The Fed Has Decided to Do Nothing -- and That's Good News

The U.S. Federal Reserve has just ended its two-day meeting and has decided to do -- wait for it -- nothing. And that's a good thing, because it's a sign that the powers-that-be think the economy is on the right track.

Here's a quick primer on the Fed, why you never want a central bank to have to do anything, and the reason why we all hang on Ben Bernanke's every word.

A Lender of Last Resort

The U.S Federal Reserve is America's central bank. The primary job of a central bank is to be a "lender of last resort." That is, if a country's commercial banks are experiencing some kind of crisis, the central bank steps in and injects "liquidity" into the system, thereby keeping the banks financially afloat, or "solvent." Liquidity is a fancy term for money. Central banks, by design, have the power to literally print money.

The other job of a central bank is to manage and tweak an economy when it's not in outright crisis. Central banks do this via various macroeconomic tools. The Fed primarily uses interest-rate manipulations:

  • If the economy is weak, it lowers interest rates -- theoretically spurring lending, spending and economic growth.

  • If the Fed thinks the economy is growing too fast and there's danger of a "bubble," i.e., too much lending and spending, it will raise interest rates to slow the economy down.

All developed countries with capitalist economies have central banks, with varying powers, to gently massage a country's economy through normal times and radically intervene in times of emergency.

Inaction Can Be the Best Course of Action

The U.S. Federal Reserve is actually a system of banks spread out across the country that meets eight times a year to assess how the U.S. economy is performing and determine what, if any, action needs to be taken.

The most recent meeting ended Thursday, with the Fed saying there would be no changes to its policy right now.

What the Fed is really saying is this: In its eyes, the economy is generally on track for a recovery, and there's nothing it should do right now to interfere. (If it ain't broke, the saying goes, don't fix it.)

Whether the economy really is on track for a recovery may be a matter for debate. And it could be argued that there's really not much the Fed can do right now. That is, we're currently in one of the weakest economies since the Great Depression, which argues for the lowering of interest rates, but interest rates are essentially at zero already. That's why you can get a 30-year home loan for less than 4% right now. So if interest rates can't get any lower, what could the Fed do, even if it wanted to?

Crank Up the Money Presses

As mentioned earlier, one of a central bank's jobs is to inject liquidity into a faltering economy. More money in the hands of the people means, theoretically, more spending, and therefore economic stimulation.

The Fed has already been through two rounds of this, which it calls "quantitative easing." Quantitative easing is when the Fed purchases securities, like U.S. Treasury bills, and thereby floods the economy with money indirectly, expecting it to make its way out into the hands of people and businesses via increased lending.

The Fed could do another round of quantitative easing, and the idea was batted about for a while. One of the dangers of too much quantitative easing, however, is inflation. Right now inflation is very low, and everyone wants it to stay that way.
With definite signs of economic improvement -- like a lowering of the unemployment rate and better-than-expected growth in the GDP -- the Fed decided not to do any more.

When Ben Speaks, People Listen

Ben Bernanke has been chairman of the Fed since 2006, when he was appointed by President Bush to replace the long-serving Alan Greenspan. When Bernanke speaks, people listen, and you can see why.

As America's central bank, with all of the financial and economic power that title implies, the Fed has great sway over all our lives -- whether we're average citizens, CEOs of Wall Street banks, or senators and presidents.

So the next time you hear Ben Bernanke say, "Following two days of intense discussions, we've decided to do nothing," take it as a good sign.