dodd, then-chairman of the United States Senate Committee on Banking, Housing, and Urban Affairs
United States Senate Committee on Banking, Housing, and Urban Affairs
The United States Senate Committee on Banking, Housing, and Urban Affairs has jurisdiction over matters related to: banks and banking, price controls, deposit insurance, export promotion and controls, federal monetary policy, financial aid to commerce and industry, issuance of redemption of notes,...
, remarked about the Fed's role in the present economic crisis, "We saw over the last number of years when they took on consumer protection responsibilities and the regulation of bank holding companies, it was an abysmal failure."
In the 2010 midterm elections, the Tea Party movement
Tea Party movement
The Tea Party movement is an American populist political movement that is generally recognized as conservative and libertarian, and has sponsored protests and supported political candidates since 2009...
made criticism of the Federal Reserve a major talking point, picked up by conservative Republican candidates across the country. In Utah, GOP Senate candidate Mike Lee has campaigned against the Fed, accusing it of trying to “monetize the debt” by printing money to buy government bonds. Fed officials have hotly denied that. GOP Senate candidate Ken Buck
Ken Buck
Kenneth R. "Ken" Buck is the District Attorney for Weld County, Colorado, and was the unsuccessful Republican challenger to Michael Bennet in the 2010 U.S. Senate race in Colorado.-Early life and education:...
in Colorado says Congress should be "shining a light on the Federal Reserve" because it is too cozy with private interests. GOP Senate candidate Rand Paul
Rand Paul
Randal Howard "Rand" Paul is the junior United States Senator for Kentucky. He is a member of the Republican Party. A member of the Tea Party movement, he describes himself as a "constitutional conservative" and a libertarian...
in Kentucky, whose father Congressman Ron Paul
Ron Paul
Ronald Ernest "Ron" Paul is an American physician, author and United States Congressman who is seeking to be the Republican Party candidate in the 2012 presidential election. Paul represents Texas's 14th congressional district, which covers an area south and southwest of Houston that includes...
has long attacked the Fed, argues that the Fed is hurting the economy by lowering the dollar and by its easy money policies that cause booms and busts. Polls indicate that the Fed's critics will have a much stronger voice in the next Congress.
Non-mainstream economics
One criticism of the Fed, typified by the non-mainstreamHeterodox economics
"Heterodox economics" refers to approaches or to schools of economic thought that are considered outside of "mainstream economics". Mainstream economists sometimes assert that it has little or no influence on the vast majority of academic economists in the English speaking world. "Mainstream...
Austrian School
Austrian School
The Austrian School of economics is a heterodox school of economic thought. It advocates methodological individualism in interpreting economic developments , the theory that money is non-neutral, the theory that the capital structure of economies consists of heterogeneous goods that have...
, is that the Federal Reserve's control of interest rates is an unnecessary and counterproductive interference in the economy. According to this theory, rates should be naturally low during times of excessive consumer saving (because lendable money is abundant) and naturally high when high net volumes of consumer credit are extended (because lendable money is scarce). These critics argue that setting a baseline lending rate amounts to centralized economic planning, and inflating the currency amounts to a regressive, incremental redistribution of wealth. While these viewpoints remain a minority position, many Austrians credit themselves with correctly predicting the Financial crisis of 2007–2010, most notably investment banker Peter Schiff
Peter Schiff
Peter David Schiff is an American investment broker, author and financial commentator. Schiff is CEO and chief global strategist of Euro Pacific Capital Inc., a broker-dealer based in Westport, Connecticut and CEO of Euro Pacific Precious Metals, LLC, a gold and silver dealer based in New York...
for his many appearances on popular US cable news channels.
Inflation
One major area of criticism focuses on the failure of the Federal Reserve System to stop inflationInflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
. This is seen as a failure of the Fed to comply with its legislatively mandated duty, as specified by the Federal Reserve Act
Federal Reserve Act
The Federal Reserve Act is an Act of Congress that created and set up the Federal Reserve System, the central banking system of the United States of America, and granted it the legal authority to issue Federal Reserve Notes and Federal Reserve Bank Notes as legal tender...
. Critics focus particularly on inflation's effects on wages and savings. They point out that wages, as adjusted for inflation, i.e. real wage
Real wage
The term real wages refers to wages that have been adjusted for inflation. This term is used in contrast to nominal wages or unadjusted wages. Real wages provide a clearer representation of an individual's wages....
s, have sometimes gone down (e.g. at the end of 2004). Additionally, critics point out that there has been a decline of over 95% in the purchasing power of the U.S. dollar since the Federal Reserve's inception, which can be seen as a failure in its mission as well.
Milton Friedman alleged that the Fed caused the high inflation of the 1970s. When asked about the greatest economic problem of the day, he said the most pressing was how to get rid of the Federal Reserve. In April 2009 former Fed Chairman Paul Volcker
Paul Volcker
Paul Adolph Volcker, Jr. is an American economist. He was the Chairman of the Federal Reserve under United States Presidents Jimmy Carter and Ronald Reagan from August 1979 to August 1987. He is widely credited with ending the high levels of inflation seen in the United States in the 1970s and...
criticized the Fed's notion that an inflation rate of two percent is consistent with promotion of price stability, noting that a two percent inflation rate will wipe out half of a consumer's purchasing power within a generation.
Legality
Congressman Ron PaulRon Paul
Ronald Ernest "Ron" Paul is an American physician, author and United States Congressman who is seeking to be the Republican Party candidate in the 2012 presidential election. Paul represents Texas's 14th congressional district, which covers an area south and southwest of Houston that includes...
, argues that:
"The United States Constitution grants to Congress the authority to coin money and regulate the value of the currency. The Constitution does not give Congress the authority to delegate control over monetary policy to a central bank. Furthermore, the Constitution certainly does not empower the federal government to erode the American standard of living via an inflationary monetary policy."
Another argument – that the power to "coin" money precludes issuance of paper money, and that the government must redeem paper money with "precious metal" – was dismissed as frivolous
Frivolous litigation
In law, frivolous litigation is the practice of starting or carrying on law suits that, due to their lack of legal merit, have little to no chance of being won. The term does not include cases that may be lost due to other matters not related to legal merit...
in Milam v. United States, citing the Legal Tender Cases.
Private ownership
The individual Federal Reserve Banks "are the operating arms of the central banking system, and they combine both public and private elements in their makeup and organization." Each bank has a nine member board of directors: three elected by the commercial banks in the Bank's region, and six chosen—three each by the member banks and the Board of Governors--"to represent the public with due consideration to the interests of agriculture, commerce, industry, services, labor and consumers." These regional banks are in turn controlled by the Federal Reserve Board, whose members are appointed by the President of the United States.Member banks ("[a]bout 38 percent of the nation's more than 8,000 banks") are required to own capital stock in their regional banks, and the regional banks pay a set 6% dividend on the member banks' paid-in capital stock (not the regional banks' profits) each year, returning the rest to the US Treasury Department. The Fed has noted that this has created "some confusion about 'ownership'":
In response to a Bloomberg request for information under the Freedom of Information Act against the Board of Governors of the Federal Reserve System, the Board objected to the request by stating that the records were housed at the Federal Reserve Bank of New York, which was "not an agency" of the government and therefore not subject to the Act.
Some have criticized this quasi-private arrangement, claiming that the Federal Reserve System is a private bank. For example, Charles August Lindbergh
Charles August Lindbergh
Charles August Lindbergh Sr. was a United States Congressman from Minnesota's 6th congressional district from 1907 to 1917...
objected to the private ownership of the Federal Reserve banks, complaining that the financial system "has been turned over to the Federal Reserve Board ... [which] administers the finance system by authority of a purely profiteering group. The system is Private, conducted for the sole purpose of obtaining the greatest possible profits from the use of other people's money."
By contrast, one commentator has stated:
-
- [ . . . ] the "ownership" of the Reserve Banks by the commercial banks is symbolic; they do not exercise the proprietary control associated with the concept of ownership nor share, beyond the statutory dividend, in Reserve Bank "profits." [ . . .] Bank ownership and election at the base are therefore devoid of substantive significance, despite the superficial appearance of private bank control that the formal arrangement creates.
In his textbook, Monetary Policy and the Financial System, Paul M. Horvitz, the former Director of Research for the Federal Deposit Insurance Corporation
Federal Deposit Insurance Corporation
The Federal Deposit Insurance Corporation is a United States government corporation created by the Glass–Steagall Act of 1933. It provides deposit insurance, which guarantees the safety of deposits in member banks, currently up to $250,000 per depositor per bank. , the FDIC insures deposits at...
, states:
-
- [ . . . ] the member banks can exert some rights of ownership by electing some members of the Board of Directors of the Federal Reserve Bank [applicable to those member banks]. For all practical purposes, however, member bank ownership of the Federal Reserve System is merely a fiction. The Federal Reserve Banks are not operated for the purpose of earning profits for their stockholders. The Federal Reserve System does earn a profit in the normal course of its operations, but these profits, above the 6% statutory dividend, do not belong to the member banks. All net earnings after expenses and dividends are paid to the Treasury.
Transparency issues
Another objection is the Fed's lack of transparency. In particular, many believe that the public has a right to know what goes on in the Federal Open Market Committee (FOMC) meetings.Also, the Fed sponsors much of the monetary economics research in the United States. Some believe this makes it less likely for researchers to publish findings challenging the status quo that is the Federal Reserve.
See also
- Austrian business cycle theory
- Core inflationCore inflationCore inflation is a measure of inflation which excludes certain items that face volatile price movements, notably food and energy.The preferred measure by the Federal Reserve of core inflation in the United States is the core Personal consumption expenditures price index...
- Criticism of fractional-reserve banking
- Discount windowDiscount windowThe discount window is an instrument of monetary policy that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions...
- Federal fundsFederal fundsIn the United States, federal funds are overnight borrowings by banks to maintain their bank reserves at the Federal Reserve. Banks keep reserves at Federal Reserve Banks to meet their reserve requirements and to clear financial transactions...
- Federal Reserve PoliceFederal Reserve PoliceThe U.S. Federal Reserve Police is the law enforcement arm of the Federal Reserve System, the central banking system of the United States.-History:...
- Federal Reserve Statistical ReleaseFederal Reserve Statistical ReleaseThe Federal Reserve of the United States gathers and publishes certain economic data and releases them as a Federal Reserve Statistical Release.The main categories include:*Principal Economic Indicators*Bank Asset Quality*Bank Assets and Liabilities...
- Free bankingFree bankingFree banking refers to a monetary arrangement in which banks are subject to no special regulations beyond those applicable to most enterprises, and in which they also are free to issue their own paper currency...
- Gold standardGold standardThe gold standard is a monetary system in which the standard economic unit of account is a fixed mass of gold. There are distinct kinds of gold standard...
- History of central banking in the United StatesHistory of central banking in the United StatesThis article is about the history of central banking in the United States, from the 1790s to the present.-Bank of North America:Some Founding Fathers were strongly opposed to the formation of a central banking system; the fact that England tried to place the colonies under the monetary control of...
- History of Federal Open Market Committee actionsHistory of Federal Open Market Committee actionsThis is a list of historical rate actions by the United States Federal Open Market Committee . The FOMC controls the supply of credit to banks and the sale of treasury securities. At scheduled meetings, the FOMC meets and makes any changes it sees as necessary, notably to the federal funds rate...
- List of conspiracy theories
- Monetary policy of the United States
- Reserve requirementReserve requirementThe reserve requirement is a central bank regulation that sets the minimum reserves each commercial bank must hold of customer deposits and notes...
- United States Bullion DepositoryUnited States Bullion DepositoryThe United States Bullion Depository, often known as Fort Knox, is a fortified vault building located adjacent to Fort Knox, Kentucky, used to store a large portion of United States official gold reserves and occasionally other precious items belonging or entrusted to the federal government.The...
- United States dollarUnited States dollarThe United States dollar , also referred to as the American dollar, is the official currency of the United States of America. It is divided into 100 smaller units called cents or pennies....
External links
- New monetary target, Financial Times Registration Required