The financial system of any state is a complex mechanism that is created with the primary goal to cultivate the stable functioning of the country, and protect its citizens by offering solid guarantees and controlling the inflation level. Because of the complexity and scope of these tasks, there are multiple approaches that might be employed by governments and various institutions to align the sufficient work of the system and create the basis for the rise of the economy and the whole nation.
Speaking about the USA, it has a unique and disputable frame called the Federal Reserve System, or the Fed. It operates as the central banking system of the USA and possesses all functions that are traditionally associated with such entities and is independent of the government. However, regardless of the prior goal of the Fed’s functioning, it is often criticized for its inability to protect citizens from serious crises as it was in 2008, or during the times of the Great Depression, and for the ineffectiveness of the given system in general. In such a way, the Federal Reserve’s functioning sets a basis for the discussion, whether it has a positive or negative impact on the state.
The Federal Reserve System was founded on December 23, 1913, by the Federal Reserve act. It was provided with all rights of the independent agency of the U.S. government, which also meant that the Fed existed outside the federal executive departments1. The given body acts as the central bank of the whole country and follows the basic three objectives for the monetary policy, such as maximizing employment, stabilizing prices, and moderating long-term interest rates2.
In such a way, the Federal Reserve system has functions that can be associated with traditional banks and tries to guarantee a high level of financial stability in the country by monitoring the functioning of other banks and making them observe the existing regulations3. The Fed also provides financial services to depository institutions, the government, foreign and official institutions, and conducts the research of the economy with the primary goal to remain informed about its current status and implement specific responses if needed4.
The System is ruled by the Federal Reserve Board appointed by the President and includes 12 regional banks located in various states5. Moreover, the Fed encompasses private and public components, which increases its flexibility. The given structure ensures the effective work of the framework and its ability to respond to emerging threats.
In such a way, the Federal Reserve System is a unique body with increased complexity and multiple authorities. However, in particular, it has three main functions, as stated above:
- To perform the nation’s monetary policy
- Provide and observe a practical payments system
- Supervise and control all banking operations in the state6
The given three functions are central when speaking about the Fed and its ability to suffice and provide people with the guarantees of stability and safety during hard times. Unfortunately, there are multiple claims regarding the Fed’s inability to perform these functions and fail to organize the work of the financial and banking systems during difficult times. Additionally, its responses to financial crises or some other challenging events are criticized because of their irrelevance and inability to improve the situation.
The improved understanding of the nature of the Federal Reserve and its impact on the functioning and evolution of the state can be acquired by analyzing the primary sources such as its statute and basic regulations. They will help to outline the advantages and disadvantages and conclude whether it can be considered a positive or negative phenomenon in the financial sector of the USA.
Thus. Admirers of the current model and the Fed’s significance emphasize the fact that the given institution plays a central role in maintaining the work of the whole state and avoiding chaos in financial relations by managing the gold reserve, issuing money, and protecting all citizens. In such a way, acting in accordance with its statute, the Federal Reserve is expected to create the environment beneficial from multiple financial operations.
The positive impact of the Federal Reserve on the state can be linked to managing currency rates and monitoring their showings. The given aspect remains a critically important element of the state’s functioning on a domestic and international level. The U.S. dollar is nowadays used by the majority of nations in deals, and various operations as this currency is considered a stable and convenient means of exchange7.
To a greater degree, it is a result of the work of the Federal Reserve Service that monitors the international discourse and factors that might trigger oscillations in currency rates, mainly the prices for oil8. Responding to some negative tendencies or trends, the Fed creates a financial policy that provides the state with a chance to effectively and timely respond and avoid critical deterioration in the situation.
Another critically important activity that is performed by the Federal Open Market Committee (FOMC) is the creation of money to preserve the existing money supply and general economic condition9. The major problem linked to this activity is the complexity of the determination of the actual amount of money that is present in the economy as multiple objects or things can be defined as money10.
Paper bills, metal coins, saving accounts, and liquid money could also be considered funds and have the power to influence the current situation. For this reason, the Fed’s work is essential for the analysis of all these factors and initiation of special open market situations presupposing buying or selling Treasurys to inject or absorb money11. In the majority of cases, a significant increase in bank reserves can be observed, which means that the Fed is successful in creating money that is needed for the economy at the moment.
The created funds do not always have a physical form or physically present to work or be taken into account by other banks or financial institutions. For this reason, another Fed’s important function is the decision of what form to use and how to guarantee their appropriate work in the existing financial environment12. The Federal Reserve might also create new liquifiable accounts, US Treasurys, and introduce them to the existing banking system13.
Due to the given operations, the U.S. dollar will preserve its importance and current value and avoid too high inflation rates14. Under these conditions, the Fed’s role in issuing and creating money should be considered an important element of the functioning of the current financial system and one of the advantages that justify the work of the given institution and its further development.
One more the Fed’s function that makes this institution important for the whole state, is the regulation of the banking system. From the generalized perspective, the Federal Reserve should be taken as the central bank of the USA that heads its financial system15. It means that other banks or institutions performing similar functions are subordinated to the Fed and depend on its regulations or decrees16.
The existence of this paradigm is vital for the country as it prevents banks from illegal or unethical actions and protects citizens from fraud and minimize the level of fears and distrust related to the given sector17. At the same time, regulation of the banking sphere is necessary during crises or other emergencies that might undermine the functioning of the state and deprive it of the stable currency of financial support. That is why the Fed acts as the guarantor of the stability in the given domain and helps to align the cooperation between leading banks of the USA.
Because of the functions mentioned above, the Fed is also associated with the protection of customers. Initially, it was not the major function of the institution as it was established with the primary goal to ensure the effective functioning of the financial sphere of the state and avoid its collapse. However, some researchers agree in the opinion that today the Federal Reserve can also be considered a body that protects citizens by securing their financial operations18.
The fact is that the monitoring of currency, other banks’ functioning, and the overall course of the state are central elements of the state’s stability that can also be associated with people’s confidence and absence of anxiety19. From this perspective, the Fed guarantees that citizens who cooperate with the financial sector of the state or use its currency will not experience significant losses and remain satisfied by the work of the given domain because of the opportunity to generate revenues or acquire beneficial conditions. For this reason, the Federal Reserve is associated with a positive impact on the given sphere.
Finally, the Fed is also a big gold vault, which means that it is responsible for its price and impact on the economy of the state. The idea of the gold standard that is one of the central elements of the modern global economy rests on the existence of a certain amount of gold that every country possesses20. It guarantees the stability of its economy and the power of its currency. At the moment, the U.S. dollar it the pricing mechanism that is used to establish the price for gold globally21.
For this reason, the Fed, as the central financial institution of the state, is responsible for the regulation of the given cost. Although the dollar was untied from gold, it still depends on its price, which means that the Fed might have a positive impact on the whole economy of the country by monitoring this aspect and introducing appropriate changes.
However, along with multiple positive functions performed by the given unique financial institution, and its fundamental role for the evolution of the state, there is significant criticism of the Fed because of its inability to guide and support the country in times of crisis, or because of the extremely high independence levels that might precondition the acceptance of doubtful decisions. For this reason, the existence of the opposite opinion on the work of the Federal Reserve System creates the basis for the discussion if it can be treated as mainly a positive or negative phenomenon in the life of the USA and its future evolution. At the same time, there is a significant number of appeals to eliminate this financial institution and exclude it from the banking sector to make it more effective and avoid repetition of dramatic events such as during the Great Depression or Crisis of 2008.
The Great Depression is one of the most difficult periods in the life of the USA22 and its causes, and the problems are often associated with the functioning of the Federal Reserve System. Thus, in accordance with the Keynesian theory, the appropriate solution was to create new money to provide the national government with the opportunity to borrow and spend23. However, the Fed selected the opposite option preconditioning the increase in taxes to avoid the shortage of budget24. This decision contributed to the emergence of the complex financial environment in the USA and the development of depression. In such a way, in accordance with the given theory, the Fed was not able to perform its main function, and, even worse, it is preconditioned the critical deterioration of the situation by its actions and crushed the economy of the state.
From the monetarist perspective, the functioning of the Fed was always not sufficient and effective during the period of Depression. Friedman and Schwartz assumed that the main cause for the appearance of the crisis was the fall of the money supply25.
The Reserve promoted a restrictive monetary policy even after the stock market crash and did not increase the money supply27. Moreover, contrary to its basic duties, the Fed refused to save banks that were trying to overcome bank runs28. The chain of mistakes and incorrect policies critically deteriorated the situation and preconditioned the catastrophic results that shocked the whole economy of the state and all its citizens.
In such a way, from various perspectives, the Federal Reserve System turned out to be unable to perform its major functions in times of crisis, which was one of the basic demands of it. On the contrary, the scope of authority peculiar to the Fed and its impact on all financial institutions made its erroneous solutions the basic causes for the critical deterioration of the situation. The lack of money supply, along with the refusal to reconsider current policies because of the crisis, resulted in the choice of the completely wrong strategy and the collapse of the state.
The Federal Reserve System was not able to regulate the banking sector and the currency of the nation, which resulted in high unemployment rates, recession, and multiple negative consequences29. The USA needed more than a decade to recover from the failure of the Fed to perform its main functions.
Opponents of the Federal Reserve system also assume that its failures preconditioned the 2008 financial crisis. The Fed preserved interest rates too low after the 2001 recession, which promoted the credit crunch30. Flaws in the financial regulations and Reserve’s inability to control the tide of toxic mortgages deteriorated the situation and made the crisis inevitable. The case demonstrates that the Fed, as the guarantor of stability, is ineffective and cannot handle the level of author and the scope of duties that were provided to it. It also means that similar situations will appear because the Fed remains the central regulatory body of the USA, impacting the whole economy and the banking sphere.
Another negative aspect that is often associated with the functioning of the discussed institution is its inability to control inflation rates. The periods of the Great Depression and the 2008 financial crisis prove this assumption; however, even in the 21st century, the functioning of the Fed is not always satisfactory as the currency experiences multiple oscillations caused by different factors, including the Reserve’s inability to control the situation and introduce appropriate measures to avoid the future deterioration of the situation and emergence of unexpected outcomes.
Finally, the high level of independence and a limited number of people who can impact the functioning of the Fed precondition the appearance of multiple claims regarding its control, which is held by the elite who own regional Federal Reserve Banks. Under these conditions, the given institution’s functioning is focused on fulfilling the needs of its owners, rather than on the preservation of the state’s stable rise32. The lack of control from the government only deteriorates the situation and preconditions the emergence of new debates about the work of the whole system and the need for its change.
In such a way, the analysis shows that the Federal Reserve Service causes both positive and negative effects on the state, its economy, and the whole banking sector. However, along with the existence of some advantages, the risks become two significant as the extremely high scope of responsibilities, authority, and independence make the Fed one of the forces that influence the life of country and the erroneous decisions along with ineffective policies create the basis for the emerged of heavy crises striking all industries and citizens. For this reason, the Fed in its current state should be considered a serious threat to the future evolution of the USA.
Another difficulty related to the Federal Reserve System is the absence of alternatives that can be used to replace it and create more effective and modern approaches to regulating the functioning of the economy and the banking sector. The given deficit comes not from the lack of options or suggestions on how to restructure the Fed, but from its deep integration with other fundamental systems of the USA and their mutual dependence. The elimination of the given structure would mean the radical reconsideration of the current political and economic paradigm, which might be a too challenging task in the contemporary environment.
For this reason, it is possible to predict that in the future, the Federal Reserve will remain the central institution regulating the functioning of the state, its currency, the gold, and the banking sector. Regardless of multiple mistakes and insufficient policies, it remains the unique body designed to introduce desired levels of financial stability. At the same time, there will also remain claims related to the need for more effective solutions and radical reconsideration of the Fed’s work because of its inability to face modern challenges and too high level of independence that transforms it into a closed system headed by the elites.
“100 Years of Inflation Rate History.” Observations. Web.
Bernanke, Ben. The Federal Reserve and the Financial Crisis. Princeton University Press, 2013.
Board of Governors of the Federal Reserve System. The Federal Reserve System Purposes & Functions. 10th ed., Independently published, 2019.
Booth, Danielle. Fed Up: An Insider’s Take on Why the Federal Reserve is Bad for America. Portfolio, 2017.
King, John. Advanced Introduction to Post Keynesian Economics. Edward Elgar Pub, 2015.
Mishkin, Federic. Economics of Money, Banking and Financial Markets. 12th ed., Pearson, 2018.
Wolf, Richard, and Stephen Resnick. Contending Economic Theories. The MIT Press, 2012.
Watkins, Thayer, and Tornado Alley. “The Money Supply and the Banking System Before and During the Great Depression.” SJSU. Web.
- (Board of Governors of the Federal Reserve System 43).
- Ibid. 43.
- Ibid. 45.
- Ibid. 49.
- Ibid. 53.
- Ibid. 58.
- (Booth 98).
- (Mishkin 123).
- (Board of Governors 100).
- Ibid. 101.
- Ibid. 101.
- Ibid. 101.
- Ibid. 100.
- Ibid. 101.
- (Mishkin 155).
- (Wolf and Resnick 99).
- (Mishkin 160).
- Ibid. 67.
- Board of Governors 101).
- (Mishkin 178).
- Ibid. 180.
- Lecture notes.
- (King 111), lecture notes.
- (Booth 99).
- (Wolf and Resnick 87).
- (Watkins and Alley).
- (King 112).
- (King 113).
- Lecture notes.
- (Bernanke 76).
- “100 Years of Inflation Rate History”.
- (Booth 134).