Central Banks in the U.S. Economy: A Look at Money and Issues Econ Ed Specialists Federal Reserve System

In the modern economy, what is a “central bank”? O A bank for government O Payment facilitator O Supervisor/regulator O Monetary policy

The bank for government Collect & disperse funds Collect & disperse funds Act as agent Act as agent Borrowing Intervention “Lender of Last Resort” “Lender of Last Resort”

Payment facilitator Issuer and guardian of currency and coin Issuer and guardian of currency and coin We are not the mint. We are not the Bureau of Engraving & Printing Processor of checks Processor of checks Processor of electronic payments Processor of electronic payments

Supervisor/regulator Protect/monitor banking/payment system Protect/monitor banking/payment system Maintain standards Maintain standards Audit financial institutions & holding companies Audit financial institutions & holding companies

Monetary policy Conduct monetary policy Conduct monetary policy Set and change the quantity of money Set and change the price of money Maintain pegs to other currencies Maintain pegs to other currencies Maintain one currency’s value relative to another currency Currency boards

The Role of Money  Functionality Issues  Medium of Exchange  Store of Value  Measure of Value  The Money Equation  M*V=Q*P or (P*T)

The History of Central Banking O The “central bank” debate O The “hard money” debate O The Great Depression and other events O The “dual banking system” debate

The “central bank” debate O First Bank of the United States O Second Bank of the United States O “No Bank of the United States” O The Federal Reserve System

First Bank of the United States  Modeled after Bank of England  Private institution  Some stock owned by foreign entities  Some stock (20%) owned by U.S. government  Stock owned by insiders  Charter allowed to expire

Second Bank of the United States OForeign investors OLoans to private sector OProvided currency and credit to western territories OAfter Jackson withdraws funds OTries to foreclose loans OTightens money supply OAllowed to expire

“No Bank of the United States” OTaxes state bank notes out of existence O“Locks up” money OShortage of coins OIndependent Treasury OGreenbacks OExperiments in bimetallism

Federal Reserve System  Independent within government  Balances private and government  Insulation from political pressure

What do we learn from “central bank” debate? Central banks can impact an economy Central banks can impact an economy For bad, or for goodFor bad, or for good Lack of a central bank can create problemsLack of a central bank can create problems Central bank structure matters Central bank structure matters Government can abuse central bank powersGovernment can abuse central bank powers Private sector can abuse central bank powersPrivate sector can abuse central bank powers

The “hard money” debate O The “continental” experience O The gold standard O Bi-metallism and “the cross of gold” O The need for “flexible currency”

The Business Cycle in American History  Inflations  Deflations  Bank panics

Deflations  Specie circular  Various bank panics  Most of the “progressive era”  Free silver vs. gold

Inflations  Continental currency  Shay’s rebellion  Wildcat banks & wildcat notes  Various gold strikes  Greenbacks during the Civil War  Inflation or deflation  Depends on who’s winning  Free silver vs. gold  1960s and 70s - Listening to Keynes

The “Great Depression” and other events O The deflations and panics of the 19th century O The Panic of 1907 O The Great Depression O The inflation of the 1970s O Money matters

Bank Panics  1819  1837  1857  1873  1893  1907  Great Depression  S&L Crisis

Panic of 1819  Second Bank of U.S. refuses to allow overspeculation  “Hard” money

Panic of 1837  Specie circular  British bank collapse calls foreign loans  Collapse of pet banks

Panic of 1857  Too much gold (1849 California strike) leads to inflation  Too much grain planted due to Crimean War  Too much land speculation due to railroad expansion

Panic of 1873  Overspeculation all over  Mining  Manufacturing  Railroads  Grain  European loans called due to collapse in Vienna  Hard money wins over easy, currency shrinks

Panic of 1893  “Free silver” brought on by bi- metallism destroys overseas credit  Silver increases above 16-1  Drains the Treasury  What happens when market forces don’t play by “da rules”

Panic of 1893 (continued)  Alaskan gold strikes create further inflation with increase in gold supply  Trivia: Actual silver/gold ratio was 32-1 when Bryan spoke of “cross of gold” in 1892  Money and the The Wizard of Oz

Panic of 1907  Problem of inelasticity  J.P. Morgan to the “rescue”

The Great Depression  The state of economic knowledge  Debate within the Fed  Real bills vs. gold standard and the discount rate  Availability of credit leads to Fed’s mistake

The “dual banking system” debate O Who has the power to charter banks? O Who has the power to regulate banks? O What is the effect on competition?

The S&L crisis  Inflation does in the thrifts  The state of economic knowledge

Key legislation and agreements  Charter – First Bank of the United States (1791)  Charter – Second Bank of the United States (1816)  National Banking Act (1863)  Federal Reserve Act (1913)  Glass-Steagal Act (1933)  Banking Act (1935)  Fed Treasury Accord (1951)  Humphrey-Hawkins Act (1978)  Depository Institution Deregulation and Monetary Control Act (1980)  Riegle Neal Interstate Banking (1994)  Gramm-Leach-Bliley Act (1999)

Key legislation and agreements  Charter – First Bank of the United States (1791)  Charter – Second Bank of the United States (1816)  Both helped develop structure by providing important lessons  Dual nature of the Fed  Financing

Key legislation and agreements  National Banking Act (1863)  Helps establish national currency  National banking centers established

Key legislation and agreements  Federal Reserve Act (1913)  Applied lessons learned  Decentralized central bank  Did not clearly establish authority within the System

Key legislation and agreements  Glass Steagal Act (1933)  Separates commercial and investment banking  Banking Act (1935)  Establishes Board of Governors as central authority for the Federal Reserve  Institutionalizes Federal Open Market Committee

Key legislation and agreements  Fed – Treasury Accord (1951)  Removes Treasury representative/oversight  Reestablishes Fed independence  Removes interest rates as primary concern

Key legislation and agreements  Humphrey Hawkins Act (1978)  Puts employment formally in the policy picture  Requires bi-annual testimony by Fed chair  (Expired but still adhered to)

Key legislation and agreements  Depository Institution Deregulation and Monetary Control Act (1980)  Broadened banking  Extended Fed reach  Services  Reserves  Discount Window

Key legislation and agreements  Gramm-Leach-Bliley Act (1999)  Fed established as “umbrella regulator”  Rescinds Glass-Steagal

Putting it all in perspective…  History provides us with  Lessons to be learned and applied  Structure  Policy application  Events to avoid  Stock market corrections  Inflations  Bank panics