Virginia Test Question Failed the Fed

The picture above comes from a 2012 Standards of Learning (SOL) test for middle school children in the Commonwealth of Virginia.

Any reporter covering the Federal Reserve (such as myself) will immediately recognize the cartoon as as public relations setback for the Federal Reserve System. Fed officials have fought for decades to maintain independence from the politics of the U.S. budget process.

The Constitution gives Congress the authority to coin money. Congress delegates that authority to the Federal Reserve and has by law defined the central bank’s goals as “maximum employment, stable prices, and moderate long-term interest rates.”

There is no authority in the Federal Reserve Act for the Fed to loan to Congress, and even though answer A in this test is marked “correct,” it is in fact wrong.

The Fed can’t loan money to the government to spend on, say, a new bridge. The Fed’s purchases of government bonds are typically aimed at the goals mentioned above, although during periods of crisis it has taken actions aimed at specific markets or institutions in the name of the greater good.

What’s interesting about this cartoon, which was seen by around 33,000 children on the 2012 test, according to the Virginia Department of Education, is that it may be an accurate reflection of the public’s understanding of the central bank after the emergency actions of 2008.

Former Fed Chairman Ben Bernanke renewed congressional interest in the Fed, and possibly distorted public perceptions of its purpose, by using the Fed’s independence from the budget process to rescue financial institutions at his discretion.

In the name of saving Main Street, Bernanke bailed out Bear Stearns Cos., American International Group, dozens of foreign banks and several U.S. corporations through emergency lending programs.

Federal Reserve Bank presidents such as Charles Plosser of Philadelphia and Jeffrey Lacker of Richmond have warned that the Fed needs to be careful about the long-term consequences of engaging in actions, such as bailouts, that should be left to Congress. (Even now, in a period of recovery, the Fed is purchasing $30 billion a month in mortgage-backed securities with the specific intent of keeping financing costs low for housing markets.)

Plosser and Lacker worry the Fed could undermine its own independence by stepping too far into realms best left to the budget process. In other words, if the Fed can do fiscal policy, why wouldn’t Congress attempt to control monetary policy? Other Fed presidents haven’t expressed much concern about these issues.

Charles Pyle, director of communications for the Virginia Department of Education, says the test is retired. However, the 2012 test was recently used as a practice test for Civics and Economics in some Fairfax County public schools.

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