There’s one grand institution that’s served this nation well since its inception in 1913. The Federal Reserve Act, signed into law by President Woodrow Wilson the day before Christmas Eve of that year, established what would become the most important and independent economic institution on the planet.
A century earlier, Alexander Hamilton argued for a federal bank to act as the bank for bankers and a new federal government. His efforts were frustrated by President Thomas Jefferson, who argued for states’ interests over Hamilton’s Federalist approach.
Without Hamilton’s impartial federal institution, state banks filled the void, created their own currencies, backed their own checks, or not, and fomented a series of bank panics and recessions. Something had to give. That was the vision of Wilson.
The Federal Reserve acted more on intuition than theory for the first few years. It arose following the Panic of 1907, when J. P. Morgan himself locked the nation’s most prominent bankers in his Madison Avenue library until they all agreed to provide the liquidity to bail out their industry before it came tumbling down. They also agreed they could not police themselves, and lobbied for a new federal institution to lend credibility and regularity to the national banking system.
If necessity is the mother of invention, true innovation would have to wait until economic theory caught up. The Fed viewed itself as the bank for banks, but didn’t have the knowledge or tools to avert the Great Crash of 1929. It took President Roosevelt, who had an intuitive sense of Keynesian macroeconomic theory, to give the Fed the tools it uses today.
By the time Roosevelt was finished, the Federal Reserve understood its importance in providing for economic stability, their power to influence banks’ credit creation through careful determination of the Fed’s discount rate, and their potency in affecting the interest rate on Treasury bonds by buying and selling massive amounts of bonds on the open market.
The Fed is sometimes pressured by politicians to manipulate the economy for their own political reasons. Yet, it remained incredibly neutral for decades. By the 1990s, it articulated its mission more clearly than ever before. The Fed would use their tools of the discount rate and their bond market intervention to be sure the banking industry had just the right amount of credit. Too little credit and the economy is held back from its true potential and endures unnecessary unemployment. And, too much credit means that the economy is overheated and risks an unstabilizing rate of inflation.
This Momma Bear approach, which attempts to keep the inflation rate around 1.5 percent to percent, and unemployment around 4-5 percent, worked well for the Federal Reserve for decades. Presidents understood that this approach was sound for the long run, even if it was not politically expedient.
Sometimes, though, presidents worry more about election year politics than prudent economics. Like now. We’ve entered into a new and historically disturbing period. For the first time, at least in my lifetime, the Fed is viewed by some as a tool for the executive branch rather than as a trusted steward for long run growth and moderated price increases.
The Fed was first pressured to install conspiracy-thinking ideologues. Then, its chair was pressured to stimulate the economy to counteract tariffs threatening consumers and farmers. This week the President pressured Powell to drop interest rates for politically-expedient reasons alone.
To the Fed our presidents have appointed economists of various political persuasions. Yet, they consistently arrive at consensus conclusions. They’ll be as divided as the country if the meddling continues.
Another recession is inevitable. Economists agree that, when it occurs, the Fed must have the latitude to lower its interest rate to encourage banks to rid themselves of reserves by encouraging investment loans.
The Fed needs a healthy dose of this interest rate tool for future recessionary times. We can’t squander it for political expediency when the economy is at its sweet spot. The politicization of the Fed to accomplish other goals, or the stacking of the Fed with ideologues, is troubling. We must avoid crossing the line from prudent economic policy to a political interference never-never land. From some things it is difficult to return.
Colin Read teaches finance and economics at SUNY Plattsburgh and has published a dozen books on local and global finance and economics. He is also mayor of the City of Plattsburgh. He can be reached at firstname.lastname@example.org.