Federal Reserve: Is understanding the Fed that difficult or even useful?

The Federal Reserve as narrative promoter …

While not a political organization, the Board of Governors of the Federal Reserve System as an agent of the Congress, is responsible for crafting a narrative around the soundness of the United States currency. The centerpiece of the soundness narrative is found in 12 USC 225(a) where Congress has mandated the Federal Reserve to pursue a path toward stable consumer prices, maximum employment (allegedly of labor), and moderate long-term interest rates.

For holders of American bonds and equity, a Federal Reserve interest rate policy that facilitates the increase in the value of said bonds and equity is the goal. These bonds and equities along with the value of land and other commodities serve as the collateral for the credit that provides asset holders with spending money. The difficulty with democracy is the necessity for agents like the Federal Reserve and the branches of the government to produce two-sided messages.

On one side of the message is the mollification of the electorate. The dual mandate found in 12 USC 225(a) serves to mollify an electorate faced with varying degrees of economic certainty by manipulating monetary policy (interest rates) with the accompanying message that the actions being taken are in the interests of the American consumer.

Lower rates are translated into a message that says credit will be cheaper for consumers. Implying to the electorate that lower rates will increase their capacity to borrow and spend more along with the certainty generated by maximum employment also is designed to increase positive consumer expectations about their economic futures.

On the other side of the message is the assurance to the asset holder that signaling maximum employment and stable prices to consumers increases spending that leads to greater yield generation by the assets held by the wealthy. Higher values assessed on the assets also means a higher capacity for these assets to fund borrowing by the wealthy.

Both worlds are connected, and Federal Reserve narrative is the glue.

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Understanding the Fed in terms of the ultimate principal …

I mentioned before that the Federal Reserve is a creature of Congress, its agent. Understanding the Fed is best done when framing Fed policy in terms of who the policy works for. The Fed is concerned about the soundness of the banking system. Banks buy and sell money from and to each other, sometimes with collateral and sometimes not, and particularly in the overnight or short-term markets. The better the collateral, the lower the interest rates by which they exchange funds with each other.

As for the Fed’s usefulness, Fed actions tell me how it is assessing the confidence banks have in each other when lending money overnight. Fed actions tell me how they see short term money markets and whether these markets are attracting liquidity.

And the principal we are concerned with is the asset holder, that person who has or controls a bundle of income-generating twigs. Banks are merely the privateers swashbuckling on behalf of their investors, owners, and depositors. To understand the Fed is to look at it primarily as a backstop for the banks and by translation a backstop for the value of assets held by investors.

The ultimate principal for the Fed is not the Congress. It is the asset holder.

Alton Drew

2 June 2025

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