- Ben Bernanke, formed Fed Chairman
The latest Janet Yellen's testimony confirmed earlier concerns the central bank cannot control everything. People give the Federal Reserve way too much credit. Earlier this year, the Fed pledged to start raising rates next year. Many believe the Fed can raise or lower the inflation rate or fix the unemployment situation at will. But does the Federal Reserve really has that much power?
Actually, the Fed does not really claim to set interest rates. The only thing it does is setting a target range for its Federal Funds Rate– the main monetary policy instrument. After the target is set, the Fed purchases securities in order to impact the supply and demand of bank reserves, hence, moving the funds rate towards the selected target. More than a decade ago Diedre McCloskey claimed that 14 years ago Fed's open market operations accounted only for a small part of the overall global capital markets. According to her projections, the capital market equalled $300 trillion, while the Fed under Greenspan was increasing or decreasing its holdings by approximately $40 billion a year. At the same time, everyday operations are based on forecasts made by the Fed and according to them, the central bank acts in consistency with the target for the fed funds rate. It will be not a surprise there are some mistakes in these forecasts that can be quite large. Finally, in a period from 1982 to 2012 the rate plunged from 12% to zero. In case the Fed can control the rate and it aims at stability, why the range is so big?
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