Transcript The Federal Reserve

The Federal Reserve
FNCE 4070 – Financial Markets and
Institutions
Bank Notes
• Paper Money got is start in London in the
early 17th century.
• Goldsmiths in London
– Merchant deposits his gold with a goldsmith
– Goldsmith issues a promissory note which was a
safe and convenient form of money backed by the
goldsmith’s promise to pay.
Bank Notes
• In the early United States bank notes were issued
by state chartered banks
• These were backed by gold and silver on demand.
– The holder of a note could go to the bank and
demand gold or silver in exchange
• There were exchange rates between state bank
dollars.
• The gold standard was finally dropped in 1971.
First Bank of the United States
• 1791-1811
• First proposed by Alexander Hamilton
• Highly controversial
– Believed by some to be unconstitutional
– Southern landowners didn’t trust banks
• $10m in seed capital and was owned 20% by the
federal government.
– The federal government did not have $2m to pay so
the bank raised $8m externally and leant the US
government $2 to buy its stake.
First Bank of the United States
• It was a combination of a commercial bank and a
central bank.
• Issued currency that became a safe medium of
exchange
– Note this existed alongside state banked issued
currency.
• Largest business in the early US
– 8 branches from New Orleans to Boston
– US government was its largest customer as a borrower
and a depositor.
Early Central Banking Functions
• Attempted to regulate state banks by
curtailing those that had over-issued their
bank notes
• In coordination with the treasury discussed
economic conditions and attempted to
promote the safety of the credit system
• Tried to coordinate aggregate policy changes
across its branches.
First Bank of the United States
• The vote to re-charter the bank was lost in
1811 and the bank closed.
• In 1812 the US went to war with the British.
• President Madison began to print
unsupported money.
• Sent the nation into a financial crisis and state
banks stopped redeeming federally issued
money.
Second Bank of the United States
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1817-1837
Larger than its predecessor $35m in capital
The government owned 20% of the bank.
Again highly controversial.
Early Central Banking Operations
• Open Market Operation
– State Bank issued money would come into the
possession of the Bank
– The bank would determine whether it believed the
State’s credit policies were appropriate or too loose.
– If appropriate then the bank would return the notes
into circulation
– If inappropriate the bank could demand gold/silver
from the state bank and thus reduce money in
circulation.
Problems with the Central Bank
• The bank effectively limited growth through these
operations.
• Many individuals feared the federal government’s
power to force bank closures – thus leaving ordinary
citizens with worthless paper money.
• Northern bankers wanted federal money deposited in
their own banks.
• Expansion-minded western bankers did not want
federal supervision.
• Democrats did not believe that the bank was
constitutional.
Independence Principle
• There is no one principle better understood by
every officer in the Bank that he must abstain
from politics. The course of the Bank is very clear
and straight on that point. We believe that the
prosperity of the Bank and its usefulness to the
country depend on its being entirely free from
the control of the officers of the Government, a
control fatal to every bank which it ever
influenced. In order to preserve that
independence it must never connect itself with
any administration – and never become a
partisan of any set of politicians
Financial Crises
• Panic of 1837
– In the last few years of the Second Central Bank
the money supply grew at an average rate of 30%
rather than under 3% previously
– The result was a speculative bubble in land and
commodities that burst in 1837
– A depression followed that lasted until 1843
National Banks
• In 1863 a bank was allowed to choose
between a state and a national charter.
• With a national charter the bank had to issue
government printed bills for their notes and
had to back these notes with federal bonds
• In 1865 state bank notes were taxed out of
existence
• This was the first time that the United States
had a uniform national currency.
More Financial Crises
• Panic of 1873 and 1893
– Generally to do with the overexpansion of
railroads and the collapse of railroad bonds.
• Panic of 1907
– Caused when Augustus Heinze attempted to
corner the copper market
– As there was no central bank J. P. Morgan and
other bankers arranged investments and extended
lines of credit to stabilize the economy
Federal Reserve Act 1913
• It was not a commercial bank
– Did not extend loans other than to banks
– Excess profits would be returned to the treasury
• It was decentralized
– 12 regional banks
– Avoided centralization of power in Washington or NY
– The regional banks were owned by the commercial
banks in the region
– Each district issued its own currency backed by the
promise to redeem it in gold.
Federal Reserve Act 1913
• The Federal Reserve Board made up of
presidential appointees
• The Federal Advisory Board elected by the
regional banks
• Took over the nations payments systems
• As before a 20 year charter – it was made
permanent in 1927
Glass-Steagall Act 1933
• Created the Federal Deposit Insurance
Corporation
• Separated Commercial Banking from Investment
Banking
• Prohibited Investment Banking from taking
deposits.
• Gave the Federal Reserve Board the power to set
maximum interest rates on time deposits.
• Created the Federal Open Markets Committee
(FOMC)