Why the Federal Reserve Bank is relevant in times of financial crisis

Harold Cole, the James Joo-Jin Kim Professor of Economics, sheds light on the Fed’s structure, objectives, and capabilities.

The Federal Reserve Bank, more affectionately known as the Fed, impacts many important aspects of our everyday lives, from purchasing power to job security. Harold Cole, the James Joo-Jin Kim Professor of Economics, who worked at the Minneapolis Federal Reserve for more than a decade, discusses the Fed’s structure, objectives, and capabilities—and why it is especially relevant in times of financial crisis.

Harold Cole.
Harold Cole, the James Joo-Jin Kim Professor of Economics in the School of Arts & Sciences. (Image: OMNIA)

“The Fed was created well before the Great Depression and basically was a response to various banking crises,” says Cole, “the Fed was designed to try to stabilize the banking system—to buy up assets and underpin their value, to make emergency loans to banks that they think are solvent, and to try and prevent these crises from snowballing.”

“Over time,” he explains, “the Fed’s role has expanded, where they now look to stabilize the price level, keep the financial system stable, and also maintain the economy running at a high level. However, all of these goals are in opposition to each other. One classic example of this is that stabilizing the price level to prevent inflation could have employment consequences, and that’s the big one we’re talking about right now.”

Cole outlines the potential effects on everyday citizens when interest rates are adjusted. “When we put in very low interest rates during the Great Recession and the COVID crisis, that hurt a lot of conservative savers. If you were in the stock market, though, it’s been very good to you. We know that wealth is very skewed in this country, but another factor is what form of wealth people have. As you go up the income distribution, people tend to hold much more stock and private equity—a bunch of things that are going to be responding positively to reductions in the interest rate. But if you were someone who was saving using these interest-bearing assets, you have not done so well.”

He adds, “one ripple effect in terms of inflation is that some prices adjust right away, but others, like wages, are much slower to adjust. So, real earnings might be doing pretty well, but then turn down. That’s because even though nominal earnings are going up, they’re not keeping pace with inflation. If you’re on social security, for instance, because that adjusts slowly, you’ll take a significant hit.”

Read more at OMNIA.