A brief history lesson on the Fed and U.S. economy

The Fed, the US central bank, was established in 1913.

How has the US economy changed since then?

And what role has the Fed played?

Let's take a look at history.

We'll see how the Fed began to operate independently, how it fought the Great Inflation, and how it handled the Financial Crisis.

1951: The Fed's independence

Unlike today, the Fed couldn't make monetary policy independently until 1951.

During World War II, to ensure the US Treasury could finance the war at a low cost, the Fed had to maintain low-interest.

However, with inflation rising, the Fed strongly wanted to change the situation and argued with the US Treasury over interest rate policy.

Finally, they reached the Treasury-Fed Accord in 1951, so the Fed could set interest rates independently to achieve economic stability.

Because the Fed is independent, the president can't fire Fed officials who disagree with him.

That's why when facing President Trump's slam (in 2019), Fed Chair Powell insisted that monetary policy should remain non-political.

As suggested by some countries' experience, when central banks are free from short-term political pressures, monetary policy can work more effectively to stabilize prices and promote jobs.

1965-1982: The Great Inflation

High inflation is a headache for us.

Martin, the Fed's 9th chairman, said in 1955, "Inflation is a thief in the night."

This thief had been stealing from the US economy for nearly 20 years, from 1965 to 1982.

During this period, easy monetary policy to promote employment spurred inflation.

Moreover, inflation was also blamed on energy shortages and fiscal imbalances.

When inflation was rising, policymakers were too slow to react, leading to recessions.

Then Chairman Burns later said, "In a rapidly changing world, the opportunities for making mistakes are legion."

Miller, Burns' successor, was even less focused on fighting inflation

because he believed inflation was caused by many factors beyond the control of the Fed.

Paul Volcker became chairman of the Fed in 1979.

Fortunately, this tall man was determined to beat inflation.

He firmly restrained the growth of the money supply and promptly raised the federal funds rate to as high as 20%.

After a hard fight, the inflation thief eventually surrendered despite there being two severe recessions.

2007-2009: Financial Crisis

The Great Inflation was followed by a period of Great Moderation (1982-2007).

But then, the financial crisis of 2007-2009 hit the United States.

In this crisis, to provide liquidity to the market, the Fed pushed short-term interest rates to nearly zero and launched a series of large-scale asset purchase programs.

Then, Chairman Bernanke and another two economists were awarded the Nobel Economics Prize in 2022.

The award recognized their "foundational research on the role of banks in the economy, particularly during financial crises."

However, some criticized Bernanke for not foreseeing the financial crisis, failing to address the property market, and using public funds to bail out the big banks with easing policies.

They thought these behaviors sowed the seeds for high inflation in the following times.

Conclusion

To sum up, what can the history of the Federal Reserve and the US economy teach us?

Firstly, the Fed should conduct monetary policy independently.

It is duty-bound to act in the long-term public interest.

However, it may have to endure short-term political pressures.

Secondly, the economy is cyclical.

Both the Fed and the public need to fight inflation and recession.

Thirdly, the economy is so complex that even the Fed may not be able to respond in time.

Thus, we should be rational about the Fed's policies and statements.

You may have other insights.

Please feel free to share!