Kavan Choksi Discusses How The Fed’s Regulatory Role Has Evolved Over the Years

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The U.S. central banking system, better known as the Federal Reserve or the Fed, is among the most powerful economic institutions in the world. Kavan Choksi mentions that the core responsibilities of the Fed include regulating financial markets, managing the money supply and setting interest rates. It also acts as a lender of resort during periods of economic crisis, as demonstrated during the COVID-19 pandemic. The Fed also formulates and implements monetary policy to achieve stable prices, maximum employment, and moderate long-term interest rates.

Kavan Choksi briefly sheds light on how the Fed’s regulatory role evolved over time

For the most part of the 19th century, the United States did not have a central bank to serve as a lender of last resort. This left the country vulnerable to a number of banking runs and financial panics. The 1913 Federal Reserve Act was passed in response to these challenges, and led to the creation of a Federal Reserve System of twelve public-private regional banks. For a significant period, the New York Fed has held a prominent position as a leading entity within the nation’s financial sphere. It manages the Fed’s trading operations and plays a role in overseeing Wall Street regulations.

Today the Fed is tasked with the responsibility of managing U.S. monetary, monitoring systemic risk in the financial system, as well as regulating bank holding companies and other member banks. It has a seven-member Board of Governors based in Washington, DC. Each of these members are appointed by the president to a fourteen-year term, subject to confirmation by the Senate. The Board of Governors essentially form a part of a larger board known as the Federal Open Market Committee (FOMC). The FOMC is responsible for managing the money supply and setting interest rate targets.

The Fed has been driven by a dual mandate historically. The first was to maintain stable prices, and the second to achieve full employment. For a long time, stable prices were characterized by an annual inflation target of 2%. However, in August 2020, the Fed announced that it shall start to tolerate periods of higher inflation to make up for periods when it is lower.

To achieve its objectives, the Federal Reserve typically utilizes the buying or selling of U.S. Treasury bonds in the open market as its key mechanism to impact banking reserves and interest rates. For example, when the Fed buys bonds, it injects more funds into the financial system, thereby lowering borrowing costs. Moreover, the Fed can extend loans to commercial banks at a rate it establishes to increase the money supply.

Kavan Choksi points out that the regulatory purview of the Fed has expanded steadily through the 1990s. The banking industry of the United States has changed dramatically under a 1999 law that legalized the merger of banking institutions, insurance and securities. The law additionally allowed banks to combine investment and retail operations. Previously under the 1933 Glass-Steagall Act, the two functions had been separated.  The changes also made the Fed responsible for ensuring the solvency of the banks by enforcing provisions like anti-money laundering policies, antitrust laws, consumer protections and minimum capital requirements.

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