On Sunday, we discussed what the Federal Reserve System is and it’s role as a lender of last resort.

Today, part two of our study guide will cover – as promised – the responsibilities that are most pertinent to today’s current events, and how the Fed’s monetary policy achieves the goal of keeping the economy relatively stable.

Wait, a relatively stable economy? We’re in the midst of a pretty bad recession right now.

That we are. But it’s only bad relatively. Between the expiration of the Second Bank of the United States (1836) and the Federal Reserve Act was passed (1913), bank panics happened roughly every twenty years. Thanks to the advent of central banking, it’s been eighty years since we’ve had these sorts of economic frets. (If you’re wondering why the Great Depression occurred after the Act was passed, legendary economist Milton Friedman will help you understand how the Fed screwed it up.) Of course, they haven’t been able to accomplish this simply by managing interest rates, as we covered in part one.

How else does the Fed stabilize the economy?

There are a few main concerns of a central bank: price stability, high employment, GDP growth, stabilizing financial markets, and stabilizing the currency in foreign exchange markets.

Some central banks (England, Canada, New Zealand) make sure prices are stable before moving on to the other goals. This allows everyone outside to peer in with at least a little perspective on how things are going. The number set aside for the goal is called the “explicit nominal anchor.”

Unfortunately, the economy is a fickle beast, so the Fed performs more of a monetary balancing act while trying to tame it. The Federal Reserve, unlike strict price stabilizers, acts as if it were targeting continuously adjusting numbers in multiple categories. Using money supply goals alongside inflation and employment outlooks helps the Fed know how to use monetary policy to control the economy using what is called an “implicit nominal anchor,” meaning there is no actual number for any specific statistic at any given point in time. This makes transparency nearly zero, which is a problem for some in Congress.

Why can the Fed use the implicit nominal anchor if we can’t really tell what they’re doing?

Simply put, because it works better than anything anybody else has ever done. The United States has been the world’s sole economic and political power since the fall of the Soviet Union, and the dollar has been the most stable currency worldwide for decades – a fact solidified by the financial crisis that took place last fall. As world markets began to weaken, the dollar – which had been falling in value over the course of the previous summer – was suddenly in high demand again, strengthening its value overseas.

Of course, the lack of specific mandates and nominal goals makes the Fed seem like a cloak-and-dagger secret society, and is a contributing factor to why a Google search of “Illuminati Federal Reserve” yields 229,000 results.

Yet – despite the Big Brother-ish concerns – having an independent central bank solves two problems. The first is the lack of funding needed from the government. The Fed, simply put, is self-sufficient. Because the Fed can lend to banks, it can make interest off those loans, which goes to paying its employees and decreasing governmental budget deficits. In addition, independence eliminates a conflict of interest. If monetary policy becomes political – rather than simply economic – it will act congressional by doing things to keep the populace happy in the short-run while ignoring long-term effects. This is because Fed workers don’t run for election, and – depending on the position – are appointed for terms longer than those of politicians (similar to – but not exactly like – Supreme Court terms).

And here ends our two-part study guide on the United States central bank. The Federal Reserve System was created to keep those living under the red, white, and blue out of a depression – or at least dampen the effects of one – and so far has succeeded exceptionally.

Of course, it’s operations and purposes are not completely straightforward, so Scoop44 hopes that this overview of the economic effects of central banking have been helpful enough to allow you to watch your favorite network’s evening news – or read your favorite newspaper’s business section – with relative ease.

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