The Federal Reserve (“the Fed”), is often called on to combat recessions. But this is not always easy to do. Typically, there is a lag—often of many months—between when the Fed makes a decision and when the effects of that decision on the economy are known. In the meantime, economic conditions have changed so you should think of the Fed as shooting at a moving target. No one can foresee the future perfectly and so the Fed’s decisions are not always the right ones.

As mentioned, too much money in the economy means that inflation will result. But not enough money in the economy is bad as well and can lead to a recession or a slowing of economic growth. These ideas are an important and extensive topic in macroeconomics, but the key problem is that a low or falling money supply forces people to cut their prices and wages and this adjustment doesn’t always go smoothly.

10

The Fed is always trying to get it “just right,” but some of the time it fails. Sometimes the failure is a mistake the Fed could have avoided, but other times it simply isn’t possible to always make the right guess about where the world is headed. Thus, in some situations the Fed must accept a certain amount of either inflation or unemployment. Central banking relies on economic tools, but in the final analysis it is as much an art as a science.

Most economists think that the Fed does more good than harm. But if you are going to understand the Fed, you have to think of it as a highly fallible institution that faces a very difficult job.