The Federal Reserve System, simply known as the Fed, was created by an Act of the US Congress in 1913 as the central bank of the United States. Its main function is to supervise and regulate commercial banks and other financial institutions to ensure economic stability and full employment.
Despite the power vested in the Fed for maintaining economic stability, it failed to prevent the Great Recession of 2008-9 caused by the big banks which ran crazy with the fantasy scheme of subprime mortgage. The Fed also failed to prevent the high inflation caused by another OPEC price hike that resulted in the US interest rate reaching an all time high of 20% in March 1980. Discounting these two major economic shocks just mentioned, the US economy has been relatively stable among all industrialized countries during the last half century.
In the modern economy increasingly based on borrowed money for investment and consumer spending, the interest rate has become the single most important lever to control the economy. The Fed is given the powerful task of setting the prime rate based on which all other interest rates vary. A rate hike will increase the cost of borrowed money that has the effects of lowering investment and consumer spending, which will lead to higher unemployment and possibly a recession. On the other hand, a rate cut will promote investment and consumer spending, resulting in better employment and economic growth. However, too aggressive a rate cut may cause the economy to overheat and bring about high inflation that will ruin the growing economy. The Fed is walking a tight rope in balancing the economy. An aggressive move in either direction can ruin the economy.
The Fed must be independent due to the broad and sensitive effects of setting the prime rate as an economic lever. All important Fed decisions are made by the 12 members of the Federal Open Market Committee. They are independent from interference by the rest of the US government. This frees them from any political and economic influence from interest groups. The Fed is created by law to make the most critical decisions solely based on the overall economic interests of the country and its people.
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