Global Interdependence and Central Banking

International considerations are key to the story of the Federal Reserve. For example, the Fed was founded to resolve imperfections in the U.S. banking system that caused domestic money demand shocks to be transmitted throughout international financial markets. Creating a central bank also was integral to promoting the United States’ growing role in the world economy. In the 1920s, policymakers struggled to balance gold standard precepts with the need to lower interest rates to stem the fall in the money supply. This led to misdirected Fed policy, which contributed to the length and depth of the Great Depression. The Great Inflation from the late 1960s through the early 1980s was another critical period of Fed history shaped by international concerns, particularly political pressure to defend the exchange value of the dollar, which limited policy actions that could have prevented the rise in inflation. Most recently, the Fed’s first special lending program in response to the financial crisis was dominated by foreign financial institutions. In addition, foreign investors disproportionately held the mortgage-backed securities that were at the heart of the crisis.