Federal Reserve System Criticisms
Federal Reserve System is a government agency comprised of twelve Federal Reserve Banks located in major cities across the US nation, mandated to regulate the monetary policy and banking system. The Fed (as it is commonly referred) is governed by Federal Reserve Board and its functions include but not limited to regulating the monetary policy which may include the open market operations and setting reserve ratios and interest rates, ensuring financial system is stable by controlling the level of currency in circulation, regulating banks and consumer credit rights protection, and providing financial services to the Government. The twelve Federal Reserve Banks have the obligation to regulate banking system and monetary policy at the district level. On several occasions, the Federal Reserve System has been criticized for various reasons.
One criticism is the price stability mandate of the monetary policy which is accused of being anti-government economic stabilization of macro economy over business cycle. The critics claim that for any macroecoinomy stabilization to hold, the monetary policy must always be flexible Others argue that inflation may improve the economy by positively adjusting labor market and reduce deflation risks which may not be avoided with price control. They further claim that cost of eliminating inflation is high due to unemployment disturbances. More criticism is made by cost-benefit analysts who claim that it’s more costly to pursue price stability compared to the benefits realized, while some other critics claim lack of definite price stability measure citing the Consumer Price Index (CPI) as biased (Saxton, 1997).
Monetarists have criticized the Federal Reserve System of being obsessed with financial market and avoiding its role in the of monetary policy which could have avoided the 1919-1921 inflation and depression as well as 1937-1938 great Depression, had the Federal Reserve System allowed money to grow constantly or adjusted for inflation (Meltzer, 2003).
Although the critics of this system may have a point to prove, the Federal Reserve System has made a milestone in its policies implementation. The criticism on price stability may not hold due to the benefits associated with price stability. According to Saxton (1997), price stability stabilizes the economy by stabilizing the financial markets and other sectors of economy that are interest rate sensitive. This is due to lower interest rates, and lower interest rates’ risk and uncertainty premiums due to low inflation.
In response to the criticism of price stability effect on labor market, the idea that increased inflation tends to lower unemployment may be construed to mean nominal wages are downwardly rigid which may not hold, as empirical evidence shows nominal wages are likely to be flexible during times of price stability as confidence builds on the part of the players in the market forces.
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