The Fed can’t save the rest of us

It’s tempting to say there are four branches of government. In addition to the Executive, Legislative and Judicial branches, there is effectively a fourth branch of government: the Federal Reserve.

Often called the Federal Reserve Bank, it’s not a bank at all. You can’t deposit money into it, withdraw money from it or take out a loan with it. Many Americans have a vague idea what it does but almost no one knows where it’s actually located (Eccles Building, corner of 20th Street and Constitution Avenue in Northwest D.C.). More often referred to as “The Fed”, it is an institution that controls the supply of U.S. dollars. It also controls the banking system in the United States and has since 1913 when the Federal Reserve Act was passed by Congress.

The Fed has seven governors, most famously its chairman, currently Jerome Powell. While you may not pay much attention to the Fed, the financial world certainly does. When the Fed chair testifies or speaks, it can move markets instantly, often severely. Your portfolio can crash or soar depending on what these seven governors decide. They indirectly affect huge swaths of the economy, including interest and unemployment rates.

The curious thing about the Fed is that unlike the rest of our government it operates largely independently of politics. It’s mostly controlled by Republicans, since Republican presidents appointed most of the governors, currently with a 6-1 Republican lean. Each governor gets a four-year term, but once appointed, there’s not much anyone can do to remove a governor. It’s basically unaccountable.

The Fed’s special sauce is to control the money supply of U.S. dollars. It can create dollars as needed and doesn’t need to actually print them. For those few who still need paper or coins, the U.S. Treasury makes them. Lately, the Fed has created trillions of dollars in response to the pandemic. It does have a mission: maximizing employment, stabilizing prices, and moderating long-term interest rates. But really its only tool to do these things is to control the supply of U.S. dollars and then to figure out what to do, if anything, with that supply.

Before the Great Recession, its only real tool was to set a benchmark interest rate for banks to get money from the Fed or each other. In that recession they invented a new tool: quantitative easing. It gave itself permission to buy a lot of quasi-public debt, specifically U.S. housing debt in mortgage-backed securities in government managed institutions like Freddie Mac. This had the effect of flooding the market with cheap cash. The Fed hoped the money would be used to create stuff, but a lot of it was used by companies to buy back their own stock, inflating share prices without adding any value. As a result, the stock market had a slow recovery.

During our more recent pandemic recession, the markets weren’t calmed much by moving interest rates to near zero again and quantitative easing. Been there, done that. So the Fed invented new policies. This time they would use dollars it created to buy corporate debt outright, and in unlimited supply. This had the effect of flooding major companies with money, which again was mostly used by companies to buy back their own stock. It over-inflated the stock market.

One indirect effect was to push up the value of people’s portfolios, at least those who had portfolios. This gave them trickle down money to spend. Unfortunately, there wasn’t much to spend it on as the economy was in the tank and most people were home, but at least there were houses to buy with the money. It caused a run on housing prices, which is counterproductive if you are a renter.

But it’s good we had the Fed. In the Great Recession, particularly after Republicans took the House in the 2010 election, the White House and Congress were at loggerheads on new spending to stimulate the economy. Sensing it was good for the party if they were obstacles, Republicans didn’t allow much of it. The Fed’s actions did allow a slow recovery, but it was needlessly slow and painful because of inaction in Congress.

In the pandemic recession, Congress was able to get relief to a lot of Americans, so the Fed’s actions were more ancillary. The Fed succeeded in calming then boosting stock prices and making money cheap to borrow again, which helped the economy. It also inflamed inflation concerns.

My point is that the Fed has limited tools at its disposal. To the extent that it can lower unemployment, its actions are indirect at best. It’s much easier for it to move markets up than it is to bring down unemployment rates. The latter is a problematic outcome of the former.

There is the perception that the Fed has saved us in the last two recessions. But mostly it succeeded in pushing up asset prices, deciding that our country as a whole was too big to fail. But the stock market is not the economy. It can’t fix the economy. That can only happen if the White House and Congress work together to take necessary actions.

We saw some of that while Trump was president: expanded unemployment benefits, rental assistance, etc. That has continued under the Biden Administration, which got additional stimulus into the economy as one of its first priorities. This is money that largely went to everyday people for things like child care. This money allowed people to avoid some poverty but also to stimulate the economy. This way, along with spending bills like Biden’s Build Back Better proposal, affects ordinary people and the economy as a whole. The Fed’s effect is indirect, at best.

There aren’t many tricks left in the Fed’s toolbox to use in the next recession. Instead, what we need is functioning government in Washington where legislation that actually meets the needs of the people occurs. But if Republicans win back one or more houses of Congress in 2022, it seems they will be more preoccupied with Biden losing a 2024 election than doing what’s in the interest of the American people.