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the FED has a dual mandate as part of its price stability so it has responsibility as Congress has drafted
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the Federal Reserve Act both for Price stability and maximum employment and that's interesting because most other
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central banks don't have this two-legged mandate where they have to look out for
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both price stability and unemployment welcome to the ripple effect the podcast that takes you on a
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journey through the minds of work and faculty I'm your host Dan Looney and in
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each episode we'll be diving deep into the inspiration behind the groundbreaking research that whon
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professors have conducted and exploring how their findings resonate with the world today well one of the things to
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look at as we continue with our series the economy and you is to get a better understanding of the Federal Reserve
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Bank the role that it's playing now but also what the central bank's role is
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supposed to be in general great to be joined by Christina Skinner who's an assistant professor of legal studies and
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business ethics here at the Wharton School hi Christina how are you today hi I'm doing great thanks so much for
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having me on the show I'm really looking forward to our conversation you know
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it's interesting because we talk about the FED it seems like almost on a daily
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basis right now because of everything that's going on with the economy and and
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the role that the FED is taking but for those that really don't follow it as
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closely what does the FED do basically on a daily basis I think this is such a great and important question you know in
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my own research I really strive toward the goal of having everyday people understand what is a central bank and
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what it does especially at this particular moment in time when we've had a surge of inflation and people sort of
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generally know that the FED has grown a larger footprint in the financial markets people are starting to pay
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attention and really get interested from a sort of you know everyday lay perspective what is the Fed doing and
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before I really answer your question directly I did want to just take a step back and make two things a little bit
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clear for our listeners and viewers which is I think so essential to having this big picture context about what is
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the Fed doing what does it mean for your everyday life so the first point is that
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the FED actually shouldn't be doing that much at all on an everyday basis really
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the fed's main job is to keep the economy and the financial system on an even Keel right so the Central Bank
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shouldn't be trying to micromanage the economy but the second Point here is also notable that the Fed doesn't have a
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direct relationship with people really at all so it doesn't lend directly to
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households ordinarily it doesn't have bank accounts for them the FED is really
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working through the banking system and the financial markets now with all that being said as you greatly suggest fed
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policy does of course ultimately touch people's everyday lives in some pretty
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profound ways and since we're just starting I'm just going to give you the
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two sort of most significant or big picture ways that fed policy touches our everyday lives now the first thing is
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that Congress gave the fed the job of pursuing price stability so that means minding watching out for inflation
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inflation is generally very bad for economies very bad for societies because it's reducing the purchasing power of
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money so it's undermining our wealth it's making people's real wages lower so
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that it's harder for them to pay for goods and services right because those wages aren't keeping up with an
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inflationary surge it's hard for businesses to plan so this really drags the economy down and this is the fed's
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main job so this means that when we see a surge of inflation above the fed's 2%
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Target it's going to do things like in the first instance raise interest rates
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to try and cool the economy down and of course when the Central Bank raises interest rates that really profoundly
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impacts people's lives and their cost of crit for things like mortgages and cars
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and credit cards the second thing to note in terms of how fed policy affects people's everyday lives is that the FED
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really takes its job seriously of stepping in during economic shocks to provide liquidity for the financial
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system however this really matters for everyday people because if the financial system freezes up this severely impacts
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the rest of the economy trickles down to households businesses so for example lots of companies use a form of
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short-term debt called commercial paper to finance their operational needs like payroll so if you've got money market
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funds that stop buying commercial paper because they're in distress well this
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means they're effectively ceasing to lend to those small medium large businesses and the FED doesn't want that
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to happen it doesn't want Banks to stop lending to people and businesses so it
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really focuses on making sure that credit can remain the lifeblood of the economy so in a nutshell fed doesn't do
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things directly for people but it works through banks and the financial system to try and keep price levels stable keep
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the financial system stable and that's how it helps us on an everyday basis but
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it it it sounds like though from what we've been going through the last few years that to degree it's also not
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exactly an exact science as well uh because the term transitory was used when inflation was first coming up uh a
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couple of years ago and as we've seen it really hasn't been transitory in fact
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it's been quite the challenge for the FED to try and bring uh inflation down
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over the last year and a half absolutely it would be nice if it were a science but like so much of public policy
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combating inflation thinking about inflation targeting it involves a healthy dose of human judgment and
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sometimes it requires just a lot of plain old common sense now interestingly transitory became almost a dirty word in
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the past few months because it was really the rationale that slowed the FED down in responding to inflation so the
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idea was that inflation would pass Us by would quickly dissipate because most of
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the inflationary surge that we were having was due to coid specific related things like supply chain bottlenecks
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spikes and energy pricing so on the basis of that rationale the fed and I will say all the other leading central
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banks as well the FED wasn't out here on a limb waited what is now consensus view
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too long to start raising interest rates and or slowing down the pace at which they were buying Bonds in their program
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of quantitative easing so because the Fed was used a set of macroeconomic models and forecasting that said
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inflation would basically go away on its own the FED waited too long but we now know that there are some demand side
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aspects to the inflation that we're seeing as well that largely have to do with a very rapid and significant
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increase in the money supply that came from fiscal stimulus in Congress and the FED tools can be used to do something
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about that demand side component of inflation so that component of monetary policy is really it is truly one of the
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key components that the FED really has to focus on uh on a day-to-day basis absolutely so you know I think when
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people tend to think about central banks they do generally think about monetary policy and they think about inflation
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now to dig in a little bit deeper give you a little bit more uh context and Nuance here the FED has a dual mandate
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as part of its price stability so it has responsibility as Congress has drafted the Federal Reserve Act both for Price
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stability and maximum employment and that's interesting because most other central banks don't have this two-legged
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mandate where they have to look out for both price stability and unemployment however the sort of course of history
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has taught us that we really can't have maximum employment if we don't have
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price stability so the FED tends to sort of think first about how it can keep inflation steady at that 2% Target and
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then sort of other ways that it can address the employment side of its mandate and So within this sort of
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umbrella of monetary policy the FED has a couple different tools I mentioned some of them already it thinks about
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setting interest rates right not just to deal with inflation but in the ordinary
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course of things the fed the Federal Open Market Committee more specifically will meet and decide what interest rate
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should be uh important to note here that sort of going back to my earlier remarks
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the FED isn't directly setting Market interest rates that people see when they're applying for a Mor a mortgage or
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a car loan but the FED does set the interest that it pays on Bank Reserves which then sort of influences the market
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rates and and tends to mirror that rate pretty closely the FED also does things like buy Bond it buys government
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securities treasuries in the open market and it usually does this now in the context of what I referred to earlier is
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quantitative easing so it buys a bunch of bonds to try and stimulate the economy if it needs to and lower an
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interest rates is no longer sufficient to juice the economy and it also does some other sort of more complicated and
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nuanced things so for example it will lend to Banks through the discount window in normal times it will lend to
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Banks and other kinds of financial institutions or companies in sort of an emergency context and now through
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something called the overnight reverse repurchase agreement facility that's a
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mouthful right it will also effectively lend to other kinds of Institutions like
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money market funds in a way that mirrors lending to the discount l so this is pretty much all the stuff that the FED
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does under its monetary policy umbrella and it's really all geared toward that
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monetary policy mandate which is price stability which the FED has defined as inflation at an average of 2% and
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maximum employment but part of it at least what we have been talking about in recent months in regards to fed and the
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banking sector also I guess ties back into what we've seen uh with some of the
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issues within the banking sector with silic Valley Bank uh and the like in recent months as well absolutely so
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after the 2010 dodf Frank act this was a piece of post crisis legislation so in the in the
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dodf Frank Act Congress was essentially responding to the global financial crisis the FED gained much more
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supervisory and Regulatory authority over systemically important financial institutions so these are Financial
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holding companies than City group and also non-banks that the financial stability oversight Council might
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designate as systemically important so the point here is that the FED is now also a regulator and a supervisor for
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really large Financial holding companies it's a supervisor it's a bank regulator
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so this is a completely separate function that it has from its monetary policy mandate so the case of Silicon
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Valley Bank was really interesting and challenging for the FED because there in that incident in that ter well you saw
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the fed's two mandates its monetary policy mandate for Price stability conflicting with its responsibility to
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be a supervisor of the banking system and sort of maintain and procure Financial stability why is that well the
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rise in inflation required that the FED raise interest rates quite rapidly and quite quite steeply which is what in
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fact it had been doing for the past 18 months at the same time when you raise interest rates there's a famous saying
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you know when the FED raises rates someone's always going to you know when you see them on the break someone's
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going to go through the windshield we just don't know who and that's basically
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sort of referring to the fact that something's going to break in the financial system causing Financial
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instability so in initial you know raising interest rates was part of the reason why this interest rate risk
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materialized for Silicon Valley Bank in a way that they had improperly managed causing that bank's failure and some
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bumps in the rest of the banking system so you saw this clash between the FED wanting to maintain Financial stability
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and it really needing to ensure price stability so that's something new that
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the FED has to wrestle with since this 2010 piece of legislation that had basically said to the fed you know
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you're responsible for financial stability for making sure that the banking sector is stable but also we
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still need you to make sure we don't have inflation what about the relationship between the Federal Reserve
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and Congress in general that's a great question so you know central banks are
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supposed to be independent right we learned this lesson a couple of decades ago so Independence is really a nuanced
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thing when you're talking about a central bank because Independence doesn't mean not accountable so the FED
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has a tricky sometimes relationship between its boss which is Congress on the one hand and the executive branch so
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when we tend to refer to the central bank we say well it's independent from the executive branch it's not supposed
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to take instructions or pressure from the from the executive from the president who has short-term political
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goals and is that really supposed to take in political instruction from Congress ideally but at the same time
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Congress created the Federal Reserve and the FED is an agent of Congress and so the FED has to be accountable to
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Congress you know Congress exercises oversight over the FED but just like we don't want the executive branch giving
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the FED sort of political jobs to do sort of you know Finance the transition to a green economy Finance uh you know
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War uh you know wall on the border those are sort of partisan issues that we prefer to keep the Central Bank out of
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as a technocratic Economic Policy maker uh so his relationship with Congress is kind of a dance right has to answer to
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Congress and Congress could technically ask it to do any range of things but historically right Congress has sort of
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said okay these are your responsibilities price stability and employment and you know we talked about
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the do Frank Financial stability and so the FED has to sort of stay in that lane
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that Congress has set for it while trying to navigate inevitably the political issues that get put on its
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plate from time to time then let me also ask you then that you also have the relationship between Congress and the
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Federal Reserve Bank but what about the the the relationship between the Federal
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Reserve Bank and the regional federal reserves as well because there are a dozen of them located in different spots
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around the country we have one here in Philadelphia how does that relationship kind of parse out uh in terms of dealing
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with a lot of these issues that's a really great question and I think it's
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an aspect of our Central Bank that a lot of people Overlook and yet it's incredibly distinctive so as you say our
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Central Bank has this Federalist structure which really sort of mirrors the Federalist structure of our country
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where we've got the board in Washington which was always intended to be a more
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uh politically responsive organization right so the FED board is a government agency it sets policy it's the you know
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J Powell the chair of the FED board is one testifying before Congress and then there are these 12 Regional reserve
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banks that have this sort of interesting public Private Structure so the reserve
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banks as you say are located in in regions all across the country and they themselves have a board of directors
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which is appointed by their private member banks so the banks in the region of the Reserve Bank are members of that
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reserving they appoint the board of directors so in that sense it has a a private element at the same time it's
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carrying out these public policy goals right so it is supposed to be responsive to the Board of Governors the Board of
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Governors you know the way to think about it the Board of Governors is set in the policy but those reserve banks
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are operationalizing policy so you've got the New York fed doing open market
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operations pursuant to instructions from the Board of Governors and you have the
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regional Reserve Bank actually on the ground supervising banks in their District on a day-to-day basis even
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though the Board of Governors is setting the overarching supervisory policy but this sort of Quirk of history that the
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reserve banks are public policy organizations but have this private sort of Board of Governors comes up from time
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to time and people wonder whether we should revisit that structure I'm actually not one of those people but
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it's worth noting that the debate is out there because we are one of the only
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central banks that has this unique public private element and for example it became sort of live issue again in
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the context of Silicon Valley Bank when people start asking questions about you know what was the Regional Federal
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Reserve Bank in San Francisco doing and not pushing harder on SVP to deal with some of its unrealized losses some of
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its unhedged interest rate risks so an interesting Quirk of our Central Bank which you know I tend to think makes it
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stronger because you have this diverse set of viewpoints coming in from all over the country feeding into the Board
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of Governors but it's it's certainly a a unique characteristic I guess the last
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point I should mention about our structure is that the Federal Open Market Committee which is the organ of
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the FED that is setting interest rate policy draws on the expertise and the knowledge of the regional Reserve Bank
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presidents and several of the Reserve Bank presidents will sit on the fomc on a rotating
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basis so fed also has to adjust to uh the changes that go on within the structure of our economy uh our
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currencies Etc uh one of which I guess is unique element that's going on right
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now in and around cryptocurrency and how our economy our culture is going to kind
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of bring that into the mix as we move longer term it has already but it's an
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element that the FED probably has to consider as well absolutely so like so many Hot Topics in our economy right now
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the FED hasn't escaped this one either and it's sort of you know fret and
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Center in the in the cryptocurrency I'll call it debate because it really is a
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debate right now both in terms of how to regulate and construct a legal framework
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around various forms of cryptocurrencies and crypto assets and also specifically
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what the Central Bank should do in its corner of the regulatory universe and I will say in the crypto World there are
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two issues in particular that are live issues for the fed the first is what to do about stable coins and I don't mean
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whether to classify them as a security or a commodity that's a separate debate
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the debate that's relevant for the central bank is whether it should provide access to Accounts at those
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regional federal reserve banks for stable coin issuers and the reason why this matters is because from a payments
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system perspective no payment is final until it's settled in Central Bank Reserves and central bank money so
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settlement has to happen on The Ledger of the central bank before any payment transaction is final so if you aren't a
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bank or another financial institution that has an account at the Federal Reserve then you can't sort of engage in
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payment settlement finality yourself you have to go through another intermediary
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so that's necessarily an inefficiency for a stable coin issuer so there's a
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live debate right now about whether the FED should open up access to these stable coin issuers bring them into the
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fold alongside the banks let them engag in in in payments work and the question is which the FED is I think still trying
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to figure out is doing so going to be net beneficial for the economy is it going to increase Financial stability
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risk or not is it going to increase payments efficiency or not and how to weigh those costs and benefits setting
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stable coin to one side the other sort of crypto issue that's lied for the FED
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right now is one that's relevant for all almost all central banks around the
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world right now which is is whether the FED should create something called a central bank digital currency referred
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to as a cbdc now a cbdc would be essentially similar to a stab coin except it would be a sovereign form of
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money you can think of it in very simplified terms like digital cash although for reasons that are probably
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too nuanced to get into right now it's not completely similar to digital cast
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but the idea is you know should the state the government create something that is a digital dollar and that's not
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the fed's decision to make that's congress's decision to make but the FED
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of course can't avoid thinking about the issue having an opinion on the issue you
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know being aware of the fact that other central banks around the world are pretty actively advanced in developing a
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central bank digital currency so that'll certainly be a issue and a debate to
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look out for in the coming years you know it is interesting because we are at a time and I want to thank you for
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coming on and talking today it seems like the Federal Reserve gets more attention now than ever before maybe
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it's a byproduct of the media World we're we're living in right now but it
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seemingly every move that the FED makes these days is scrutinized even more so than maybe it has been ever
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before I think that's you know absolutely the case for a number of factors as you suggest right it's the
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fact that we're having inflation for the first time since the 70s it's the fact
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that the FED is an incredibly effective and Powerful institution so people will naturally look to it to do things that
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they want governments to do whether or not that is necessarily within the fed's
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statutory mandate and because our financial system is really large and complex and the FED has become a
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counterparty to so many institutions so again thank you for the opportunity to to speak to the audience a little bit
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more about what the the FED does and I hope we can do a part two sometime soon absolutely Christina schinner assistant
00:21:53
professor of legal studies and business ethics here at the Wharton School thank you for listening to the ripple effect
00:21:59
we hope you found this episode informative and engaging don't forget to subscribe and leave us a review so that
00:22:04
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