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In: Economics

Is the Federal Reserve Bank (the Fed) too powerful? Explain the pros and cons of having...

Is the Federal Reserve Bank (the Fed) too powerful? Explain the pros and cons of having a central bank controlling the money supply.

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Expert Solution

The Federal Reserve is considered the most powerful economic institution in the world because of its ability to influence access to the world's most influential currency: the US dollar. Despite the controversy of the dollar as an international reserve currency, especially in the wake of the 2007-2009 financial crisis, it is still held in large amounts in the forex reserves of numerous central banks across the world. As a result, many countries trade in US dollars because of its versatility.

Since the US Federal Reserve System is the only institution* that has the power to print and destroy USD, it is therefore considered the most powerful central bank in the world. The Fed has the power, for instance, to print more dollars and devalue the currency and in turn the value of its debt to foreign lending institutions.

List of Pros of Federal Reserve

1. It established a national currency.
Before the Fed system was implemented, there were tens of thousands of currencies used in the US. Then, it made a single currency valid throughout the country, helping the economy to run smoothly.

2. It increases transparency and predictability.
The rule-based systems used in the Fed’s monetary policy increase predictability and transparency, helping the Central Bank with explaining its actions to the public and helping the market to predict what the Fed would do. This has a significant impact on people’s lives, like low interest rates benefiting debtors over the creditors.

3. It ensures a sound financial system.
The Federal Reserve System functions by conducting the country’s monetary policy by influencing credit and money conditions in the economy to ensure full employment and stable prices.

4. It represents the country and its financial interests.
Without such a system, interests would be represented by banks and would not be clearly the best financial option as these institutions are normally more concerned about private sector than the public. Also, the Fed requires banks to subject themselves under impartial and external audit. And if the system did not exist, all audits would just have taken place internally, which can lead to corruption among banks.

5. It increases the credibility and accountability of future policy actions.
By setting rules, the Fed is able to reduce the incentive to later renege on their promises. Without a rule-based system, it is argued that a central bank will still be able to promise to keep inflation low, but it would later be tempted into printing money just to generate revenue for the government.

6. It contains systemic risks in the country’s financial system.
The Federal Reserve works to maintain financial system stability and contain systemic risk that would arise in the financial markets. Also, it provides certain financial services to the US financial institutions and government, as well as foreign official institutions. Aside from this, it plays a major role in overseeing and operating the payments systems in the country.

List of Cons of Federal Reserve

1. It is considered as invasive and unconstitutional.
The Federal Reserve System is often regarded as anti-capitalism, as finances will be controlled by a huge government organization, instead of a group of private businesses. This means an expansion of government size, which is criticized by many people.

2. It is created as a means of enslaving the government with debt.
Actually, the US government could only go into debt if it chooses to. Many people speculate that the government would one day simply decide to print as many US dollars as it wants and then pay off all debts of the government.

3. It is often seen as favoring private interests over public interests.
It is stated that private interest and lobby groups have a great deal of influence over the Federal Reserve, allowing individuals to benefit rather than the whole society and taking away the well-being and rights of the public

4. It is believed to increase instability.
Contrary to the belief that the Federal Reserve has alleviated the bank panics in the past, some people believe that the Central Bank cannot adequately manage a country’s monetary policy and can actually increase economic instability. And while some people believe that it is highly willing to accommodate political administrations and allow asset bubbles to inflate, other people think that it interferes in the economy too much.

5. It manipulates the US economy by setting national interest rates.
As it can keep rates low or high, the Fed has the capability to foster growth or hinder it. It can inflate massive bubbles and then just pop them up. While many Americans give much credit and blame to the presidents on how the economy is doing, these leaders actually do not much control over it compared to the Fed.


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