The role of the federal reserve.

• Author: Walker, Hon. David M.
• Position: Cover Story

Former Comptroller General of the! United States David M. Walker reviews the history of the Fed and offers some salient advice. On how it can be most, effective in addressing factors critical to the nation's monetary policy.

The year 1913 was a very consequential one for the federal government. Three major changes were made that year that had significant implications for the federal government and the United States.

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First, the income tax was enacted into law. The income tax has served to fuel a dramatic expansion in the size and role of the federal government. This expansion accelerated with the passage of Social Security in 1935 and Medicare in 1965, along with new payroll taxes and individual premiums for Medicare's voluntary programs. History has shown that federal policymakers have generally spent and promised more than the related revenue sources can support overtime.

Second, the basis for selecting U.S. senators changed from appointment by state legislatures to direct election by voters. This also contributed to expanding the size and importance of the federal government, while reducing the protection of states' rights. And it facilitated the use of unfunded mandates, whereby the federal government imposes certain conditions or requirements on the states without providing funding to meet such requirements.

Third, the U.S. Federal Reserve System (Fed) was established to provide an independent means to help ensure the stability of the financial system and set monetary policy (determining the size of the money supply and various interest rates). While all of these changes were significant and are worthy of lengthy articles, this piece focuses on the role of the Federal Reserve and possible reforms.

It is important to learn from history and to learn from others. Therefore, let's start with a brief review of the history of the Fed and lessons from history.

Establishment and Evolution of the Fed

Like previous national bank debates, the Federal Reserve Act of 1 was a controversial piece of legislation. It was a result of concerns arising from the banking crises of the late 19th and early 20th century. However, unlike the two prior banks of the United States, which were primarily private institutions, the Federal Reserve Act created a public institution that was designed to be insulated from political pressure.

The legislation was passed largely on a party-line vote with most Democrats being in support and most Republicans opposed. President Woodrow Wilson signed the legislation into law on Dec. 23, 1913.

The initial mission of the Fed was to help ensure the stability and integrity of the nation's financial system and to control the nation's money supply in a manner that would promote economic growth and promote stable prices (that is, the relative stability in the purchasing power of the dollar). To accomplish its mission, the Fed was also provided certain additional responsibilities, including supervision of banking in the U.S.

The original number and geographical boundaries of the 12 Federal Reserve Banks was based on the U.S. economy in 1913. Needless to say, the country has grown and the distribution and location of the nation's population, economic activity and major financial institutions have all evolved over the years. Nonetheless, the original regional bank structure has remained the same for the past 99 years.

There have been a number of important pieces of federal legislation impacting national economic policy since 1913, yet not all of them have had a direct impact on the Fed. Some pieces of legislation set out national objectives without amending the Federal Reserve Act. Therefore, since the Fed is an independent entity with its own governing legislation, it was not technically bound to comply with the legislation. However, as can be expected, the Fed can be subject to pressures from the president, the Congress, the press and the public in difficult economic times.

Some of the most significant and lasting pieces of national economic policy legislation since the Fed's creation are the Banking Act of 1935, the Employment Act of 1946, the Federal Reserve Reform Act of 1977 and the Full Employment and Balanced Growth Act of 1978.

In addition, the repeal of the Glass-Steagall Act in 1999 had a profound effect on the conditions that facilitated the most recent financial crisis that began in 2008 and which resulted in unprecedented interventions by the Fed to ensure the stability of, and confidence in, the nation's banking and financial system.

One piece of legislation that did have a direct impact on the Fed is...