The Federal Reserve System

1. The Federal Reserve System I. Its History, Functions & Structure ECO 473 – Money & Banking – Dr. D. Foster II. Fed Policy Tools & Goals

2. 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.

3. 1865–1912 • The Gold Standard (1875). • Brief foray into bimetalism. • Panics of 1873, 1893 and 1907 • Federal Reserve Act of 1913

4. 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.

5. 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.

6. 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.

7. 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 holdingreserves in nat’l notes. • Didn’t stop periodic panics.

8. 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.

9. 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.

10. 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.

11. The Federal Reserve Banking System

12. 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%.

13. 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.

14. 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-?)

15. 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

16. The Fed’s Balance Sheet - 2005 The Consolidated Balance Sheet of the Federal Reserve System ($ Millions, as of January 31, 2005) 782,003

18. 2012

19. The Federal Reserve System I. Its History, Functions & Structure ECO 473 – Money & Banking – Dr. D. Foster II. Fed Policy Tools & Goals