The Establishment ofthe Federal Reserve

Namwen Relyt, Rhel Tterrag, and Hemarad Nomolos

The Creation of the Federal ReserveThe Federal Reserve is the central bank of the

United States.

The Federal Reserve was created on December 23, 1913 when President Woodrow Wilson signed the Federal Reserve Act.

The Federal Reserve was created in order to provide the nation with a safer, more flexible financial system.

The Federal ReserveThe Federal Reserve made it easier to conduct financial transactions between

businesses and individuals.

Helps promote a stable, low inflation environment.

provides emergency access to cash to financial markets.

The Federal ReserveThe Fed can step in on an emergency basis as a lender of last resort.

It can buy government securities on the open market in order to inject money into the banking system.

Can lend emergency finances to depository institutions in order for them to meet their short-term payment obligations. These transactions are known as “discount window” loans.

The Federal ReserveNormally, banks can only borrow from these discount windows when they are

having trouble raising funds.

When the interbank lending markets become severely impaired, such as in the 2008 recession, this discount window can become a primary source for funds.

The Federal ReserveIn order to make it easier for banks to borrow through the discount windows

during times of crisis, the Fed created a number of changes.

One of these changes included reducing the difference between the interest charged on discount rate loans and the Fed’s target for the federal funds rate.

In case of extraordinary problems, the Fed is allowed to step beyond its regular role as a last resort lender to banks.

Purpose of the Federal ReserveConducting the nation's monetary policy by influencing money and

credit conditions in the economy in pursuit of full employment and stable prices.

Supervising and regulating banks and other important financial institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers.

Purpose of the Federal Reserve (Cont.)Maintaining the stability of the financial system and containing systemic

risk that may arise in financial markets.Providing certain financial services to the U.S. government, U.S.

financial institutions, and foreign official institutions, and playing a major role in operating and overseeing the nation's payments systems.

Purpose of the Federal Reserve (Cont.)To address the problem of banking panicsTo serve as the central bank for the United StatesTo strike a balance between private interests of banks and the centralized

responsibility of governmenta. To supervise and regulate banking institutions

b. To protect the credit rights of consumersTo manage the nation's money supply through monetary policy to achieve the

sometimes-conflicting goals ofc. maximum employment

d. stable prices, including prevention of either inflation or deflation

e. moderate long-term interest rates

Purpose of the Federal Reserve (Cont.)To maintain the stability of the financial system and contain systemic risk in

financial marketsTo provide financial services to depository institutions, the U.S. government, and

foreign official institutions, including playing a major role in operating the nation's payments systema. To facilitate the exchange of payments among regions

b. To respond to local liquidity needsTo strengthen U.S. standing in the world economy

Purpose of the Federal Reserve (Cont.)To maintain the stability of the financial system and contain systemic risk in

financial marketsTo provide financial services to depository institutions, the U.S. government, and

foreign official institutions, including playing a major role in operating the nation's payments systema. To facilitate the exchange of payments among regions

b. To respond to local liquidity needsTo strengthen U.S. standing in the world economy

Purpose of the Federal Reserve (Cont.)Banking institutions in the United States are required to hold reserves — amounts of currency

and deposits in other banks — equal to only a fraction of the amount of the bank's deposit liabilities owed to customers.

This practice is called fractional-reserve bankinga. As a result, banks usually invest the majority of the funds received from depositors.

On rare occasions, too many of the bank's customers will withdraw their savings and the bank will need help from another institution to continue operating; this is called a bank run.

b. Bank runs can lead to a multitude of social and economic problems. The Federal Reserve System was designed as an attempt to prevent or minimize the

occurrence of bank runs, and possibly act as a lender of last resort when a bank run does occur.

1775-1791: U.S CurrencyTo finance the American Revolution, the Continental Congress printed

the new nation's first paper money.

Known as "continentals," the flat money notes were issued in such quantity they led to inflation, which, though mild at first, rapidly accelerated as the war progressed.

1791-1811: First Attempt at Central Banking

Secretary Alexander Hamilton persuaded Congress to establish the first nation bank, centralized in Philadelphia.

It was the largest corporation in the country and was dominated by big banking and money interests.

Many agrarian minded Americans uncomfortable with the idea of a large and powerful bank opposed it.

1836-1865: The Free Banking EraState-chartered banks and unchartered “free banks” took hold during

this period, issuing their own notes, redeemable in gold or specie.

Banks also began offering demand deposits to enhance commerce.

The New York Clearinghouse Association was established in 1853 to provide a way for the city’s banks to exchange checks and settle accounts.

1863: National Banking ActDuring the Civil War, the National Banking Act of 1863 was passed,

providing for nationally chartered banks, whose circulating notes had to be backed by U.S. government securities.

the act required taxation on state bank notes but not national bank notes, effectively creating a uniform currency for the nation..

1913: The Federal Reserve System is BornFrom December 1912 to December 1913, the Glass-Willis proposal was hotly debated, molded and reshaped. By December 23, 1913, when President Woodrow Wilson signed the Federal Reserve Act into law, a decentralized central bank that balanced the competing interests of private banks and populist sentiment was ushered in.

1914-1919: Fed Policy During the WarWhen World War I broke out in mid-1914, U.S. banks continued to

operate normally, thanks to the emergency currency issued under the Aldrich-Vreeland Act of 1908.

But the greater impact in the United States came from the Reserve Banks’ ability to discount bankers acceptances.

United States aided the flow of trade goods to Europe, indirectly helping to finance the war until 1917, when the United States officially declared war on Germany and financing our own war effort became paramount.

1920s: The Beginning of Open Market Operations

The U.S recognized that gold no longer served as the central factor in controlling credit.

During the 1920s, the Fed began using open market operations as a monetary policy tool.

1929-1933: The Market Crash and the Great Depression

During the 1920s, Virginia Representative Carter Glass warned that stock market speculation would lead to dire consequences.

In October 1929, his predictions seemed to be realized when the stock market crashed, and the nation fell into the worst depression in its history.

From 1930 to 1933, nearly 10,000 banks failed, and by March 1933, newly inaugurated President Franklin Delano Roosevelt declared a bank holiday, while government officials grappled with ways to remedy the nation’s economic woes.

1933: The Depression AftermathIn reaction to the Great Depression, Congress passed the Banking Act

of 1933, better known as the Glass-Steagall Act, calling for the separation of commercial and investment banking and requiring use of government securities as collateral for Federal Reserve notes.

The Act also established the Federal Deposit Insurance Corporation (FDIC), placed open market operations under the Fed and required bank holding companies to be examined by the Fed,

1935: More ChangesThe Banking Act of 1935 called for further changes in the Fed’s

structure, including:

the creation of the Federal Open Market Committee (FOMC) as a separate legal entity

removal of the Treasury Secretary and the Comptroller of the Currency from the Fed’s governing board

establishment of the members’ terms at 14 years.

Following World War II, the Employment Act added the goal of promising maximum employment to the list of the Fed’s responsibilities.

1970s-1980s: Inflation and DeflationThe 1970s saw inflation skyrocket as producer and consumer prices

rose, oil prices soared and the federal deficit more than doubled.

By August 1979, when Paul Volcker was sworn in as Fed chairman, drastic action was needed to break inflation’s stranglehold on the U.S. economy.

1980 Setting the Stage for Financial Modernization

The Monetary Control Act of 1980 required the Fed to price its financial services competitively against private sector providers and to establish reserve requirements for all eligible financial institutions.

Following its passage, interstate banking proliferated, and banks began offering interest-paying accounts and instruments to attract customers from brokerage firms.

1999 the Gramm-Leach-Bliley Act was passed, in essence, overturning the Glass-Steagall Act of 1933 and allowing banks to offer a menu of financial services, including investment banking and insurance.

1990s: The Longest Economic Expansionthe stock market crashed on October 19, 1987

The 10-year economic expansion of the 1990s came to a close in March 2001 and was followed by a short, shallow recession ending in November 2001

The decade was marked by generally declining inflation and the longest peacetime economic expansion in our country’s history.

2006 and Beyond: Financial Crisis and ResponseDuring the early 2000s, low mortgage rates and expanded access to credit made homeownership possible for more people, increasing the demand for housing and driving up house prices. The housing boom got a boost from increased securitization of mortgages—a process in which mortgages were bundled together into securities that were traded in financial markets. Securitization of riskier mortgages expanded rapidly, including subprime mortgages made to borrowers with poor credit records.

Case Study: September 11, 2001The effectiveness of the Federal Reserve as a central bank was put to the test on September 11, 2001 as the terrorist attacks on New York, Washington and Pennsylvania disrupted U.S. financial markets. The Fed issued a short statement reminiscent of its announcement in 1987: “The Federal Reserve System is open and operating. The discount window is available to meet liquidity needs.” In the days that followed, the Fed lowered interest rates and loaned more that $45 billion to financial institutions in order to provide stability to the U.S. economy.