The idea of a Federal Reserve can be traced back to the foundation of the United States of America by Alexander Hamilton in 1790. Hamilton insisted on implementing a central bank that conducted financial business on behalf of the US government. Though the current Federal Reserve is not the exact model Hamilton had envisioned, it shares several key features which make it an intangible asset. The foremost feature is its ability to use monetary policy to affect the US economy in times when fiscal (government-implemented) policy does not have time to clear Congress.
To fully understand what makes monetary policy so unique and effective, we must first understand the basics of how its counterpart, fiscal policy, functions. fiscal policy is a method of attacking inflations and recessions by either increasing or decreasing government spending, taxes, or a mix of both. However, this process can often take months just to be debated and could just as easily not clear Congress. In addition, even when fiscal policy is successfully performed it can take large spans of time before impacting the public and thus is preferred more to reform than to correct. Furthermore, the banking system with which all financial institutions operate in the US plays a large part in its effectiveness. Since monetary policy being handled by the Federal Reserve, is a method of attacking economic problems via increasing or decreasing the discount rate: the rate at which banks take loans from the Fed, Open Market Operations: the purchasing or selling of Federal Bonds to banks, or changing the reserve requirement, it is most effective with a fractional reserve banking system. This method allows for swift and surgical shifts in the economy and management of inflation.
However, this limited reserves system had opened banks up to too much risk of closure in the event of stagflation or supply shock as per the Fed. Thus in the midst of the pandemic, 2020, the Fed switched to an Ample reserves system, which aimed to provide a more stable financial environment. This system promoted banks to keep larger sums of reserve by providing Interest On Reserves (IOR). The shift to an Ample reserves system also allowed the Federal Reserve to have even greater and finer control over the money supply.
As inflation soared to unimaginable highs near the end of 2022, Gerome Powell, the chairman of the Federal Reserve, has been announcing increases to the previously mentioned IOR. This promotes banks to withhold money and slows financial activity within the nation. Though direct impacts have yet to be felt, several analysts believe that a recession will be felt throughout the end of 2023, however, others also speculate a soft landing. A soft landing is a term that expresses when the Federal Reserve successfully raises the interest rate in which the economy succeeds and does not fall into a recession. As perfect as this may sound, this soft landing has only been accomplished once in the past sixty years and that was with the old forms of monetary policy.
To end on a high note, let's circle back to the original question, “Does The Federal Reserve Control Inflation?”. In fact, the Federal Reserve plays a very important role in controlling inflation in the United States; however, it is important to note that there are many other factors that can also affect inflation, including global economic conditions, government policies, and consumer behavior. So while the Federal Reserve does have some control over inflation, it is not the only factor at play. Hopefully, this article left you with a lasting understanding of the federal reserve, monetary policy, and what that all means for the individual.
Sources
