Criticism of the Federal Reserve

Criticism of the Federal Reserve

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.[1]

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."[2]



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.[3]

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,[4] Henry Reuss,[5] and Henry B. Gonzalez.[citation needed] 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,[6] although these have been unsuccessful, garnering neither cosponsors nor hearings.[7] 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.[8][verification needed]


Some critics of the Federal Reserve, such as Peter Temin, believe that monetary policy is often too tight.[9] 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.[10]

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.[11] 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.[9]

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:

Formula for the Taylor rule

where it is the federal funds rate, πt is the rate of inflation, \pi_t^* is the target rate of inflation, yt is the logarithm of real GDP, and \bar y_t is the logarithm of potential output.[12]

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 Committee (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:[13]

In our previous research we have detected that New York City banking entities usually exert substantial influence on legislation, greater than their large proportion of United States’ banking resources. The authors describe how this influence affected the success or failure of central banking movements in the United States, and the authors use this evidence to support their arguments regarding the influence of New York City bankers on the legislative efforts that culminated in the creation of the Federal Reserve System. The paper argues that successful central banking movements in the United States owed much to the influence of New York City banking interests.

The Great Depression 1929

Crowd gathering on Wall Street after the 1929 crash.

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.”[14]

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.[15]

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.[16]

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.[17]

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,[18] 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."[19]

Global financial crisis

Some economists, such as John Taylor,[20] have asserted that the Fed was responsible, or at least partially responsible, for the United States housing bubble. They claim that the Fed kept interest rates too low following the 2001 recession,[21] and that this in turn prompted borrowers to be reckless.[22] 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.[23]

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.[24]

Non-mainstream economics

One criticism of the Fed, typified by the non-mainstream Austrian School, is that the Federal Reserve's control of interest rates is an unnecessary and counterproductive interference in the economy.[25] 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.[26][27]


CPI (relative to 1967) since 1800

One major area of criticism focuses on the failure of the Federal Reserve System to stop inflation. This is seen as a failure of the Fed to comply with its legislatively mandated duty, as specified by the Federal Reserve Act.[28] Critics focus particularly on inflation's effects on wages and savings. They point out that wages, as adjusted for inflation, i.e. real wages, have sometimes gone down (e.g. at the end of 2004).[29] 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.[30]

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.[31] 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.[32]


Congressman Ron Paul, 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."[33]

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.[34]

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."[35] 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."[36] 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")[37] are required to own capital stock in their regional banks,[37][38] 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.[39] The Fed has noted that this has created "some confusion about 'ownership'":

[Although] the Reserve Banks issue shares of stock to member banks ..., owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan....[40]

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.[41]

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."[42]

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.[43]

In his textbook, Monetary Policy and the Financial System, Paul M. Horvitz, the former Director of Research for the Federal Deposit Insurance Corporation, 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.[44]

Transparency issues

Another objection is the Fed's lack of transparency.[45] In particular, many believe that the public has a right to know what goes on in the Federal Open Market Committee (FOMC) meetings.[46][47][48]

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.[49]

See also


  1. ^ Johnson, Roger (1999-12). "Historical Beginnings… The Federal Reserve" (PDF). Federal Reserve Bank of Boston. pp. 247. Retrieved 2009-06-21. 
  2. ^ Quoted in Scott Rasmussen and Doug Schoen. Mad As Hell: How the Tea Party Movement Is Fundamentally Remaking Our Two-Party System (2010) p 57
  3. ^ Congressional Record June 10, 1932, Louis T McFadden
  4. ^ "Banking: Fight over the Federal Reserve". Time. February 14, 1964.,9171,870767-1,00.html. Retrieved August, 20 2010. 
  5. ^ Uchitelle, Louis (August 24, 1989). "Moves On in Congress to Lift Secrecy at the Federal Reserve". The New York Times. Retrieved August 20, 2010. 
  6. ^ E.g. H.R. 2755 (110th Congress); H.R. 2778 (108th Congress); H.R. 5356 (107th Congress); H.R. 1148 (106th Congress).
  7. ^ H.R. 2755: Federal Reserve Board Abolition Act (
  8. ^ Wooley, John T. (1984). Monetary Politics: The Federal Reserve & The Politics of Monetary Policy, p. 153. Cambridge University Press. 
  9. ^ a b Paul Krugman Misguided Monetary Mentalities, 11 October 2009
  10. ^ Federal Reserve Bank of San Francisco How does monetary policy affect the U.S. economy?
  11. ^ Willem Buiter Fiscal options for the UK: sovereign insolvency, inflation or serious fiscal pain, 3 June 2009
  12. ^ Bernanke, Ben S. (2010-01-03). "Monetary Policy and the Housing Bubble" (text). 
  13. ^ New York and the Politics of Central Banks, 1781 to the Federal Reserve Act. Federal Reserve Bank of Atlanta. Working paper 2003-42. December 2003.
  14. ^ Friedman 1965, p.4.
  15. ^ Friedman 2007, p.15.
  16. ^ Paul Krugman, "Who Was Milton Friedman?" New York Review of Books Volume 32, Number 32 • February 3, 2007 online community
  17. ^ Speech by Ben Bernanke, November 8, 2002, The Federal Reserve Board, retrieved January 1, 2007 saying on November 8, 2002
  18. ^ "Greenspan voices concerns about quality of economic statistics". Stanford News Service. 1997-09-09. 
  19. ^ Ebeling, Richard. M. Monetary Central Planning and the State, Part 27: Milton Friedman's Second Thoughts on the Costs of Paper Money.
  20. ^ Fed and the Crisis: A Reply to Ben Bernanke
  21. ^ Did the Fed Cause the Housing Bubble?
  22. ^ Ron Paul Texas Straight Talk:Don't Blame the Market for Housing Bubble
  23. ^, A paper from the Congressional Research Service corroborates the rate increases referred to by Greenspan,
  24. ^ Sewell Chan, "Tea Party Advocates, Anger at the Federal Reserve," [ New York Times Oct 10, 2010]
  25. ^ Rothbard, Murray (1926-95). "The Mystery of Banking" (PDF). The Ludwig von Mises Institute. Retrieved 2009-06-21. 
  26. ^
  27. ^ Fox, Justin (June 1, 2009). "Why We Should Listen to Peter Schiff's Bad News". Time.,9171,1900233,00.html. 
  28. ^ FRB: Mission
  29. ^ / World—US real wages fall at fastest rate in 14 years
  30. ^ Calculated at on March 1, 2010, based on the Consumer Price Index provided by the U.S. Bureau of Labor Statistics. CPI data was last updated by BLS on February 19, 2010, and covers up to January 2010.
  31. ^ "Interview with Milton Friedman". Minneapolis Federal Reserve. 1992-06. 
  32. ^ "Heavyweights Kohn, Volcker Spar Over Inflation Goal". Wall Street Journal. 2009-04-18. Retrieved 2009-04-19. [dead link]
  33. ^ Darryl Robert Schoon Silver, gold & the last American Hero JFK
  34. ^ Milam v. United States, 524 F.2d 629 (9th Cir. 1974).
  35. ^ The Federal Reserve System: Purposes and Functions 10
  36. ^
  37. ^ a b
  38. ^ 12 U.S.C. § 282 et seq.
  39. ^ 12 U.S.C. § 289(a)(1)(A)
  40. ^
  41. ^ Legal Opinion by Miranda Fleschert
  42. ^ Charles A. Lindbergh, Sr. Quotes,
  43. ^ Michael D. Reagan, "The Political Structure of the Federal Reserve System," American Political Science Review, Vol. 55 (March 1961), pp. 64-76, as reprinted in Money and Banking: Theory, Analysis, and Policy, p. 153, ed. by S. Mittra (Random House, New York 1970).
  44. ^ Paul M. Horvitz, Monetary Policy and the Financial System, 3rd ed., p. 293 (Prentice-Hall 1974).
  45. ^ Poole, William (2002-07). "Untold story of FOMC: Secrecy is exaggerated". St. Louis Federal Reserve. 
  46. ^ FOMC Transparency—William Poole, President, Federal Reserve Bank of St. Louis
  47. ^ Remarks by Chairman Alan Greenspan - Transparency in monetary policy (October 11, 2001)
  48. ^ Remarks by Vice Chairman Roger W. Ferguson, Jr.—Transparency in Central Banking: Rationale and Recent Developments (April 19, 2001)
  49. ^ White, Lawrence H. "The Federal Reserve's Influence on Research in Monetary Economics" (August 2005).

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