There is lots in the news these days about the actions of the Federal Reserve (the Fed). It’s pretty clear that they have some important role in controlling inflation and interest rates. So what exactly is The Fed, what do they do, and why?
Banking
As noted in Money, Money, Money, Money, the banking system evolved as the logical way to store money safely and allow people to transact business across distances. Initially, banks simply stored money for a fee and helped people pay for goods and services. But soon they also began to loan some of that money out.
Since the beginning of their existence on earth, humans have needed ways to trade with each other. Initially, there were simple barter systems. One person had wheat and someone else had milk, so they could swap wheat for milk, and both of them end up with both wheat and milk. That simple example didn’t actually go very far. If the person who had milk didn’t want wheat, there was no way for them to do a deal.
In March of 2023 we almost had a bank crisis. Lots of money was quickly pulled out of banks and suddenly everyone realized 1) bank deposit interest rates are ridiculous when compared to other alternatives like money market funds and CDs and treasury bills, 2) banks might actually be in trouble because they have so much money tied up in low interest rate investments and loans, and 3) lots of bank deposits aren’t covered by federal deposit insurance and could be lost if the bank goes under.
I have wondered for years what happened during the Great Depression of the 1930s. One day there was plenty of money, everyone was working and spending, and the next day everyone was broke. Where did the money all go? How could all that money evaporate? Did it all go into the pockets of a few rich people? Many many years later I understand it better. Lots of things happened, but one that is important is that credit suddenly disappeared.