Whom Does the Fed Serve?

In my article on economic myths I raised the point that the Fed isn’t quite the conspiracy construct that many believe it to be.  And in the past, I have argued that the Fed is a strange sort of public private hybrid entity that isn’t really “owned” by anyone.  It is, for all practical purposes, a public/private hybrid entity that operates independently (that is, without governmental approval) within government (the Fed is a creation of Congress and is overseen by Congress).

But this raises an interesting question.  If the Fed operates as a public/private hybrid entity then who does it really serve?   Does it serve public purpose as part of the government?  Or does it serve private purpose as part of the banking system?  The answer is both.   After all, the Fed was created after the Panic of 1907 to help create a central clearinghouse for the nation’s banking system.  It became clear, after a series of financial crises, that banking was too important to be left entirely to the hands of private bankers.  But the Fed system did not take a private banking system and create a nationalized system.  It bridged the divide and established a hybrid system which is part public and part private.

So the Fed was created to establish a government supported/regulated central clearinghouse where payments could settle on a daily basis.   This leveraged the strengths of the government, but kept banking in the hands of private institutions.  The Fed essentially became an essential piece of the private banking system in doing so and became inextricably linked to these private entities.   If this looks like a conflict of interest of some sort then you’re probably not far off.  After all, the member banks of the Fed own a small slice of the Fed’s profits and they get to elect most of the directors to the regional Fed boards.  In fact, the directors the member banks elect are specifically designated not to serve public purpose.  They are “elected to represent stockholding banks”.  So there’s very clearly an element of private purpose in the leadership of the Fed.  Some, like Jonathan Reiss of Analytical Synthesis argue that even this structure leaves the banks with too much power.  But he also rightly notes that Congress or the Fed itself can change this rather easily.

It’s also clear that the Fed serves public purpose.  After all, monetary policy is specifically designed to help support the domestic economy even if it works through the banking system primarily.  So the Fed isn’t there just to support and prop up private banks.  And if the Fed were just funnelling profits to the banking system and not helping the rest of the private sector I am pretty sure that Congress would get fed up with them pretty quickly.

So it’s a tricky question here.  Who does the Fed really serve?  I’d argue that it serves two masters – the private for profit banking system as well as the public.  That means there’s a certain balance within how the Fed operates.  It is neither a purely public nor private entity and cannot be when it serves two masters.

I think this point is important because it’s crucial to understand the balance within how the Fed is constructed and operated.  We often see people with political agendas trying to convince us that the Fed is either public OR private.   There’s really no need to make this distinction unless you’re trying to convince people of a strict political position and in my view, this doesn’t help us arrive at a balanced and objective understanding of how the Fed system operates.  The truth, as is often the case, lies somewhere in the middle.

See the following pieces for more detail:

https://pragcap.com/feds-dual-mandate-bull-sht

https://pragcap.com/who-owns-the-federal-reserve