by Steve G. Parsons, Ph.D.

Some suggest simply abolishing the Federal Reserve (Fed) and perhaps returning to the gold standard.  And while we could debate such an approach, there is little support for full abolishment of the Fed.  Fortunately, there are fundamental changes to the Federal Reserve that would greatly improve the institution – short of abolishing it.  First consider the background of the Fed.  

Conflicting and Unattainable Goals.  The Federal Reserve Act was signed into law by President Woodrow Wilson in December of 1913, it was amended in 1977 to require the Fed "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." However, “… poorly executed monetary policy can have severe consequences, and the government’s poor record of monetary stewardship is sufficient cause for reforming the Fed.” Reforming the Federal Reserve, Section 2: Enforcing Rules-Based Monetary Policy | Cato Institute

Smoke and Mirrors.  The Board of Governors of the Federal Reserve System correctly notes that the Fed does not purchase new Treasury securities, but it then claims: “Federal Reserve purchases of Treasury securities from the public are not a means of financing the federal deficit.” (Available at The Fed - How does the Federal Reserve's buying and selling of securities relate to the borrowing decisions of the federal government?) 

This statement is highly deceptive at best; when the Fed makes those purchases it owns Treasury securities and thereby holds part of the debt of the United States.  This can be seen at the website of the Fed of St. Louis showing that in January 2020 (before the pandemic) the Fed had $4.17 trillion in assets.  These are primarily Treasury securities.  That is, one branch of the federal government (the U.S. Treasury) owes another branch of the government (the Fed) over $4 trillion.  If your instincts tell you this is smoke and mirrors – your instincts are correct.  But it gets worse, by May of 2020 (four months later) the Fed had over $7 trillion in assets.  Federal government spending for the pandemic was financed by deficit spending, thereby increasing the national debt.  However, this deficit spending was not funded via the public purchasing substantial amounts of new Treasury securities – rather it was largely financed by the Fed purchasing that debt.

The Fed “Creating Money” out of Thin Air.  Typically, when the Fed purchases Treasury securities from the public it “pays” for the securities by creating money out of thin air. Decades ago, we would have said that the Fed was simply printing more money; the effect is very similar. In February 2022 the Washington Post noted “The Fed’s broadest measure of the money supply, called M2, is more than $21.6 trillion today, up from $15.5 trillion in February 2020.”  (Or see M2 (M2SL) | FRED | St. Louis Fed (stlouisfed.org)). That is, in two years the Fed increased the money supply by approximately 40%. This was of course possible because the Fed could create money out of thin air to purchase Treasury securities on the secondary market.  

An Enabler to Spend-aholics.  For those with a substance abuse (or overeating disorder) often there is a friend or family member that enables the bad behavior.  In this case it is the Federal Reserve– enabling the federal government to deficit spend by paying for it with newly created money.  This fuels the growing national debt (which will certainly hit $40 trillion in 2026).

Causing Inflation.  In an October 1977 issue of Newsweek, Nobel Prize winning economist Milton Friedman described how growth in the money supply was the ultimate cause of long-term inflation.  If you don’t believe that growth in the money supply drives inflation, you should visit Argentina (as I did) where growth in the money supply and inflation had both topped 100% per annum for many years before Milei became president.

Changes Needed at the Fed.  I consider myself a practical economist (making my living helping companies make business decisions in the face of regulatory constraints), and a practical Libertarian. One option is to retain the Fed, but key changes are needed.   1) Eliminate the 1977 conflicting and unattainable goals of maximum employment, stable prices, and moderate long-term interest rates.  2) Explicitly eliminate or greatly rein in the Fed’s ability to create money out of thin air.  This could be done with a rule-based constraint such as no increase in the money supply greater than the real growth in GDP plus some percentage (perhaps 1%).  Other changes are possible, but the Fed’s ability to enable deficit spending by creating money out of thin air must be curtailed. 3) The Fed should focus instead on maintaining banking system solvency and maintaining US trust in the banking system.

A more detailed description of the Federal Reserve and how to fix it is available in a multi-part series created by the Cato Institute Reforming the Federal Reserve | Cato Institute: “Given the multiple instances of the Fed’s failures as a regulator, the abundance of other regulatory agencies, and the conflict of interest that arises from the Fed supervising banks while conducting monetary policy, the first-best solution is to eliminate the Fed’s regulatory authority altogether.”