The Federal Reserve For (And By) Dummies
By Paul-Martin Foss
You know that the Federal Reserve System is starting to catch the general public’s eye when Katie Couric decides to publish a video explaining what the Fed does. But as you can see from watching the video, her explanation of the Fed is cringeworthy. Yes, it’s difficult to explain the Fed in all of three minutes, but this video is simplistic, superficial, and downright dangerous.
So what exactly does Couric’s video get wrong?
You could probably write a book trying to pick apart all the errors, so let’s just stick to a few points. For one thing, the Fed is not the “gatekeeper of the US economy.” Yes, that’s probably how it likes to see itself, but that’s not what it was created to do. Its role was not to ensure that the US economy stays strong, and in fact it is incapable of doing that. While the Fed has used its mandate to “promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates” by exercising ever-greater power in pursuit of those aims, that is an overreach that needs to be corrected, not a design characteristic of the system.
Congress didn’t create an entity that should “be in charge” of the economy or the banking system when it created the Fed. The Fed was created to furnish an “elastic currency.” The theory was that the Fed was supposed to act as a lender to banks, pushing money into the system when demand for money increased and pulling money out of the system when demand for money decreased, all in the hopes of preventing the reoccurrence of banking and currency panics such as the Panic of 1907. This of course was intended by the Fed’s creators to ensure the continued survival of the big Wall Street banks and the continued existence of New York as a center of financial power.
In practice, the Fed often acted as an arm of the Treasury Department, and for the first four decades of its existence it was heavily involved in monetizing newly issued government debt. Oversight of the banking system didn’t come until well after the Fed’s founding, and the responsibility for keeping the banking system safe and sound was split among many regulators, including OCC, OTS, FDIC, and the Fed. The Fed failed miserably in its stated mission, leading the country into the Great Depression. Yet Congress, rather than ending yet another failed foray into central banking, decided to continue down the same path, allowing the Fed to continue soldiering on and creating monetary mischief.
Couric’s video blithely ignores the effects of interest rate manipulation on the economy. Its simplistic explanation of raising interest rates as pumping the brakes and trying to stave off inflation and lowering interest rates as a way to kickstart the economy makes it seem as though are no negative effects of monetary policy. The malinvestment and misallocation of resources that occurs in low interest rate environments is completely overlooked. Watching this video, one gets the sense that it’s a very easy thing to just raise and lower interest rates and make the economy heat up or cool down. Easy as pie, just ease a little here, raise interest rates there, and the Fed will just magically guide the economy along the right course. Reality is quite a bit different, as the Financial Crisis has shown us.
The Fed’s activities today are tantamount to central planning, something that, almost 25 years after the collapse of the Soviet Union, should be abhorrent to Americans. That central planning of the type undertaken by the Federal Reserve is so readily accepted and viewed as beneficial in the United States needs to be corrected. That’s why we at the Carl Menger Center believe that our work is so important. The American people need to understand what the Federal Reserve System is and what it really does. We hope to get our FED101 series off the ground in the near future to provide a useful counterpoint to the type of misinformation peddled in videos such as this one by Katie Couric. There is far too much at stake to allow the American people to be misled about the origins, development, and functioning of the Federal Reserve System.