Project 2025 has recently received significant attention and has been the subject of much discussion. Project 2025 features a 900-page plan for government administration (Mandate for Leadership) that provides domestic, political and economic policies which would significantly transform the U.S. government and American society. It was created by the Heritage Foundation, a conservative think tank in Washington, D.C., and includes input from several former senior Trump administration officials. The purpose of the plan is to serve as a policy guide for the next administration. Policy proposals include a broad expansion of presidential power and significant changes to the leadership, staffing, and mission of federal government agencies. The proposals also cover education, immigration, climate and energy, healthcare, and LGBTQ+ policies. In addition, Project 2025 contains detailed economic policy prescriptions.
The United States currently has the largest and strongest economy in the world. The economy is significantly impacted by monetary and fiscal policies of the U.S. government. The Federal Reserve is responsible for monetary policy – implemented primarily through targeting the fed funds rate by controlling the money supply. The Federal Reserve is required by law to direct its policies toward the dual mandate of achieving maximum employment and price stability and report regularly to Congress. Fiscal policy includes government spending and tax policies, which are implemented through a combination of presidential and congressional actions. Project 2025 would significantly change each policy. This blog will focus on monetary policy.
Project 2025 and Monetary Policy
The Project 2025 playbook offers policy prescriptions regarding the future of the Federal Reserve and monetary policy. At a minimum, the authority of the Federal Reserve would be significantly reduced; at a maximum, the Federal Reserve would be fully eliminated. The authority and regulatory power of the Federal Reserve, combined with how monetary policy would be implemented, would be transferred to “elected officials,” meaning that presidential and congressional power over monetary policy would increase while the Federal Reserve’s authority would be significantly decreased or eliminated.
The Project 2025 monetary policy proposals include:
- Returning the U.S. to the gold standard (commodity backed money).
- Elimination of the Federal Reserve’s dual mandate of maximum employment and price stability replaced with a focus solely on price stability.
- Reduce and limit Federal Reserve purchases of financial assets, including federal debt and mortgage-backed securities.
- Limiting the Federal Reserve’s lender-of-last-resort function, which offers loans to banks near collapse.
- Exploring alternatives to the Federal Reserve System, including elimination of the Federal Reserve and the implementation of “free banking”.
Much of the monetary policy proposals relate to requiring the Federal Reserve (or an alternative to the Federal Reserve) to have stable monetary growth, rather than discretionary monetary authority that guides interest rates in order to affect economic growth. The stable monetary growth and lack of discretionary monetary policy would limit or eliminate the Federal Reserve’s ability to bolster financially ailing financial institutions and corporations. Project 2025 argues that expanded Federal Reserve discretionary powers with respect to monetary and regulatory policy have created operational ineffectiveness and the potential for policy decisions based on political pressure.
Before discussing the Project 2025 policy prescriptions, a brief review of the history of the gold standard, the Federal Reserve, and monetary policy.
The Gold Standard
Project 2025 argues that a return to the gold standard should be strongly considered. From 1879 through 1933, the United States was on the gold standard. Most major nations, including the United States, backed their currencies with gold. A gold standard is a monetary system where the supply (amount) of a country’s currency (and consequently its value) is based on a fixed quantity of gold held by the country. In other words, the supply of a nation’s currency is determined by the gold held by a country, and the value of the currency in terms of gold is fixed. Both were objectives of the gold standard – tying the money stock to gold, and keeping a fixed, stable exchange rate for the currency into gold. Since the gold standard limits the supply of a country’s currency, the argument is that inflation will not be caused by a central bank’s discretionary printing of money.
The gold standard removes a central bank’s authority (like the U.S. Federal Reserve) for discretionary changes in the country’s money supply. Interest rates are not targeted through changes in the money supply; rather, the supply of money is exclusively a function of the amount of gold held by the government. Because interest rates are not targeted, they will generally be less volatile under the gold standard. A key feature of the gold standard is that a nation guaranteed the free exchange of gold and paper money at a set price. The gold standard provided a fixed rate for a country’s currency relative to gold and a fixed value relative to the currencies of other countries. It removed uncertainty regarding international transactions, providing the fixed rate reflected the financial market value of the currency. Governments had to buy and sell gold to ensure that currency value remained fixed relative to gold. Money stock was rigidly tied to gold; the money supply increased and decreased automatically in conformity with movements of gold holdings.
For example, if a nation imported more than it exported, then a deficit in its international payments would occur and an outflow of gold would be required to keep the exchange rate stabilized. An excess supply of the country’s currency would appear on foreign-exchange markets due to the negative balance of trade. The country would have to buy up the excess supply of its own currency by selling gold (exchanging gold for its currency) to keep its promise of a fixed rate and have the fixed rate reflect the market value. Otherwise, the excess currency supply would create a market value that is less than the fixed rate value. The currency would be overvalued based on its fixed rate, and the demand for the currency would decrease. The excess supply would create an overvalued currency.
While the U.S. remained on the gold standard following World War I, several countries were no longer willing to buy and sell gold at fixed prices and consequently abandoned the gold standard. War can cause inflation, and countries desired more control over monetary policy which in turn would impact interest rates, inflation, and economic growth. The gold standard severely limited a country’s ability to respond to the war-caused inflation. The post-war inflation resulted from supply shortages and changes in demand resulting from the war effort; not from the printing of money. While the gold standard may alleviate inflation simply caused by the printing of money since the money stock is limited by the gold held by a country, the gold standard can severely limit a country’s ability to respond to inflation caused by changes in demand and supply.
A system with more liquidity and greater flexibility was needed as trade increased. The gold exchange standard evolved, with the British pound and U.S. dollar as key currencies. Rather than holding gold as international reserves, nations using the gold exchange standard could use prominent currencies (pound and dollar) rather than gold to stabilize currency exchange rates. This provided more control over monetary policy and the ability to fight inflation, as gold holdings did not strictly control money supply. In addition, it also alleviated the problem of storing of gold and simplified international transactions between countries. However, the gold exchange standard would only be effective if the value of the underlying currencies (pound and dollar) remained stable.
The Federal Reserve and the Gold Standard
The Federal Reserve System is the central bank of the United States and was created by an act of Congress that was signed into law by President Woodrow Wilson on December 23, 1913. The Federal Reserve System consists of a Board of Governors and 12 regional Federal Reserve banks located in major cities throughout the nation. The Board of Governors is a central, independent governmental agency, and led by the Chairman of the Federal Reserve. The chairman serves a four-year term after being nominated by the President and confirmed by the Senate. A chairman may serve multiple terms, each requiring a nomination by the President and confirmation by the Senate. The current chair, Jerome Powell, began serving his first term in 2018 after being nominated by President Trump and confirmed by the Senate. He received a subsequent term after being nominated by President Biden and confirmed by the Senate in 2022. The Chairman and the Board of Governors strive to serve as an independent body when implementing monetary policy for the United States. The Federal Reserve is responsible for monetary policy, oversees the financial stability of the banking system, supervises and regulates banking institutions, and provides financial services to depository institutions, the U.S. government, and foreign official institutions.
Originally, the Federal Reserve’s primary mission was to enhance the stability of the American banking system. In the 19th century, the country’s currency consisted primarily of notes issued by national banks, with the volume of notes that a national bank could issue tied to the amount of U.S. government bonds the bank held. That created an “inelastic” currency, as the supply of notes was unresponsive to changes in demand for currency. That led to bank runs, and even bank failures, as bank customers worried about the safety and ability to withdraw funds.
A primary goal when creating the Federal Reserve System in 1913 was to have a new, “elastic” currency. The liquidity of the U.S. financial system was increased through the creation of the Federal Reserve in two ways. First, banks could borrow in times of need from the Federal Reserve to meet customer demands for cash. Second, the Federal Reserve note (the dollar) was created, and the amount of currency supplied could be varied to adjust for changes in demand, with limitations. The creation of the Federal Reserve had little, if any, effect on the gold standard. The gold standard was implicitly built into the framework of the Federal Reserve, as the law required the Federal Reserve to hold gold equal to 40 percent of the value of the currency issued. In other words, the amount of currency in circulation, and consequently its value, was tied to the amount of gold held by the Federal Reserve.
The gold standard ended for the United States in 1933. Although the Federal Reserve increased the liquidity of the banking system, the liquidity was still limited by the gold standard. A series of bank runs and large bank failures occurred over the period 1930 – 1933, as the Federal Reserve failed to provide sufficient liquidity. The gold standard constrained the Federal Reserve’s ability to create money and provide banks with cash to meet customer demands. Simply creating more money without increasing gold holdings would have created doubts on the country’s ability to remain on the gold standard, as the country’s currency would be overvalued based on the established fixed rate. In addition, creating more money would lower interest rates, which would increase the export of gold as investors looked abroad for higher returns. Gold would have to be used to buy the excess supply of U.S. currency that would appear on financial markets as lower interest rates made U.S. investments relatively less attractive. The Federal Reserve needed a policy of monetary expansion to keep the economy from collapsing in the early 1930s. The gold standard, however, prevented implementation of an appropriate monetary policy which would have provided an economic recovery from the Great Depression, and failed to provide needed liquidity for the financial system.
President Franklin Roosevelt effectively ended the gold standard in 1933, eliminating American convertibility of currency into gold. The dollar’s value relative to gold was devalued approximately 40%, which was important for international transactions. From 1934–1973, the United States remained on a partial gold standard, but only for international transactions. After World War II, the Bretton Woods Agreement put the dollar as the dominant currency in the international financial system for most major industrialized economies. Most countries pegged the value of their currency to the dollar and the value of the dollar was defined in terms of gold. The Treasury was still committed to buying and selling gold at a fixed price internationally. However, gold transactions were limited only to official settlements with the central banks of other countries.
The partial gold standard and fixed rate era ended for the dollar in 1973. Although the dollar was still defined at a fixed rate in terms of gold for international transactions, the dollar became overvalued in the 1960s as large payment deficits increased the foreign holdings of U.S. dollars. The value of foreign holdings of the U.S. dollar in terms of gold was greater than the value of United States gold reserves. President Nixon took the U.S. completely off the gold standard, and the dollar was no longer convertible into gold by foreign countries. The value of the dollar was no longer tied to gold. The value of the dollar relative to a foreign currency was determined by the demand and supply of the dollar relative to the demand and supply of a given foreign currency. The value of the dollar varied as the demand and supply of the dollar changed relative to the demand and supply of the foreign currency. The dollar “floated” (fluctuated) in value as did most major foreign currencies, reflecting changes in market value. The floating system mitigated the difficulty by any country in trying to establish and maintain a fixed value for its currency. Currently, most major countries float the value of their currency. No country follows the gold standard.
Monetary Policy
The Federal Reserve controls the three tools of monetary policy: 1) open market operations – the buying and selling of financial securities to change interest rates, 2) the discount rate – the rate at which financial institutions can borrow from the Federal Reserve, and 3) reserve requirements – which are the amount of cash that financial institutions must hold to cover possible withdrawals. The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements. A separate committee, the Federal Open Market Committee, is responsible for open market operations and meets periodically to discuss changes in interest rates.
Since its founding in 1913, the role of the Federal Reserve has been modified. The Federal Reserve Reform Act of 1977 requires the Fed to direct its policies toward the dual mandate of achieving maximum employment and price stability and report regularly to Congress.
The Federal Reserve has the dual mandate of achieving maximum employment with low and stable inflation through its monetary policy. To achieve these goals, the Federal Reserve acts in an independent manner to balance economic growth with inflation. The Federal Reserve tries to accomplish this goal through targeting the “fed funds rate” – a very short-term interest rate that when changed, typically has a rippling effect through the financial markets. The Federal Reserve influences this rate by primarily controlling the money supply in the United States. The amount of money circulating in the economy has an impact on interest rates and credit conditions – more money, lower interest rates; less money, higher interest rates. The federal funds rate is increased when the Federal Reserve decreases the money supply by selling Treasury securities (technically called Open Market Operations). The federal funds rate is decreased when the Federal Reserve increases the money supply by buying Treasury securities.
The Project 2025 Proposals
- Returning the United States to The Gold Standard
Historically, the gold standard did not work well in the United States and it wouldn’t work now. The driving force of the gold standard is tying the money supply to the country’s gold stock. Discretionary monetary policy is removed from the central bank (the Federal Reserve) and the money supply is determined solely by the amount of gold held by the government. Proponents of the gold standard, including Project 2025, argue that the gold standard reduces inflationary risk by limiting the printing of money, limits a central bank’s ability to bail-out financially distressed institutions and hence reduce risk-taking, eliminates any political motivation to follow a certain discretionary monetary policy, and lessens economic cyclicality due to a varied money supply.
History has shown that the gold standard was highly ineffective in dealing with inflation and economic downturns. The gold standard did not prevent nor help the country recover from the Great Depression. The appropriate solution to any problem depends on what caused the problem. Although the gold standard can limit the printing of money which could cause inflation, the printing of money is not always the reason that inflation occurs. Inflationary pressures caused by World War I resulted from supply shortages and the ramp-up in demand for certain products and resources caused by the war effort. Simply having a fixed money supply tied to gold didn’t solve the problems; consequently, countries bailed from the gold standard to gain more control over monetary policy and inflationary pressures. In addition, inflation could lessen the market value of a currency, unless gold was used to buy currency which in turn would stabilize its value. That would lessen a country’s supply of gold and place tighter restrictions on the money supply, which in turn could have further damaging economic effects.
The recent spike in global inflation began in 2021. Inflation was global, primarily caused by global factors, not simply the printing of money or government spending by any single country. Near record or record levels of inflation were recorded for the United States, the Euro Area, Canada, Australia, and the United Kingdom in 2022. Annual inflation rates varied between approximately 7% and 9%. Global inflation increased in 2021 as supply chain problems appeared and global oil prices began rising due to the economic recovery. Those factors peaked in 2022, with price spikes in global energy and food prices linked to Putin’s invasion of Ukraine and lingering supply chain issues which contributed significantly to inflation. The mitigation of global factors that contributed to inflation are reflected by the significant decline in inflation that has generally occurred around the world since 2022.
Another factor that contributed to price increases for U.S. consumers – record corporate profits and profit margins. A measure of U.S. corporate profit margins tracked by the Federal Reserve was recently at levels not seen since the early1950s, indicating that the increased prices charged by businesses exceeded their increased costs for production and labor. After-tax profits as a share of gross value added for non-financial corporations, a measure of aggregate profit margins, exceeded 15% in both 2021 and 2022, the highest level since the early 1950s. In the fourth quarter of 2023, corporate profits were approximately double what they were in the fourth quarter of 2019.
The gold standard would not have prevented the recent post-COVID inflation. Rather, the lack of a gold standard helped countries deal with the effects of inflation. In 2022 the focus of the Federal Reserve, and central banks around the world, shifted to increasing interest rates to fight inflation. The Federal Reserve, the European Central Bank, the Canadian central bank, the Bank of England, and Australian central bank all significantly increased interest rates since 2022. The objective of the rate increases was to lower consumer and business spending, which in turn would lower inflation through reduced demand for goods and services even though global factors were the primary drivers of inflation. The gold standard could have exacerbated the inflationary problem by preventing any central bank actions.
The gold standard ties the country’s money stock to gold. The money supply is increased and decreased automatically in conformity with movements of gold holdings to maintain a fixed rate. A return to the gold standard potentially creates another problem for the United States. If a nation imports more than it exports, then a deficit in its international payments would occur and an outflow of gold would be required to keep the exchange rate stabilized. The United States has generally had a consistently growing balance of trade deficit since the early 1980s. In June 2024, the balance of trade (goods and services) deficit was $73.1 billion. That would create an outflow of gold, unless that deficit is offset by payments back to the United States. That potentially creates another problem. In May 2024, foreign holders owned $8.1 trillion of U.S. government securities. The top two holders of U.S. securities: 1) Japan ($1.1 trillion), and 2) China ($768 billion). A drop in foreign holdings of U.S. securities, or a desire to own gold rather than U.S. securities, would potentially require an outflow of gold to maintain the fixed rate stability of the dollar. Any attempt to reduce the trade balance through a blanket implementation of tariffs would simply increase U.S. inflation, as U.S. corporations would pass on additional costs to consumers through price increases.
If the U.S. goes back on the gold standard, it will likely go it alone. The lack of monetary policy flexibility in dealing with economic downturns would be a significant detriment for any country returning to the gold standard. The lack of a gold standard has increased the ability of countries to deal with economic downturns and unemployment. No country currently follows the gold standard.
- Elimination of the Federal Reserve’s dual mandate of maximum employment and price stability replaced with a focus solely on price stability.
A focus on employment would seem to be an extremely important part of both fiscal and monetary policy since policies should be implemented for the benefit of the American public, including helping their employment. After ending the year at 3.6% in 2019, the unemployment rate shot to a record high of 14.8% in April 2020. A combination of monetary and fiscal policy was used to combat the effects of COVID on the economy. The fed funds rate ended 2019 at a target range of 1.50-1.75%. In 2020, the Federal Reserve lowered the target rate to the historical low of 0.00-0.25%. The objective was to minimize borrowing costs for consumers and businesses in an effort to counteract the effects of the economic downturn caused by COVID. Fiscal policy (bipartisan) included the $2 trillion CARES Act that was passed in March 2020.
The April 2020 unemployment rate of 14.8% surpassed the previous record high of 10.8% in 1982. The economic recovery began in May, and the unemployment rate declined to 6.7% in November. Despite the CARES Act, the economic recovery stalled in December 2020. After consecutive monthly job gains that began in May, job losses returned in December and the unemployment rate remained steady at 6.7%. Exactly how much fiscal policy is needed for a recovery from an economic downturn is difficult, if not impossible, to determine. Additional fiscal policy (including the American Rescue Plan) was needed and used to kick-start the recovery in 2021. Fiscal and monetary policy combined to lower the unemployment rate to 3.9% by December 2021.
Project 2025 argues fiscal policy (government spending) is more effective than monetary policy in dealing with economic downturns. However, fiscal policy in combination with monetary policy is even more effective. The problem with just using fiscal policy is its lack of precision. In addition, any fiscal policy can be extremely controversial and politically difficult to implement. Monetary policy can be used to help ease the financing burdens of consumers and businesses through reduced interest rates to help bolster an economic recovery in combination with appropriate fiscal policy.
Unemployment was also a significant problem during the financial crisis that began to unfold in late 2007. By 2009, the United States had arguably the worst economic landscape since the Great Depression. A tanking stock market, falling housing prices, increasing unemployment, and an economic recession. The unemployment rate had bottomed out at 4.4% in May 2007 before climbing to 10.0% in October 2009. The root cause of the crisis – the housing market. Collectively, a collage of factors contributed to the housing market problems. Those factors included: 1) early 1980s legislation that allowed adjustable-rate mortgages, 2) the innovation of mortgage-backed securities, which potentially allowed the transfer of risk from lenders to investors, 3) lack of financial market oversight which allowed easy credit by financial institutions, and 4) inappropriate credit ratings for mortgage-backed securities by bond rating agencies.
The United States began 2009 with a two-fold problem: 1) a credit crisis in the financial markets, as funds available for short-term loans by financial institutions to businesses and consumers dried up, and 2) a lack of consumer and investment demand due to the economic downturn and increasing unemployment. The cure for the ailing economy would be dependent on solving both of these problems. Through a combination of monetary and fiscal policies, those problems were solved. The Federal Reserve embarked on an aggressive program of purchasing Treasury securities (quantitative easing) which lowered the fed funds rate to a then historical low of 0.00-0.25% in December 2008. The 2007 fed funds rate had peaked at 4.75% in September. In addition, the Federal Reserve increased the short-term liquidity of banks and other financial institutions through providing greater access to short-term credit. The available flexibility of monetary policy enabled the Federal Reserve to aggressively combat the negative effects of the economic downturn, that included a spike in the unemployment rate to 10.0%.
The United States economy typically chugs along at a pretty good pace unless there is a bump or shock to derail its progress. The key is to get the economy moving forward – precipitating a snowballing effect, where economic growth continues until something happens to stop it. When economic growth occurs, increased employment leads to more consumer spending, which leads to more economic growth. Consumer spending is generally the primary driver of U.S. economic growth, as it comprises approximately two-thirds of Gross Domestic Product (GDP). GDP is the benchmark for economic growth and measures the value of goods and services produced in a given period. Likewise, a snowballing effect can occur in the opposite direction. If consumer spending declines, then an economic contraction continues until something happens to reverse it. If something happens to derail consumer spending, that’s where fiscal policy (spending by the U.S. government) and monetary policy (the Federal Reserve reducing interest rates) can be used to put consumer spending back on track. The financial crisis resulted in an economic recession that began in January 2008 but ended by June 2009. The combination of fiscal and monetary policy contributed to the longest period of U.S. economic growth that began in July 2009 before ending with COVID in February 2020.
- Reduce and limit Federal Reserve purchases of financial assets, including federal debt and mortgage-backed securities.
Project 2025 argues that policy expansions of the Federal Reserve, such as the broad purchase of financial assets, have created significant risks associated with “too big to fail” financial institutions and facilitated government debt creation.
The risks of “too big to fail” financial institutions were created by industry concentration and lack of government oversight, not the Federal Reserve.
According to the Federal Reserve, the five largest banks in the United States currently account for nearly 50% of total bank assets. Bailouts of “too big to fail” institutions, both financial and nonfinancial, occur because of the fear of what would happen to the U.S. economy if these institutions failed. In response to the financial and economic crisis, the $700 billion Toxic Asset Relief Program (TARP) was implemented in late 2008. TARP was a joint effort of Congress, the President, the Treasury, and the Federal Reserve to bolster the financial stability of the U.S. economy and ailing institutions. The objective of TARP was for the government, through the Treasury and Federal Reserve, to buy troubled financial assets, including mortgages and mortgage-backed securities, from financial institutions. In essence, the government was providing funds to financial institutions to increase liquidity and financial stability, in exchange for financial assets that had little, if any, value. Companies such as Bank of America, J.P. Morgan Chase, Citigroup, Wells Fargo, and Goldman Sacks received funds. The automotive industry, primarily General Motors and Chrysler, was also bailed out.
If financial institutions failed, it could have a devastating effect on the U.S. in multiple ways. Short-term funds for business inventories and consumers would not be available. The housing market would suffer from a lack of available financing, and long-term business investment declines as financing disappears. The failure of financial institutions would create a vacuum that would suck funds out of financial markets, with no infrastructure readily in place to replace the dried-up financing. The fear of bank failures would lead to depositors withdrawing funds, leading to a further drop in available funds within the industry. Banks also issue certificates of deposit, a type of debt, as a source of financing. Certificates of deposit can be held by money market mutual funds, which are generally viewed as a safe investment. In 2008, the Treasury took the extraordinary step of temporarily guaranteeing the value of money market funds, in response to concerns that their value would fall over concerns about the ability of banks to pay debt such as certificates of deposit. The reality is that without the bailouts, a bad situation would be made worse.
The Federal Reserve purchase of U.S. federal debt increased significantly during the financial crisis and economic downturn caused by COVID. Massive fiscal policy spending was used in each case to bolster the U.S. economy out of recession and prevent depression. The Federal Reserve purchases of debt were used to keep interest rates at historically low levels to bolster an economic recovery. The Federal Reserve was responding to the implemented fiscal policy. Although the Federal Reserve can counteract the interest rate effects of fiscal policy required borrowing, government debt creation generally results from fiscal policies – not the Federal Reserve.
Another fiscal policy that resulted in significantly increased government borrowing was the 2018 tax cuts. The budget deficit usually decreases during periods of economic growth. That, however, changed with the tax cuts of 2018, which contributed to increasing budget deficits during a period of economic growth that began in 2010 and ended with the onset of COVID. Between 2015 and 2019, the budget deficit doubled to over $900 billion.
Project 2025 argues that housing costs have been driven to recent historic highs by the purchase of mortgage securities by the Federal Reserve, which reduces mortgage rates. The main culprit in causing housing prices to increase significantly, however, is the lack of inventory. Housing supply (listings) declined significantly in early 2020, and rising interest rates have contributed to monthly listings being approximately 30-50% lower than pre-COVID levels. Housing prices began to rise quickly in early 2020 as housing supply declined significantly. Despite rising interest rates that began in 2022 which led to higher financing costs, a continued supply strain propelled home prices to record highs in 2024.
Project 2025 also argues that the Federal Reserve’s purchase of Treasury securities allows the government to issue debt while starving business borrowing in the financial markets. That hasn’t happened either. According to the Federal Reserve, nonfinancial corporate debt rose to record levels in 2024, hitting nearly $14 trillion. Corporate debt has more than doubled over the last decade, so access for corporations to the debt markets does not seem to be a problem.
- Limiting the Federal Reserve’s lender-of-last-resort function, which offers loans to banks near collapse.
In the United States, the Federal Reserve can serve as the lender of last resort to financial institutions that have no other means of borrowing and whose failure would have a significant, detrimental, effect on the economy. Having an available lender of last resort can potentially increase the risk taking of financial institutions. However, other means of regulation, or lack thereof, can also affect the risk taking of financial institutions.
Executive and Congressional policies can affect financial institution risk. Contributing to the growth of larger banks was the repeal of the Glass-Steagall Act in 1999, which had prevented commercial banks from engaging in riskier investment banking activities. Most large banks, such as Bank of America, J.P. Morgan Chase, Citigroup, and Wells Fargo, now offer investment banking services.
As a result of the financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed by Congress in 2010 to increase government oversight and strengthen the financial system and prevent the causes of the financial crisis from ever happening again. Included in Dodd-Frank was increased monitoring of the financial stability of major financial firms, the creation of the Consumer Financial Protection Bureau which aimed to curb predatory mortgage lending practices and increase consumer understanding of mortgage provisions, a limitation on the risk of bank investments and speculative trading, and measures to improve the reliability of credit ratings by credit agencies.
However, in 2018, Congress passed the Economic Growth, Regulatory Relief, and Consumer Protection Act, which rolled back significant portions of the Dodd-Frank Act. In particular, the new law eased the regulations for small and regional banks (such as the recently failed Silicon Valley Bank) by increasing the asset threshold for the application of certain standards, stress test requirements, and mandatory risk committees.
A lender of last resort can increase risk taking by financial institutions. However, regulation, or lack of it, can have a greater impact on the risk taking by financial institutions.
- Exploring alternatives to the Federal Reserve System.
Included in the Project 2025 policy proposal alternatives is the elimination of the Federal Reserve and the implementation of “free banking”. The government does not control the money supply or interest rates; rather, banks issue liabilities (like checking accounts) denominated in dollars and backed by a commodity such as gold. The commodities backing currency could also be other financial assets, such as real estate or equities, but exactly how those commodities would be valued for currency creation is not specified. Transforming to free banking would transfer control of monetary policy from the Federal Reserve to the President and Congress, which would oversee implementation of the system. In contrast to a nationwide, uniform approach to economic policy, “free banking” creates a disjointed and increased politicalization approach to monetary policy. “Free banking” could revert the U.S. to an “inelastic” currency, as the money supply is unresponsive to changes in demand and determined by an underlying commodity.
The Federal Reserve is always subject to scrutiny and criticism, and certainly has not been perfect in the timing and implementation of monetary policy. However, the system has created an important policy mechanism which has been effectively used to deal with economic downturns, including increasing employment, lowering inflation, and stimulating economic growth. A major difficulty is responding to crises (such as the financial crisis and COVID) is that the Federal Reserve had to respond to problems that it did not cause. The Federal Reserve faces a balancing act of reacting to problems with being proactive to prevent future problems.
Project 2025 argues that expanded Federal Reserve discretionary powers with respect to monetary and regulatory policy have created operational ineffectiveness and the potential for policy decisions based on political pressure. However, any transfer of authority and regulatory power from the Federal Reserve to the President and Congress would decrease the political independence of monetary policy. The Federal Reserve system relies on the input of the Board of Governors, the Federal Open Market Committee, and the Fed Chairman to collectively attempt to determine the best course of action for monetary policy. This collective input strives to ensure that the Federal Reserve is acting in a nonpartisan manner to implement policies that are in the best interests of the United States. The United States currently has the largest and strongest economy in the world – the Federal Reserve has been a significant contributor to that accomplishment.
For further information:
- The Project 2025 playbook (p. 731 for Federal Reserve)
- From the BBC:
- From NBC News:
- From Barron’s:
- From Forbes:
- From Benzinga:
- From the Federal Reserve:
- Federal Reserve History
- What is the Purpose of the Federal Reserve System?
- Monetary Policy: What are its Goals and How Does it Work?
- The Gold Standard and Price Inflation
- The Federal Open Market Committee
- Bank Asset Concentration
- Corporate Debt
- Federal Reserve Policy Actions During the Financial Crisis
- From Federal Reserve History
- From the Congressional Research Service
- From Investopedia:
- From the U.S. Treasury:
- From the Bureau of Economic Analysis:
Kevin Bahr is a professor emeritus of finance and chief analyst of the Center for Business and Economic Insight in the Sentry School of Business and Economics at the University of Wisconsin-Stevens Point.