The Federal Reserve System I. Origins of the Fed ECO 473 – Money & Banking – Dr. D. Foster

Central Banking - The 1st and 2nd BUS Mercantilist movement behind banks. Fed owns 20%, deposits funds here. Banks buy government debt; issue notes. 1791-1796 wholesale prices up 72%. Periodic specie suspension and bank panics. BUS will hold bank notes. 2nd BUS inflates, then deflates in 1819. “The bank was saved, but the people ruined.” Jackson kills the 2nd BUS.

The “Free Banking” Era: 1836-1863 Van Buren sets up Independent Treasury System Came and went and lasted only until Civil War. Fed’l government held only specie, not paper. Decentralized banking 1836-1862 Still heavily regulated. State banks required to hold state gov’t. debt to back their note/dd issue. Notes accepted for taxes. Restricted branching making redemption harder. Private note clearing – Suffolk System Held specie reserve of members. Different bank notes accepted. Insulated banks from panics.

Evolution to Central Banking: 1865–1912 The National Banking Act (1863) The Gold Standard (1875). Brief foray into bi-metalism. Panics of 1873, 1893 and 1907 Federal Reserve Act of 1913

The National Banking System The National Banking Act of 1863 Created nationally-chartered banks. Created a national currency. Taxed non-national bank notes. Bought gov’t debt & issued notes. The rise & fall of Jay Cooke. State banks still benefit by holding reserves in nat’l notes. Didn’t stop periodic panics.

The Federal Reserve System “An engine of inflation.” An addition layer means more money creation. 1914 to 1920, MS doubles member banks DD 250%. non-member banks DD 33%. Reserve deposits on savings falls. Shift from DD to TD. Generally accepted that savings are “payable upon demand.” Ben Strong & the Morgans.

The Federal Reserve Banking System Purpose: Develop, supervise & control the nation’s money. Serve as a national check-clearing system. Serve as depository for federal gov’t. funds. Board of Governors of the FRS 7 members, equal standing . . . but, includes Secretary of the Treasury and Comptroller of the Currency. Problems: Only using discount window, Each District Bank sets its own policy.

The Federal Reserve Banking System

The Early Fed, 1913–1935 Accommodates the Treasury Dept. during WWI. Buys Treasury bonds to finance G spending (aka “monetizing the debt”). From 1916 to 1918, this increases MS by 70%. Huge risk of inflation. The Great Depression - Failure of the Fed Initially increased liquidity, but pulled back. By 1933, 33% of banks fail, MS fallen 33%.

The Fed - version 2.0, 1935 Serves as a “lender of last resort.” Board of Governors reconstituted: All 7 member selected by President/Senate confirms. Can’t include Treasury Sec. nor Comptroller of Currency. Members serve 14 yr. terms on staggered basis. Geographic diversity. Office of Chairman and Vice Chairman created. Has authority over district banks. Federal Open Market Committee (FOMC) 12 members; primary policy-making body.

The Evolution of the Modern Fed WWII - working “for” the U.S. Treasury Federal Reserve–Treasury Accord (1951) “Leaning Against The Wind” Martin (1953-1970) The technocratic Fed Burns (1970-1978) . . . the “political business cycle” Coping with inflation Volcker (1979-1987) Keeping the economy stable? Greenspan (1987-2006) Coping with recession Bernanke (2006-2014) Yellen (2014-?)

The Federal Reserve System I. Origins of the Fed ECO 473 – Money & Banking – Dr. D. Foster