NCPA - National Center for Policy Analysis

The Role of the Federal Reserve

May 20, 2011

Congressman Ron Paul recently held hearings of his Subcommittee on Domestic Monetary Policy and Technology to consider the role of the Federal Reserve, so it is not a bad time to reexamine the essential functions of the Fed, says Alex J. Pollock, a resident fellow at the American Enterprise Institute.

The most fundamental functions of the Fed are three things: providing an "elastic currency," managing the banking club and financing the government.

  • The first function is made clear by the 1913 Federal Reserve Act itself, which begins: "An Act to provide for the establishment of federal reserve banks, to furnish an elastic currency."  It means the ability to make loans and expand credit, and to print money, to match the cyclical exigencies of the time.
  • The second function is that central banks solve the coordination problems of the banking business by becoming the independent manager of the banking club.  In this country, the club is now being expanded to include non-bank financial companies, making the Fed the manager of an even bigger financial club.
  • Finally, and most basic of all, is financing the government.  This became evident very early in the history of the Fed, when America needed to finance its plunge into the First World War.

So the fundamental reality is the "triple mandate," which indeed makes a lot of sense from the government's point of view.  It allows us to understand why the Fed, while not doing so well at stabilizing prices or maximizing employment, has nonetheless gained ever greater power and status in the course of its first century, says Pollock.

Source: Alex J. Pollock, "The Federal Reserve's Real Mandates," The American, May 17, 2011.

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