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In: Economics

Do We Need the Federal Reserve? Why do we or why should we get rid of...

Do We Need the Federal Reserve? Why do we or why should we get rid of it.

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Expert Solution

"The country had been ravaged by financial crises before the creation of the Federal Reserve. These emergencies also led to "panics" in which individuals rushed to their banks to withdraw their deposits. One bank's collapse often had a domino effect, in which other bank clients scrambled to withdraw funds from their own banks even though those banks were not in danger of failing. Banks wanted a backup source of emergency to avoid the panics and the ensuing runs from putting them out of business.

Indeed the Fed does a lot. You really can't remove these features. If you got rid of the central bank, you'd have to push a lot of those roles to other regulators or private companies. Inflation, for example, somehow needs to be kept in check. Prudential supervision is critical, too. The problem with eliminating the Fed is that you would need to delegate these responsibilities to another entity that could do them better.

Supervision is a two way street for the Fed. On the one side, it offers much additional information about the banking system to the central bank, which it can use for its other functions such as maintaining financial stability. On the other hand, when it comes to supervision, the Fed has a unique perspective to give, because it has a lot of data on and experience with financial markets, global regulation and macroeconomics. And supervision will not only help the central bank be more effective, but its experience will help it become an exceptionally well-informed supervisor.


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