The Purposes and Functions of the Federal Reserve System…
The goals of monetary policy are spelled out in the Federal Reserve Act, which specifies that the Board of Governors and the Federal Open Market Committee should “seek to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.
— The Federal Reserve: Its Purposes and Functions, 9th Edition, 2005
We gave away the power to create 99 percent of our new money to the private banking sector, only retaining a right to appoint a Board of Governors that will in theory guide this money system. The law granting this power mandates that the Board seek to promote certain goals – a loosey-goosey, pretty-please, if-you-can maybe sort of mandate.
Seek to promote effectively…
I can only think of one thing as seductive as the ability to create money: sex. Imagine putting naked teenagers into a dark room and asking them to seek to promote chastity and safe sex. That’s comparable to giving private bankers the power to create as much money as their mood allows, in a minimally regulated, private enterprise, profit-driven system and asking them to “seek to promote maximum employment, stable prices, and moderate long-term interest rates.” History and common sense tell us it does not work.
1. Maximum employment
Why is employment a goal of a banking system? Because the Fed is not merely a banking system; it creates new money for our economy, and the supply of money has an impact on whether people – wage earners and business owners – can flourish. Employment is the heart of an economy. The Fed is mandated to use the amount of unemployment as a barometer of how well the amount of money in the system matches the needs of the economy – from their point of view.
However, there is no definition of maximum in the law and it will mean different things to different segments of the population. When there is plenty of money, and even too much money for a time, the economy will accelerate and there will be low unemployment. There could be a job for everyone who wants to work. People who work for a living can pick and choose to a greater extent. This puts competitive pressure on employers to increase wages and improve working conditions, which cuts into owners’ profits. This spreads more wealth around and benefits those who work for others for a living.
When there is not enough money, the economy will slow, throwing people out of work. A higher level of unemployment puts working people at a disadvantage; the employers have the advantage and can pick and choose, cut benefits, and ignore safety because people need a job to live. Higher unemployment is a benefit to the owners of invested wealth because they can increase their profits at the expense of their employees.
Determining a maximum unemployment rate is a question of values. Some consider the exploitation of labor by a wealthy few natural and acceptable, even desirable. Some consider a balance between the rights and well-being of employees and owners to be optimum.
Policy and practice have defined it as a steady 5–6 percent unemployment, which is a rate that suits business owners better than employees. We have chosen a system that deliberately aims to make it impossible for five or six people out of every 100 to find work, tolerating levels of nearly ten during the economic downturns that are inevitable. It is unfair to blame the unemployed when we have chosen a system that intentionally mandates their unemployment. This is the value we live by now.
In a neutral and stable money system, employment sorts itself out in the marketplace. Sometimes it will be to the advantage of labor and sometimes to the advantage of business owners. Like a real business cycle, it will be business specific, not economy-wide; there might be too few nurses and they can demand a high wage, or too many combustion engine mechanics when all vehicles are electric.
However, in our current system, the Fed acts on the belief that its goal is to keep overall employment in the sweet spot for big and global business owners. The general idea seems to be to maximize the profits going to the owners of invested capital without throwing the nation into dissolution or depression – but, a little pain for small business and the working class is considered the nature of things. In this regard, the Fed has been overachieving. It makes as much sense to keep it in the sweet spot for the majority of citizens, but that requires a different set of values about human worth and capital ownership.
2. Stable prices
The Federal Reserve Act of 1913 specifies an elastic value money system; it declares our intent to steadily reduce the value of our money by expanding the supply beyond that required by economic needs. The Fed board sets a target rate of 2 percent annual devaluation.18 Earn $1 this year. It will be worth $$0.98 next year (or less).To reduce the value of our money at the desired rate, the money supply must increase 2 percent beyond increases required by population growth and productivity. Then with too much money chasing goods, services and property, the value of each dollar will go down and prices will go up. The governing board, independent of elected oversight, determines what monetary policies will best meet this demand to overgrow the money supply.
Given our system choice, “promoting stable prices” is an impossible goal for the Fed; stable means a steady and acceptable-to-some decline in the value of our money – also called inflation. Some consider inflation’s steady dollar decline a form of taxation – but often mistakenly believe the tax is going to government. It is not. It is going to the bankers who create our money. A fractional reserve money creation system that allows new money to carry interest will always be an exponentially increasing money supply with a declining value. Unless increases are carefully controlled to stay within the increases in population and productivity, the value of the money will decrease. Our system does not have these controls. It’s disingenuous to call this deliberately depreciating money, stable.
3. Moderate long-term interest rates
In a commonwealth money system, interest rates would be about the supply and demand for capital in the marketplace. When there are more people with savings to invest than there are borrowers and investment opportunities, the savers might need to accept low interest rates and investment returns. When few savings are available to loan or invest, savers and investors could earn premium interest rates and returns.
However, while it is an available choice, we do not have a commonwealth money system, yet. In our current system, the price of money (how much interest you have to pay to borrow it) is not so much determined by supply and demand. It is determined by how confident the bankers are about the future and how many people they can rope into borrowing.
The Governors of the Fed system once thought they could influence the interest rates by setting the rate at which banks could borrow from the central Fed when their reserves were low. The idea was if the banks had to borrow from the Fed at a higher rate to establish reserves, they would lend at a higher rate. Fewer people would borrow, reducing the money supply. However, the Fed acknowledges this influence is minimal. The Fed sets a target rate for interbank lending and sets a rate for central bank reserve lending (money creation) to accommodate the money creation of the independent bankers after the private, independent banks have created the money. According to the Fed, there is about a three-month lag between the creation of money by the private banking sector and the creation by the central bank of the needed reserves and government debt.19
As the shadow banking sector has grown, and as the banks have created more new money for each other’s gaming, the connection between the growing size of the money supply and interest rates has drastically diminished. The Fed certainly has little influence over the interest rates, so the goal of moderate interest rates is an exercise in futility.
4. Ensure the safety and soundness of the nation’s banking and financial system and protect the credit rights of consumers.
These outcomes are compromised by the choice of a fractional reserve money creation system in the hands of private parties. This system is inherently unstable and prone to cycles of euphoric lending (which increases the money supply, creating asset bubbles) and crashes (which severely reduce the money supply, creating widespread dysfunction.)
To counterbalance these risks inherent in this system, the Fed establishes banking rules, regulations and standards, requires reporting from its members, and audits their reporting.
How the Fed achieves its goals
In the next section we consider what powers the Federal Reserve Board has to meet its mandates.