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Contents Introduction Duties & Structure of the Fed The Fed's Authority Structure The Fed Mandate

As bureaucratic organizations go, the Federal Reserve System is a tour de force. Even when the economy is performing well, the financial markets respond with the direction of the Federal Reserve, the central banking system of the United States. And when the financial crisis hit the country full bore in 2008, it was largely the aggressive actions of the Federal Reserve ("the Fed") that stabilized the country's economy. Sometimes in coordination with Congress and the President, but to some extent on its own, the Fed sprang into action, contributing hundreds of billions of dollars to bail out Wall Street. Traditionally an organization that shies from the limelight, the Fed became a highly visible player in the media. Fed Chair Ben Bernanke was named Person of the Year by Time Magazine in 2009, which proclaimed that "He didn't just reshape U.S. monetary policy; he led an effort to save the world economy." (Grunwald)

The US Federal Reserve building, July 30, 2009

But while the Fed has garnered praise from President Barack Obama as well as most mainstream economists for its actions in staving off economic disaster, it has also faced heavy criticism from across the political spectrum. The Fed has been charged with failing to avert the crisis as well as handling the crisis in a manner that may have staved off disaster, but benefited bankers at the expense of taxpayers. Even supporters of the Fed acknowledge that while the bailouts may have been necessary for the greater good, they were unpopular. Columnist George Will quipped, "Like the Fed, dentists are always important and urgently desired when pain is intense. But they are rarely objects of their patients' affections."

Harsh criticism, particularly in the form of populist anger, has targeted the Fed's bailout of Wall Street. Lawmakers are critical of the Fed for its power over vast sums of money and loans in the hundreds of billions of dollars, regardless of whether these loans helped grease the economy's wheels. Following the Fed's aid to American International Group Inc. (AIG) to keep the company from collapsing in 2008, news of subsequent extravagant bonuses for AIG executives — all while unemployment continued to rise — fueled the public's ire. Some of this frustration is evident in floor testimony from Congressman Alan Grayson (D-Fl.).

Let's audit the Federal Reserve. And let's find out once and for all who owns the hotels, who owns the houses, and try and put this wild beast that creates money out of nothing and jams it into the pockets of special interests like Maiden Lane, like Bear Stearns, like J.P. Morgan, like all their friends; let's put them under some degree of restraint . . . these hotels, these houses — before it all comes crashing down on us. (C-Span, 2009)

Perhaps even more significantly, the Fed has been taken to task for failing to prevent the economic crisis before it developed. Some question whether the Fed can be trusted as an effective manager of the monetary system. It has been criticized by Democrats and Republicans alike for its failure to adequately regulate financial markets to enact rules on subprime mortgages prior to the collapse of the housing market, despite instruction and authorization to do so. (Irwin) In a session with Congress this year, Representative David Scott (D-Ga.) expressed this general sentiment in asking Ben Bernanke, "Where was the Fed? How did this happen under your watch?" (Puzzanghera) Longtime Fed critic William Greider argues this point.

Like the largest banks that have been bailed out, the Fed was a co-author of the destruction. During the past twenty-five years, it failed to protect the country from reckless banking and finance adventures. It also failed in its most basic function — moderating the expansion of credit to keep it in balance with economic growth. (p 13)

US Rep. Ron Paul (L) R-TX questions Federal Reserve Chairman Ben Bernanke, April 2, 2008

But in some respects, liberal and conservative critiques vary. For example, Chris Dodd (D-Ct), acting Chairman of the Senate Committee on Banking, Housing, and Urban Affairs, has argued that the failure of the financial regulatory system played a significant role in allowing the economic collapse to occur. In contrast, Paul has argued that the Fed's existence itself, and its attempted management of the economy, is the root of the problem. Consequently, there is no great consensus on a remedy that will repair the system.

As recently as 2007, Congress did enjoy a measure of consensus. Before the economic crisis, few members of Congress would challenge Federal Reserve policies (Ron Paul being a notable exception). (Ullmann, p 24) With the macroeconomy in seemingly good health, critics of the Fed might take it to task for its overemphasis on keeping inflation low at any given time (although not in the recent past), but the health of the financial system was not considered a problem. In 2005, Ben Bernanke reflected on the longtime success of the Fed in overseeing the American economy:

The low-inflation era of the past two decades has seen not only significant improvements in economic growth and productivity but also a marked reduction in economic volatility, both in the United States and abroad, a phenomenon that has been dubbed 'the Great Moderation.' Recessions have become less frequent and milder, and quarter-to-quarter volatility and output has declined significantly as well. The sources of the Great Moderation remain somewhat controversial, but, as I have argued elsewhere, there is evidence for the view that improved control of inflation has contributed in important measure to this welcome change in the economy. (Bernanke, p 277)

In naming Ben Bernanke its Person of the Year, Time Magazine called the Federal Reserve the "most important and least understood force shaping the American — and global — economy." (Grunwald) This Discovery Guide attempts to shed light on the rationale behind the Federal Reserve System's power and relative independence. Part I provides a brief overview of the role and history of the Fed and its system of organization and authority. Part II will examine the Fed's relationship with the federal government and how insulated its policies are from elected officials, as seen from a variety of points of view. The Discovery Guide will conclude by reflecting what this scholarship offers for interpreting recent events.

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