The Federal Reserve
The most powerful economic institution in the world operates largely outside democratic accountability — by design, and for reasons that are more defensible than they appear.
The short version
- The Federal Reserve controls short-term interest rates, regulates major banks, and manages the money supply — decisions that affect mortgage rates, unemployment, inflation, and the availability of credit for every American.
- The Fed is deliberately structured to be independent of elected government: its governors serve 14-year terms, its decisions are not subject to presidential or congressional approval, and it controls its own budget.
- The Fed's dual mandate — maximize employment and maintain price stability — creates a structural tension, because the tools used to fight inflation (raising rates) tend to slow employment growth, and vice versa.
- The 2008 financial crisis and the COVID-19 response demonstrated the Fed's capacity for extraordinary emergency action — buying trillions in assets, bailing out money market funds — that was never explicitly authorized by Congress but was undertaken under broad statutory authority the Fed interpreted expansively.
What it is
The Federal Reserve System — established by the Federal Reserve Act of 1913 — is the central bank of the United States. It consists of a Board of Governors in Washington, D.C. (seven members appointed by the president and confirmed by the Senate to 14-year terms) and twelve regional Federal Reserve Banks distributed across major U.S. cities, whose presidents are appointed by regional boards subject to Board of Governors approval. The Federal Open Market Committee (FOMC) — composed of the Board of Governors plus five of the twelve regional bank presidents on a rotating basis — sets monetary policy, specifically the target range for the federal funds rate: the interest rate at which banks lend reserves to each other overnight. This is the number you hear when the Fed 'raises' or 'cuts' rates.
The federal funds rate is the fulcrum on which most of the economy's borrowing costs rest. When the Fed raises it, banks' cost of funds rises; they pass this through to the interest rates they charge customers. Mortgage rates, auto loan rates, credit card rates, corporate bond yields, and the rate at which the U.S. government borrows all tend to move in the same direction as the federal funds rate, with varying lags and degrees of correlation. When borrowing becomes more expensive, households and businesses borrow and spend less, slowing economic activity and reducing inflation. When the Fed cuts rates, borrowing becomes cheaper, stimulating activity and raising inflation. This mechanism — raising and cutting the price of credit — is the Fed's primary instrument. It is powerful and it is blunt: it affects all borrowers simultaneously regardless of which parts of the economy need cooling or stimulation.
The Fed's mandate, as established by the Federal Reserve Reform Act of 1977, is explicitly dual: to promote maximum employment and stable prices. 'Stable prices' has been operationalized by the Fed as approximately 2% annual inflation, a target adopted formally in 2012. This dual mandate is distinctive — many central banks, including the European Central Bank, have a single mandate of price stability. The dual mandate creates a genuine policy tension. The primary tool for reducing inflation is raising interest rates, which slows economic activity and raises unemployment. The primary tool for promoting employment is keeping rates low, which can overheat the economy and raise inflation. When inflation and unemployment are both high simultaneously — a condition called stagflation, experienced in the 1970s — the Fed's two mandates point in opposite directions and there is no clean solution.
The Fed's independence from elected government is a design choice with a concrete historical rationale. The Federal Reserve Act was passed in part because the U.S. lacked a lender of last resort during the banking panics of the late 19th and early 20th centuries — the Panic of 1907 was the immediate catalyst. But the independence from political direction was reinforced by the experience of the 1970s, when the Nixon administration pressured Fed Chair Arthur Burns to keep rates low ahead of the 1972 election despite rising inflation — a political accommodation that contributed to the inflation spiral that took Paul Volcker's brutal rate increases of 1979–1982 to break. The academic and policy consensus since then has been that monetary policy decisions made by politically insulated technocrats produce better long-run outcomes than decisions made by officials responding to electoral incentives. This consensus has been contested by political economists who argue that the insulation also removes a form of democratic accountability, and that questions about the distribution of the costs of inflation-fighting (which fall disproportionately on workers and debtors) are inherently political choices being made by unelected officials.
Why it matters
The Federal Reserve's interest rate decisions affect more Americans' daily lives than most presidential decisions, a disproportion that receives almost none of the political attention it warrants. When the Fed raised rates from near zero to over 5% between 2022 and 2023 to combat post-pandemic inflation, it raised mortgage rates from approximately 3% to over 7% — adding roughly $700 per month to the cost of an average home purchase and effectively freezing millions of would-be homebuyers out of the market. Simultaneously, it increased the return on savings accounts and money market funds, transferring wealth from borrowers to savers. The decision was a technocratic one, made by unelected officials, with no required public deliberation and no direct democratic accountability. Whether the decision was correct is a separate question from whether the process by which it was made reflects appropriate democratic governance.
The Fed's balance sheet expansions — quantitative easing — introduced during the 2008 crisis have permanently transformed the institution. Before 2008, the Fed's balance sheet was approximately $900 billion, mostly Treasury securities. After the financial crisis, the Fed purchased mortgage-backed securities and Treasuries on a massive scale, expanding its balance sheet to approximately $4.5 trillion by 2015. It contracted the balance sheet, then expanded it again to nearly $9 trillion during the COVID-19 response in 2020–21. As of 2025, it remains at approximately $6–7 trillion. This 'quantitative easing' — buying assets to inject money into the financial system and lower long-term interest rates — was a significant policy innovation with distributional consequences: it inflated asset prices (stocks, real estate, bonds), benefiting asset holders disproportionately relative to wage earners. The policy may have been economically necessary; its distributional effects contributed meaningfully to wealth concentration.
The Fed's role as emergency crisis manager — most visible in 2008 and 2020 — involves powers that stretch the statutory language of the Federal Reserve Act in ways that have generated significant legal and democratic controversy. Section 13(3) of the Act allows the Fed to lend to 'any individual, partnership, or corporation' in 'unusual and exigent circumstances' — a provision designed to allow emergency support in extreme situations. In 2008, the Fed used this authority to engineer the rescue of Bear Stearns, extend credit to AIG (an insurance company, not a bank), and create numerous emergency lending facilities that supported money market funds, commercial paper markets, and securities dealers. In 2020, it used it to purchase corporate bonds — including the debt of companies that later laid off workers — and extend credit to municipal governments. These actions prevented financial catastrophe and may have been appropriate; they were also decisions of extraordinary economic and distributional consequence made without explicit congressional authorization, under pressure of crisis and time.
The question of who the Federal Reserve serves — and who bears the costs of its decisions — has moved from the economic fringe into mainstream policy debate. The 2022–23 rate hike cycle renewed attention to the fact that the primary mechanism by which the Fed reduces inflation is by raising unemployment — by making credit more expensive, slowing economic activity, and weakening workers' bargaining power in a tighter job market. This is not a hidden mechanism; it is explicit in economic models. Former Fed Chair Alan Greenspan testified before Congress that low unemployment itself could be inflationary because it gave workers leverage to demand higher wages, which firms would then pass to consumers. The logical consequence of this framework is that the Fed, in fighting inflation, sometimes deliberately works to reduce workers' bargaining power — a distributional decision with clear winners and losers that is never described in those terms in Fed communications, and is made by a body whose governance structure gives the financial sector significant institutional representation through the regional bank boards.