Definition: The Federal Reserve, or “Fed,” is a privately operated central bank based out of Washing DC; it is part of the Federal Reserve System, which includes twelve regional banks located throughout the U.S. and whose members are part of the Federal Open Market Committee (or “FOMC”), which is responsible for setting up and controlling U.S. monetary policy—i.e. the price (interest rate) and supply of money.
Advantages: Imagine if you had the ability to use a magic computer that legally allowed you to access your bank’s mainframe and gave you permission to add three or four zeros to your checking account balance any time you were in a financial pinch? Sound crazy? Well, that’s what the Fed does: create money out of thin air for the benefit of other US banks in need or the American economy when in a crisis. The Fed also controls short term interest rates, which theoretically it raises in times of inflation and lowers in times of deflation, mostly with the aim of controlling inflation—i.e. keeping prices from going too high.
Risks: Whenever you add too much water to lemonade, you dilute the flavor. The same is true when creating too much money with the Fed’s “magical computer”—i.e. if you create too much money, you dilute the value of the currency, and reduce the purchasing power of your dollar. Since 2008, the Fed has increased the money supply by 5X in order to pay for all the “stimulus” needed to get the economy back on track. Some of this “stimulus” went to bailing out the very banks that caused the crisis, the rest was basically used to buy sub-prime mortgage bonds and US Treasuries that no one else wanted, thus creating artificial demand for bonds, artificial confidence in markets, and historically unmatched asset bubbles in credit, equity and real estate markets. The other “stimulus” used by the Fed in the post-08 Twilight Zone was a “zero-interest-rate- policy” (or ZIRP) of low to zero bound interest rates. The idea was to artificially keep rates low (despite low inflation rates) in order to induce more borrowing in the US economy and stimulate growth. Instead, the low rate policy ignored Main Street (the little guys there couldn’t qualify for even low rate loans) and created a boon for Wall Street. Companies that were struggling on the public exchanges due to a lack of any demand, earnings or revenues, turned instead to borrowing money at cheap rates so they could buy back their own stock or roll-over debt year after year after year…. This is called “drinking your own KoolAide,” not a recovery.
Further Reading: For more on the Fed, see: "Four Broken Banks," "The Rain Ahead," and "The Fed and Inflation."