The Power of the Federal Reserve

In 1913, Congress established the Federal Reserve System, often referred to as the Fed. It is the central bank of the United States, represented by three entities: A Board of Governors (Federal Reserve Board), the Federal Open Market Committee (FOMC) and 12 regional banks, which operate independently but under the supervision of the Board of Governors.

The Fed has a very specific function: to promote the effective operation of the U.S. economy. Within this capacity, the Federal Reserve banking system:¹

• Manages the country’s monetary policy to promote maximum employment, stable prices and moderate long-term interest rates
• Monitors the stability of the financial system and individual financial institutions
• Provides services to the banking industry and the federal government to secure facilitation of U.S.-dollar transactions and payments
• Conducts ongoing research and analysis of emerging consumer issues and trends, community economic development activities, and the administration of consumer laws and regulations

The Fed has several levers it uses to influence monetary policy. For example, it can change the interest rate banks charge to lend money. This affects short- and long-term interest rates, foreign exchange rates, the amount of money and credit funneled into the U.S. economic system, and economic indicators such as employment and the prices of goods and services.

When the pandemic hit the U.S. hard and fast, initially 14 million people lost jobs between February and May.² Even as employment has begun to recover, overall growth — as measured by gross domestic product (GDP) — has dropped dramatically. Consequently, over the first half of 2020, the Fed cut interest rates to near zero and launched a diverse array of lending programs designed to help businesses stay afloat during this crisis.

Much of the power held by the Fed stems from the available economic data that it evaluates on an ongoing basis — and the influence that this knowledge and experience affords. However, there are many factors that affect our economy that the Fed cannot control. These include the status of foreign currencies, the global economy, international trade agreements and fiscal policy.

In recent months, Chairman Powell and other Fed leaders have emphasized the importance of Congress passing legislation to complement the Fed’s actions. In other words, the Fed believes lending money is not stimulus enough; Congress needs to send money directly to people and businesses to keep today’s economy from sinking any lower.³ While the Fed is charged with an enormous responsibility and the power to influence current economic indicators, it cannot control the long-term outlook. Both monetary and fiscal policy actions taken this year are likely to have a negative impact on the nation’s future growth. That’s because, at some point, Americans will have to pay the piper.

The federal deficit is the amount of money the government spends each year above and beyond its annual revenue, which is mainly provided by taxes. Because of the pandemic and the loss of employment, this year’s federal deficit as a percentage of GDP is already the largest in 75 years, since World War II.

Not only is the government spending trillions of dollars, but with fewer people in the workforce, there are far less individual and corporate tax revenues coming in during 2020. To date, pandemic-related government spending has reached nearly $3 trillion, which is on schedule to put this year’s deficit at around $4.5 trillion.⁴ Every year, the amount of spending that is not covered by revenues is added to the national debt total, which currently stands above $26 trillion. Our debt is financed through bonds, on which the government pays interest. As of the end of July, the interest alone on America’s debt cost more than $436 billion!⁵

It’s easy to see why the Federal Reserve sometimes comes under fire for its aggressive monetary policies.

But it’s alternately the subject of praise. The Fed has been credited with the stock market’s continued strong performance. That’s because when the Fed announces an interest rate cut, that floods more money into the economy so that consumers and businesses increase spending and investment. This, in turn, can cause stock prices to rise.

However, longer term, aggressive easing by the central bank causes a surge in U.S. debt, and that tends to lead to inflation. This is why it is important to work with your financial advisor to create a long-term plan with regard to your portfolio and to also consider strategies to help preserve purchasing power in the long run.

If you have questions or concerns about your retirement plan, please give us a call at 801-465-6990.

1. Federal Reserve. 2020. “About the Fed.” https://www.federalreserve.gov/aboutthefed. htm. Accessed Aug. 17, 2020.
2. Rakesh Kochhar. Pew Research Center. June 11, 2020. “Unemployment rose higher in three months of COVID-19 than it did in two years of the Great Recession.” https://www.pewresearch.org/fact-tank/2020/06/11/unemployment-rose-higher-in-three-months-of-covid-19-than-it-did-in-two-years-of-the-great-recession/. Accessed Aug. 25, 2020.
3. Thomas Franck. CNBC. July 29, 2020. “A full recap of Fed Chief Powell’s market-moving comments on rates, economy.” https://www.cnbc.com/2020/07/29/watch-fed-chair-powell-discuss-the-central-bank-s-latest-policy-decision.html. Accessed Aug. 17, 2020.
4. Lyn Alden. Fedweek. Aug. 12, 2020. “Massive Deficits and Historical Investment Implications.” https://www.fedweek.com/tsp/massive-deficits-and-historical-investment-implications/. Accessed Aug. 17, 2020.
5. U.S. Department of the Treasury. Aug. 6, 2020. “Interest Expense on the Debt Outstanding.” https://www.treasurydirect.gov/govt/reports/ir/ir_expense.htm. Accessed Aug. 17, 2020.