Transcript The Federal Reserve

The Federal Reserve System
I. Its History,
Functions &
Structure
II. Fed Policy
Tools & Goals
ECO 473 – Money & Banking – Dr. D. Foster
The Origins of U.S. Central Banking
1791–1836
 Bank of England
 The Bank of North America (1781)
 The First Bank of the United States (1791)
 The Second Bank of the United States (1816)
1837–1865
 The Free-Banking period.
 The Civil War & Greenbacks - a fiat money.
1865–1912
 The Gold Standard (1875).
 Brief foray into bimetalism.
 Panics of 1873, 1893 and 1907
 Federal Reserve Act of 1913
Central Banking – The Bank of England
• Created in 1694
–
–
–
–
–
–
–
–
–
Bought gov’t bonds and issued notes.
Held all government debt.
Notes were not “legal tender,” but widely accepted.
Insolvent in 2 years.
Parliament allowed them to suspend specie payment.
Brief competition (Nat’l Land Bank; South Seas)
1708: monopoly on bank notes & short term loans.
Late 1700s, massive suspension lasted 24 years.
1833: notes made legal tender.
• Peel Act – limit fractional reserve notes.
– Failed to recognize deposits as money.
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.
The National Banking System
• Specie suspension & greenbacks 12/1861.
• 1861 to 1863, MS doubled.
– Wholesale prices up 22% per year during war.
• The National Banking Act of 1863
– Created national currency.
– Taxed non-nat’l bank notes.
– Bought gov’t debt & issued notes.
– The rise & fall of Jay Cooke.
– State banks 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.
Pyramiding the Money Supply
Banks have $1 mill. of gold and rr = 25%.
They can issue $4 mill. of loans = notes + demand deposits.
Add national banks. They can hold $1 mill. of gold and
expand money to $4 million.
Other banks can treat $4 mill. as their reserves and expand
the MS (by increasing dd) to$16 million.
Add the Federal Reserve. They can hold $1 mill. of gold and
expand money to $4 million.
National banks can treat $4 mill. as their reserves and
expand the MS (by increasing dd) to $16 million.
Other banks can treat $16 mill. as their reserves and expand
the MS to $64 million.
The Federal Reserve Banking System
 Purpose:
1. Develop, supervise & control the nation’s money.
2. Serve as a national check-clearing system.
3. 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.
 Political party 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 Fed’s Balance Sheet
• THE FED’S ASSETS
– Treasury securities
– U.S. agency securities
– Discount window loans
– Gold certificates.
– Special Drawing Right
(SDR) certificates
– Foreign currency
reserves
– Cash items in the
process of collection
• LIABILITIES AND
EQUITY CAPITAL
– Federal Reserve notes
– Bank reserve deposits
– U.S. Treasury deposits
– Foreign official
deposits
– Deferred availability
cash items
– Equity capital
The Fed’s Balance Sheet - 2005
The Consolidated
Balance Sheet of
the Federal
Reserve System
($ Millions, as
of January 31,
2005)
782,003
2012
The Federal Reserve System
I. Its History,
Functions &
Structure
II. Fed Policy
Tools & Goals
ECO 473 – Money & Banking – Dr. D. Foster