Federal Reserve System

1. Federal Reserve System History of the Federal Reserve System Presented by S. Cox

2. Objectives • Describe the first two central banks in the US • Explore the problems caused by the lack of a central bank • Explain how the Federal Reserve System solved the nation’s financial problems

3. Central Bank in the US • Secretary of the Treasury, Alexander Hamilton, advocated and developed the First Bank of the United States • A central bank is the organization that oversees a nation’s monetary system

4. Central Bank in the US • The First Bank was chartered in 1791, was considered a central bank and • Assumed the debts of the individual states • Made commercial loans • Held federal funds • Issued payments • Performed well but the chartered expired in 1811 • Thomas Jefferson and other opponents believed it took power away from the states and put it in the hands of eastern bankers

5. Central Bank in the US • In 1816 Congress saw the need again for a central bank and the Second Bank was chartered…similar to but bigger than the First Bank • The bank’s existence was challenged…farmers from the South and West opposed it • States tried to undermine the authority of the bank which led to the Supreme court challenge to its constitutionality… • McCulloch v. Maryland (1819) – Supreme court ruled that it was within the rights of Congress to create a central bank

6. Central Bank in the US • Once in office, President Andrew Jackson ordered all government funds be withdrawn from the bank and in 1836 vetoed the bill that renewed the bank’s charter • 1837-1863 was known as the era of free banking • All bank functions were handled by the state banks and federal funds were held in the US Treasury

7. Banking Without a Central Bank • Many banks failed without constant regulation • Government needed strong and reliable banks to get financing for the Civil War • National Currency Act created the Office of the Comptroller of the Currency (OCC)in 1863 • The Office of the Comptroller of the Currency created a uniform national currency and a system of national banks • Today, the OCC still charters and supervises national banks

8. Banking Without a Central Bank • 1864 – National Currency Act became the National Banking act which allowed the federal government to charter private banks • These new banks issued bank notes which were intended to be used as currency and promise immediate payment by that bank that issued the note • State banks had to pay 10% tax which persuaded them to seek a national charter

9. Banking Without a Central Bank • National charter had strict rules one of which required the banks to have a minimum cash reserve • Many state banks failed because they weren’t subject to the same strict rules as were national banks which led to bank panics in 1873, 1893, and 1907 • A widespread worry that banks do not have enough money to cover customer demands for withdrawals • Started by a run on a single bank…bank run…depositors arrive in great numbers at the same time to withdraw their money

10. Banking Without a Central Bank • After the bank panic in 1907, the idea of a central bank began to take hold • 1913 – Federal Reserve System was established • President Woodrow Wilson signed the Federal Reserve Act

11. Federal Reserve System Structure of the Federal Reserve System

12. Objectives • Explain how the Federal Reserve System is structured • Describe how decentralization affected the location of the Federal Reserve Banks • Identify the roles of the Federal Reserve’s Board of Governors and Federal Open Market Committee

13. Structure of the Federal Reserve • Also known as the Fed • Responsible for the US’s monetary system (the mechanism a nation uses to provide and manage money for itself) • Has a lot of power, so checks need to be put in place • Structure is meant to safeguard against corruption

14. Location of the Federal Reserve • Decentralization was one of the driving forces that determined how the Fed would be organized • Decentralization – when a central authority shares power with regional and local authorities • The Fed is composed of 12 regional central banks, known as the Federal Reserve Banks

15. District Reserve Banks

16. Organization of the Federal Reserve • Each Federal Reserve Bank governs itself and supervises the member banks in its region

17. Board of Governors • Board of Governors is the governing body of the Federal Reserve System • Independent central bank…does not report to the US president or any other member of the executive branch, but the Fed reports to the US Congress • Fed’s actions should be in-line with the government’s economic goals • Twice a year the Fed chairperson reviews recent actions and its economic predictions and presents these to Congress

18. Board of Governors • BOG members are appointed by the US president and confirmed by the Senate • Has only had 15 Fed chairs since its creation…longest was Al Greenspan and in 2006 Ben Bernanke was appointed by President G W Bush and then reappointed four years later by President Obama

19. Federal Open Market Committee • Even though the Fed chair is a very visible position, the Federal Open Market Committee is responsible for making monetary policy • The BOG members are also members of the FOMC, which has 12 members • Meets eight times a year • The BOG chair is also the FOMC chair • The president from New York is always a member and the other four are chosen from the other Federal Reserve Banks and those not on the FOMC still attend the meetings and participate in the discussions

20. Federal Reserve System Function of the Federal Reserve System

21. Core Functions • Establish the nation’s monetary policy, which affects the monetary and credit conditions in the economy • Supervise and regulate banking institutions • Provide financial services to depository institutions, the US government, and foreign official institutions, including operating the nation’s payments system • Maintaining the stability of the financial system

22. Monetary Policy • Monetary Policy is the regulation of a country’s money supply to achieve economic goals and stability • Fed uses tools to regulate the interest rate charged for loans and the amount required in reserves • Open market operations…example FMOC supervises the purchase and sale of long-term loans issued by the government to raise money • The discount rate – the interest banks pay to borrow money from a Federal Reserve Bank…affects the interest rate banks charge customers to borrow money…set every two weeks…prime rate – interest rate that banks charge their best commercial customers • Reserve requirements – amount of money a bank must keep and not invest or loan out • if banks are instructed to have higher reserves, the interest rate borrowers must pay drops, which causes the economy to grow

23. Bank Regulation and Supervision • All national banks and some state-chartered banks are members of the Federal Reserve System • Issues regulations that affect how member banks conduct business • Supervises it’s member bank to evaluate their soundness…on-site audits • Uses software to screen the activities of member banks for negative trends and possible problems

24. Financial Services • Collecting and paying funds when two member banks use checks to transfer funds between them • Transferring funds almost immediately • Offering customer services such as depositing a payroll check directly into a bank account and automatic payment of some bills • Holding the reserves that member banks are required to maintain

25. Financial Services • For Government – • Holds all of the checking accounts owned by the US government from which tax refunds and Social Security benefits are paid • Monitors the value of the dollar compared to the currency issued by other nations • Buys and sells the dollar and currency issued by other countries to keep the valued of the dollar stable • Charges fees for the services provided to its member banks to pay its own expenses…if any is left over it is given to the US Treasury where it is applied to the national debt

26. Stability of the Financial System • By issuing regulations and supervising its bank members it is able to: • Monitor the economy • Supervise and regulate member banks • Serves as the nation’s bank