Thursday, October 13, 2011

Why The Federal Reserve No Longer Controls The Money Supply

The Federal Reserve (the Fed) takes a lot of crap for today's U.S. economy. Personally, I feel a lot of this blame is misplaced, due to a) having a convenient scapegoat to blame the financial crisis on and b) the ignorance on the part of the majority of Americans on what the Fed is actually capable of doing in response to recessions, depressions, and economic difficulties.

The Fed is essentially charged with maintaining the banking industry's stability. If a bank runs into trouble, it can contact its regional Federal Reserve bank and take out a loan to temporarily ease the crisis. This role is generally called "lender of last resort." The Fed also can manipulate inflation by manipulating interest rates on short-term (generally overnight) loans. By moving interest rates up, the Fed can effectively decrease the money supply, which then lowers inflation. By setting interest rates lower, the Fed increases the money supply, which can increase inflation.

But here's the problem. Since the 1990s, the Fed has not had control of the money supply, and therefore has little to no control over inflation. This is illustrated by the fact that the Fed has not been able to influence the economy enough to bring unemployment down during the recent crisis. Interest rates up, interest rates down, the only people who really seem to care are investors on Wall Street who are so jumpy that the hint of a rumor of a rate increase will send stocks plummeting 1000+ points.

So who controls the money supply? I suggest that it's banks and credit card companies. This is why:

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