The Logic and Limits of the Federal Reserve Act

Over the past fourteen years, the U.S. Federal Reserve has rescued overleveraged financial companies, purchased trillions of dollars of mortgage-backed securities, and created novel facilities to support ordinary businesses, nonprofits, and local governments. While some argue that the Fed has gone too far, others believe that it should expand its ambit further still to address issues such as climate change, racial injustice, and crumbling infrastructure. This Article seeks to clarify the nature and stakes of this debate by recovering the logic and limits of the Federal Reserve Act. It argues that to understand the Fed it is necessary first to understand the U.S. system of money and banking. That system uses publicly chartered, investor-owned banks to issue most of the money supply. Congress designed the Fed for a limited purpose: to administer the banking system. And Congress equipped the Fed with an integrated set of tools to achieve a specific objective: ensure that the banking system creates enough money to keep economic resources productively employed nationwide. The rise of shadow banks—firms that issue money instruments without a bank charter—has impaired the Fed’s tools. As the Fed has scrambled to adapt, it has taken on tasks it was never designed to handle. This has prompted calls for it to do more and pleas for it to do less. These conflicting demands reflect rival visions about how to divide responsibility for creating money between politicians, technocrats, and private interests. These visions are often untethered from the considerations that animate existing law, sidelining politicians and elevating technocrats and investors. Only by reexamining the Fed’s statutory framework can we appreciate the fault lines in the present debate and evaluate the Fed’s capacity in the future