The Expansion of the Federal Reserve over History and into the COVID-19 Pandemic

From the beginning of the coronavirus outbreak in the United States, the Federal Reserve (The Fed) has served as a key and central actor in the government’s economic response. The Fed quickly employed its arsenal of monetary policy initiatives to stimulate the rapidly slowing economy caused by consumers’ inability to leave their homes and spend money on goods. These aggressive responses aim to provide economic relief to sustain the economy until the impact of coronavirus subsides. Recently, the Federal Reserve announced new policies that dramatically expand its role in the national economy. This credit expansion calls into question the scope and purpose of the Federal Reserve as it continues to stretch beyond its initially limited goals. Looking into the future after the decline of COVID-19 underscores the highly alarming potential of the Fed’s newfound influence on businesses of all sizes and the politicization of Federal Reserve appointments. 

The instability of the US financial system at the beginning of the 1900s caused a series of financial crises instigated by bank failures. Essentially, the failure of one bank would cause customers of other banks to panic over the security of their own money and pull their funds out. With most of its money lent out, the banks did not have enough cash reserves to handle this unexpected influx in demand for cash. Therefore, without a central bank, these other banks did not have a source of emergency lending to save them from bankruptcy. A particularly severe panic in 1907 propelled Congress to create the Federal Reserve System. The 1913 Federal Reserve Act established a network of twelve regional Reserve banks overseen by the Board of Governors. Its primary purpose was to stabilize the American financial system in order to reach maximum employment and promote long-run economic growth. The Federal Reserve achieved these limited objectives by controlling the monetary supply, setting interest rates, and serving as the lender of last resort. However, the effects of and response to several financial crises have dramatically enlarged its power and sphere of influence beyond just these measures. 

The Great Depression highlighted the failure of the Federal Reserve to prevent a nationwide financial disaster. Disagreement amongst its leaders over the appropriate course of action resulted in a lack of coordination and detrimental measures that severely worsened the crisis. This failure propelled Congress to pass a series of legislative reforms from 1932-1935.

These changes restructured aspects of the Federal Reserve system itself by adding the Federal Open Market Committee (FOMC) which focused on regulating banks. The Fed now was charged with monitoring banks’ solvency by enforcing minimum capital requirements, consumer protections, antitrust laws, and anti-money laundering policies. 

The next augmentation of Fed monetary policy arose from its measures to combat the Great Recession. The Fed instituted the first round of monetary policy, dropping interest rates to near zero, to stimulate the slowing economy. As the economic downturn persisted, the Fed expanded its policy menu to include quantitative easing. Quantitative easing aims to increase the money supply as the Fed purchases longer-term government bonds and mortgage-backed securities to provide banks with more liquidity. Quantitative easing represents yet another expansion of the Fed into the financial markets. Data provided by the St. Louis Fed exhibits that, “between 2008 and 2014, the Fed’s balance sheet ballooned from about $900 billion to over $4.5 trillion as the central bank launched several rounds of asset buying” (Council on Foreign Relations). The Fed also decided to begin lending money, not just to banks, but to banklike financial firms that had emerged since the Great Depression, such as insurance companies and money market mutual funds. 

As you may have guessed, the stock market crash caused by COVID-19 has resulted in another expansion of the Fed’s engagement in the financial system. Within the first week of the crisis in the US, the Fed has already exhausted its traditional monetary policy levers by lowering the interest rates to essentially zero to lower liquidity buffers. The Fed announced initiatives similar to that of the Great Recession to offer loans to nonbank financial firms and engage in aggressive quantitative easing. To further stimulate the economy in response to COVID-19, the Fed launched a quantitative easing program totaling at least $700 billion. 

On April 9th, the Fed announced the initiation of the Main Street Lending Program, which connects the Fed directly to small and medium-sized businesses as well as state and local governments. The program sets up a structure and criteria for banks and financial institutions to give out more risky loans to these businesses, because the Fed will purchase 95% of the value of each loan. Therefore, the Fed will incur the substantial loss if a business defaults, not the individual banks. This program extends a lifeline to businesses in the middle ground, ones that are too small to receive massive bailouts and too large to be eligible for small business loans, or still require additional funding. 

To recap, the Fed is providing funds to other banks, financial firms, large corporations, state and local governments, and now, medium and small businesses. The government entity designed to solely function as the “bank’s bank” now has transitioned into virtually everyone’s bank. This monumental change forgoes the complex set of in-depth institutional processes, such as capital markets, bond markets, credit rating agencies, and intermediary banks, that typically determine who should be receiving loans and at what price. Essentially, now the Federal Reserve has taken the place of free market competition to determine which of these firms fail and which do not.

This expansion of Fed influence into all levels of the national economy causes alarm over the potential effects of this unprecedented rise in power. The aforementioned program directly intertwines the Federal Reserve with every level of American industry, creating financial relationships that will be very difficult to extricate itself from. After the 2008 Great Recession, the Federal Reserve did not stop its quantitative easing purchases until six years later and did not begin shrinking its balance sheet until 2017 (Council on Foreign Relations). Coronavirus has caused a much broader impact, upsetting the lives of every single American. Furthermore, the time element of paying back loans implies that this progress will take much longer than after 2008 for the Fed to revert to its pre-COVID-19 standard operation. Therefore, the Federal Reserve is likely to continue playing a primary role in the everyday operation of the US market for years into the future and possibly forever if it does not revert back to its pre-COVID-19 limitations. This rising, lasting influence attracts the attention of politicians and their desire to control the use of this power. With the power to heavily impact the future of firms, the Fed will bring upon itself the censure of politicians inquiring as to which firms were funded and why. The position of the Fed chair, presently held by Jerome Powell, has remained relatively unpolitical. This appointment does not function like one to the Supreme Court, where both sides are viciously fighting for or against the appointee. Instead, a respected technocrat is typically chosen without notable pushback. However, with its powerful influence growing to the funding of firms and state governments, the Federal Reserve Chair appointment may become akin to the Supreme Court process. This tragic result would destroy the independence held by the Fed since its founding that is vital to the unbiased execution of its important role in the economy.  

With businesses forced to close down for months to prevent the spread of this deadly virus, the Federal Reserve has enacted every measure to stimulate the economy and support struggling businesses. However, the flip side of this expanded role is the increased possibility for politicization as parties attempt to further control the actions of its powerful government entity. This observation highlights the importance of the Fed returning to its more limited role as soon as it is appropriate to reinstate the typical channels of capital flow, retract government reach into the economy, and prevent the politicization of the Federal Reserve. 

Works Cited:

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