Understanding Economic Equilibrium

CHAPTER 31

The Fed’s Job: A Stable Economy

The primary directive and overall responsibility of most central banks is to maintain economic stability. It was instability that led to the Federal Reserve Act and the establishment of the U.S. Federal Reserve System in 1913. In response to bank runs and depositor panics, the Fed was created as a lender of last resort to banks when their mix of short-term liabilities and long-term assets had them temporarily illiquid.

Today’s Fed has a dual mandate. It is charged by Congress with preserving price level stability but also maintaining maximum employment. The two goals often go hand-in-hand, although they can be in conflict, as was the case from the late 1960s through the early 1980s when both inflation ...