Federal Reserve SystemHistory of the Federal Reserve System

Presented by S. Cox

Objectives Describe the first two central banks in

the US Explore the problems caused by the

lack of a central bank Explain how the Federal Reserve

System solved the nation’s financial problems

Central Bank in the US Secretary of the Treasury, Alexander

Hamilton, advocated and developed the First Bank of the United States

A central bank is the organization that oversees a nation’s monetary system

Central Bank in the US The First Bank was chartered in 1791, was

considered a central bank and› Assumed the debts of the individual states› Made commercial loans› Held federal funds› Issued payments

Performed well but the chartered expired in 1811

Thomas Jefferson and other opponents believed it took power away from the states and put it in the hands of eastern bankers

Central Bank in the US In 1816 Congress saw the need again for a

central bank and the Second Bank was chartered…similar to but bigger than the First Bank› The bank’s existence was challenged…farmers

from the South and West opposed it› States tried to undermine the authority of the

bank which led to the Supreme court challenge to its constitutionality… McCulloch v. Maryland (1819) – Supreme court ruled

that it was within the rights of Congress to create a central bank

Central Bank in the US Once in office, President Andrew

Jackson ordered all government funds be withdrawn from the bank and in 1836 vetoed the bill that renewed the bank’s charter

1837-1863 was known as the era of free banking› All bank functions were handled by the

state banks and federal funds were held in the US Treasury

Banking Without a Central Bank

Many banks failed without constant regulation Government needed strong and reliable

banks to get financing for the Civil War National Currency Act created the Office of

the Comptroller of the Currency (OCC)in 1863 The Office of the Comptroller of the Currency

created a uniform national currency and a system of national banks

Today, the OCC still charters and supervises national banks

Banking Without a Central Bank

1864 – National Currency Act became the National Banking act which allowed the federal government to charter private banks› These new banks issued bank notes which

were intended to be used as currency and promise immediate payment by that bank that issued the note

› State banks had to pay 10% tax which persuaded them to seek a national charter

Banking Without a Central Bank

National charter had strict rules one of which required the banks to have a minimum cash reserve

Many state banks failed because they weren’t subject to the same strict rules as were national banks which led to bank panics in 1873, 1893, and 1907› A widespread worry that banks do not have enough

money to cover customer demands for withdrawals Started by a run on a single bank…bank run…

depositors arrive in great numbers at the same time to withdraw their money

Banking Without a Central Bank

After the bank panic in 1907, the idea of a central bank began to take hold

1913 – Federal Reserve System was established› President Woodrow Wilson signed the

Federal Reserve Act

Federal Reserve SystemStructure of the Federal Reserve System

Objectives Explain how the Federal Reserve

System is structured Describe how decentralization affected

the location of the Federal Reserve Banks

Identify the roles of the Federal Reserve’s Board of Governors and Federal Open Market Committee

Structure of the Federal Reserve

Also known as the Fed› Responsible for the US’s monetary system

(the mechanism a nation uses to provide and manage money for itself)

› Has a lot of power, so checks need to be put in place

› Structure is meant to safeguard against corruption

Location of the Federal Reserve

Decentralization was one of the driving forces that determined how the Fed would be organized› Decentralization – when a central authority

shares power with regional and local authorities

The Fed is composed of 12 regional central banks, known as the Federal Reserve Banks

District Reserve Banks

Organization of the Federal Reserve

Each Federal Reserve Bank governs itself and supervises the member banks in its region

Federal Reserve System

Board of Governors (BOG)7 members

14-year terms

Chairperson4-year term

Vice-Chairperson4-year term

Federal Open Market Committee (FOMC)

12 membersBOG + NY Fed President + Presidents from 4 of the

other district reserve banks

District Banks

Board of Governors Board of Governors is the governing

body of the Federal Reserve System› Independent central bank…does not report

to the US president or any other member of the executive branch, but the Fed reports to the US Congress

› Fed’s actions should be in-line with the government’s economic goals Twice a year the Fed chairperson reviews

recent actions and its economic predictions and presents these to Congress

Board of Governors BOG members are appointed by the US

president and confirmed by the Senate› Has only had 15 Fed chairs since its

creation…longest was Al Greenspan and in 2006 Ben Bernanke was appointed by President G W Bush and then reappointed four years later by President Obama

Federal Open Market Committee

Even though the Fed chair is a very visible position, the Federal Open Market Committee is responsible for making monetary policy

The BOG members are also members of the FOMC, which has 12 members

Meets eight times a year The BOG chair is also the FOMC chair The president from New York is always a member

and the other four are chosen from the other Federal Reserve Banks and those not on the FOMC still attend the meetings and participate in the discussions

Federal Reserve SystemFunction of the Federal Reserve System

Core Functions Establish the nation’s monetary policy,

which affects the monetary and credit conditions in the economy

Supervise and regulate banking institutions Provide financial services to depository

institutions, the US government, and foreign official institutions, including operating the nation’s payments system

Maintaining the stability of the financial system

Monetary Policy Monetary Policy is the regulation of a country’s money

supply to achieve economic goals and stability Fed uses tools to regulate the interest rate charged for

loans and the amount required in reserves› Open market operations…example FMOC supervises the

purchase and sale of long-term loans issued by the government to raise money

› The discount rate – the interest banks pay to borrow money from a Federal Reserve Bank…affects the interest rate banks charge customers to borrow money…set every two weeks…prime rate – interest rate that banks charge their best commercial customers

› Reserve requirements – amount of money a bank must keep and not invest or loan out if banks are instructed to have higher reserves, the interest rate

borrowers must pay drops, which causes the economy to grow

Bank Regulation and Supervision

All national banks and some state-chartered banks are members of the Federal Reserve System› Issues regulations that affect how member

banks conduct business› Supervises it’s member bank to evaluate

their soundness…on-site audits› Uses software to screen the activities of

member banks for negative trends and possible problems

Financial Services Collecting and paying funds when two

member banks use checks to transfer funds between them

Transferring funds almost immediately Offering customer services such as

depositing a payroll check directly into a bank account and automatic payment of some bills

Holding the reserves that member banks are required to maintain

Financial Services For Government –

› Holds all of the checking accounts owned by the US government from which tax refunds and Social Security benefits are paid

› Monitors the value of the dollar compared to the currency issued by other nations

› Buys and sells the dollar and currency issued by other countries to keep the valued of the dollar stable

Charges fees for the services provided to its member banks to pay its own expenses…if any is left over it is given to the US Treasury where it is applied to the national debt

Stability of the Financial System

By issuing regulations and supervising its bank members it is able to:› Monitor the economy› Supervise and regulate member banks› Serves as the nation’s bank