The Federal Reserve (1)

The U.S. Federal Reserve recently has been embroiled in controversy.  Chair Jerome Powell is under pressure to lower the interest rate or resign. This puzzles many. The U.S. economy seems to be doing well. Why is this controversy? Below, I will give a brief explanation of the current controversy. Do not expect that my explanation will answer all questions. Instead, it might help you understand the complexity of this problem. 

Normally, I do not pay much attention to the Federal Reserve (I am too busy, and its decisions are important only sometimes). The recent interview of former Fed Governor Kevin Warsh [1] caught my attention. Since he is one of three front-runners to the next Fed chair, I watched this interview and was impressed with his arguments for reforming the Fed. However, since he has yet to be confirmed, I did not think much at the time. Then, former Dallas Fed president Richard Fisher appeared on CNBC [2]. Fisher appears regularly on CNBC and Bloomberg and is one of the “good” guys. He strongly advocated Fed independence. A short time later, Judy Shelton made a strong case for a regime change of the Fed Reserve [3]. Soon after, Treasury Sec. Scott Bessent called for a full review of the Fed Reserve [4,5]. The dam was broken. More influential figures came out to argue for fundamental changes of the Fed: Larry Summers, Mohamed El-Erian, and Jeremy Siegel (see references at the end). So why are experts at odds? 

Let us start with ‘the history of the US Federal Reserve.’ When I Googled it, the AI Overview gave the following:

The Federal Reserve, established in 1913, is the central banking system of the United States. It was created to address the instability and financial crises that plagued the nation, particularly the panic of 1907. The Federal Reserve Act, signed into law by President Woodrow Wilson, aimed to create a more stable financial system and provide a central bank for the nation. (This shows the usefulness of AI: a good summary.)

How has the Federal Reserve worked so far? If you compare the US with other nations, especially in recent decades, the US Federal Reserve works relatively well. Thus, Fisher is correct to a certain extent. However, Thomas Sowell of the Hoover Institution compared the US economy before and after the Federal Reserve was established. He showed that (in some intervals) the Federal Reserve might have caused more instability rather than reducing it. Furthermore, great economist Milton Friedman suggested scrapping the Federal Reserve altogether. How should we understand these? 

The Federal Reserve controls the amount of money in circulation. By limiting the money supply and changing the interest rate, it controls the rate of economic expansion: a low interest rate encourages growth, while a high interest rate impedes growth. The idea of establishing a central bank was to reduce the severity of economic cycles. 

One important contribution of Milton Friedman is to show that the Federal Reserve CAUSED the Great Depression in the 1930s. Without the meddling of the Fed and the US government, it would be a recession, not a depression. No wonder Friedman advised to scrap the Federal Reserve altogether. (I have written a short article in Chinese [6].) Friedman’s monetary theory helped us to avoid depressions during the GFC and COVID. 

Now back to the original topic. What role should a central bank play? What does central bank independence mean? We need to understand the US government debt and deficit problem, which I mentioned in some earlier write-ups. Former House Speaker Kevin McCarthy explained well in  [7]. I will continue this later. 

References: 

1. *Former Fed Governor Kevin Warsh: We need regime change at the Fed (7-18) 

2. Richard Fisher: When presidents have interfered with the central bank we've had hyperinflation (7-17) 

3. *We need to open up the Fed and move to a different construct, says Judy Shelton (7-22)

4. *Watch CNBC's full interview with Treasury Secretary Scott Bessent (7-22)

5. Treasury Sec criticizes Fed Reserve's 'UNDUE INFLUENCE' in economy (7-25)  

6. 废除社会科学！？

7. *Former House Speaker Kevin McCarthy: Debt is the greatest threat to America (7-30) 

Further References: 

• Mohamed El-Erian: Fed should be cutting this month, but I don't expect them to (7-17) 

• *Summers Backs Bessent on Questioning Fed ‘Overreach’ (7-23)  

• *Bessent calls for internal Federal Reserve review, says it could be Powell's legacy (7-23) 

• *Fed's long-term independence may be enhanced if Powell steps down, Jeremy Siegel (7-19) 

• Mohamed El-Erian: Powell needs to resign to maintain the Fed's autonomy (7-26)    

• 'WHACKING THE FED?’: Kevin O’Leary warns of removing Powell before term ends (7-25) 

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