Short Answer: Not really. The true role of the Fed is to orchestrate and backstop the banking system. By encouraging lending, money supply rises, and economic activity follows. Unfortunately, so does inflation. Therefore, inflation – or as the Fed calls it, stable prices – is part of the deal. Control over short-term interest rates is more of a side show and arguably does more harm than good.
Full Answer: The question of whether or not the Federal Reserve actually has the ability to steer the economy and influence the wellbeing of the average American has been a debate ever since its formation in 1913. On one side of the debate stage, you have the argument that without the Federal Reserve acting to promote maximum employment and stable prices, along with the original objective of banking oversight, the economy would suffer periodic recessions as a result of undulating boom and bust cycles. On the other side of the stage, you have those making the point that despite the efforts of the Fed, we’ve consistently seen boom/bust cycles, high inflation, bouts of high unemployment, and to boot, extreme gaps in socioeconomic status – all despite the Fed’s dual mandate to help avoid these things. Seems like a fairly easy debate to settle, doesn’t it?
A couple observations worthy of pointing out when it comes to assessing the levels of efficacy and altruism with respect to Fed actions are:
1) Narrative versus reality of interest rate moves – The narrative and heuristic around the Fed’s most popular and visible tool of interest rate setting is that raising the overnight lending rate will slow economic activity and thus, inflation, while lowering it will stimulate growth and inflation. The reality however is that higher interest rates are more consistent with both growth and inflation, and lower rates more aligned with economic sluggishness and disinflation, if not deflation. When one thinks this through, it’s actually fairly intuitive. Growth and inflation come first via separate but often overlapping cycles, thus pushing up interest rates as those cycles mature. Risks increase toward the end of cycles as the easy and safe loans have already been made – lenders start demanding more return from the more heavily indebted and less creditworthy in exchange for their capital. Rising inflation as a result of increasing money supply via the expansion of bank lending also pushes interest rates up. So, the business and inflation cycles drive rates, not the other way around.
If anything, one could make the argument that raising rates to artificially high levels can actually create more future inflation by discouraging capital investment in goods. Less investment, less supply, higher prices. The same would be true in reverse. Artificially low rates today could lead to overinvestment and cheap prices down the road. The consequence however is that overinvestment via debt can also lead to bankruptcy of the very companies we depend on for goods, so lower prices 3 to 5 years from now could lead to dramatically higher prices 5 to 10 years from now. The unnatural suppression of borrowing rates at the wrong point in the business cycle encourages debt-financing when it makes the least sense to do so, and when these businesses fail, they can no longer contribute goods to the supply pool; the end result is higher prices for those things still in demand. We are in the midst of this situation right now. The artificially low interest rates post-financial crisis left so many firms overindebted and gun-shy for such a long period of time, we are currently facing one of the largest capital underinvestment stories in natural resources that we’ve seen in modern times.
2) Bailouts – We’ve had an opportunity to witness a lot of irresponsible activity in the banking sector over the last few decades, and what’s been a common theme is that the largest banking institutions get recapitalized and bailed out while the smaller ones get rolled up into the larger ones. Additionally, very few consequences find the executives at these larger institutions for this irresponsible behavior. This strongly aligns with the original intent of the Federal Reserve – to be lender of last resort when (big) banks get into trouble and to make sure the close calls of the 1907 financial panic never again present an existential risk to the public (or bankers). I’m being somewhat cheeky, but the factual point here is that every time a bank is bailed out by the Federal Reserve regardless of the merits of that rescue, the bill goes to the taxpayer in the form of inflation. Why inflation? Because every bailout essentially involves new printed money without any corresponding losses or destruction of money that would have otherwise accompanied a banking failure. Every bailout leads to more money in the system which leads to more inflation, and as we’ve all come to learn very well in recent years, inflation is a tax that disproportionately affects those without millions and billions in net worth.
And why must the banks be bailed out or rolled up rather than allowed to fail? The easiest explanation is because our economy and financial system is based on debt for growth. A common misconception is that the Federal Reserve prints money to inject into the system, but this isn’t entirely true. They infuse reserve assets into the banking system, but it’s the banks that actually leverage those reserves to print money into creation via loans and credit. With a 10% reserve requirement (prior to March 2020) in place, banks can lend 90% of customer deposits, which in turn, creates an equal amount of new deposits within the banking system. So, an initial $1 million in deposits allowed for $900,000 of new loans, which simultaneously created $900,000 of additional deposits. Of course, this can be repeated multiple times as newly printed deposits create new lending opportunities, and as long as each bank keeps 10% of their customer deposits in cash or Treasury assets, they are considered compliant. That 10% rule however was pre-2020. The current reserve requirement is now 0% with the new regulatory framework for keeping banks compliant being a much more nebulous capital ratio that looks at bank equity relative to the quality of its loans/assets. So long as the balance sheet and its many components looks up to snuff, the bank is free to lend away.
The easiest way to think about this is by imagining that debtors in unison discovered fiscal religion and all the outstanding loans were suddenly paid off – the money supply would rapidly approach zero. This is because in a fiat system where the money isn’t backed by anything other than the “legal tender” status imparted on it by the government, there is truly nothing behind it other than faith. It is lent into existence, and therefore if paid off, will be retired out of existence. Now, it’s impossible for that many loans to be paid off simultaneously of course, but widespread bank failures would have a similar effect on the money supply. Thus, the need to keep the charade going with bailouts, and to never allow inflation (money supply) to drop to contagion-catalyzing levels. Yes, in this respect, the banks are too big to fail. A more accurate way to put it however is that the system created by the Federal Reserve’s actions over a century has become too big to fail.
So, in the end, the raising and lowering of overnight lending rates are more of a side show than a main event. If anything, these actions are more likely to disrupt the normal ebb and flow of natural cycles than to compliment them. The biggest role of the Fed is by far its ability to steer as well as backstop the banking system via money creation and bailout. This comes at the extraordinary long-term cost of price and asset inflation, which we are suffering the very real effects of now. It’s odd that more people don’t recoil after hearing the Fed utter the words “price stability”, when their stated objective is to actually keep inflation at 2% and their primary role is to facilitate never-ending money creation (otherwise known as…inflation). One wouldn’t be blamed for wondering who it is the Fed actually serves.
Editor’s Note: This article was originally published in the October 2026 edition of our Cadence Clips newsletter.
Important Disclosures
This blog is provided for informational purposes and is not to be considered investment advice or a solicitation to buy or sell securities. Cadence Wealth Management, LLC, a registered investment advisor, may only provide advice after entering into an advisory agreement and obtaining all relevant information from a client. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
Past performance is not indicative of future results. It is not possible to invest directly in an index. Index performance does not reflect charges and expenses and is not based on actual advisory client assets. Index performance does include the reinvestment of dividends and other distributions
The views expressed in the referenced materials are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
