The federal reserve system, a reaction to bank panics in the Gilded Age, manages monetary policy for the U.S. through interest rates, reserve requirements, and more.
The Federal Reserve Act of 1913 was signed into law by President Woodrow Wilson. This act created a central bank for the United States, with a board of directors that would help to regulate monetary policy, manage interest rates, and later set reserve requirements for depository institutions like credit unions and local banks. The history of the federal reserve pitted two different economic ideologies against each other in the political theater.
The Federal Reserve System
The first national bank was established in 1791 at the urging of then-Treasury Secretary Alexander Hamilton. The bank was located in Philadelphia and had a 20-year charter granted by Congress. Called the First Bank of the United States, the national bank was designed to help the thirteen separate colonies, with different currencies, debts, and obligations, to use one central bank.
In 1811 the charter expired and Congress chose not to renew it amid populist southern concern that the national bank infringed on states’ rights. In 1816 a second national bank was created but it, too, died as a result of populist fears and later President Andrew Jackson’s suspicion that fraud and corruption ran throughout the national bank. The 20-year charter was not renewed, and the Second National Bank survived as a private bank for five more years, closing its doors due to bankruptcy in 1841.
In 1862 the National Banking Act created a system of national banks that provided very weak management of the U.S. economy and what modern-day economists call monetary policy. In 1913, finally, after decades of economic speculation and depression, the Federal Reserve Act created the Federal Reserve System.
Monetary Policy and the Fed
The federal reserve system, known as the “Fed,” manages monetary policy for the United States government and the economy. Fed responsibilities range from setting interest rates to managing money supply to managing employment and more. The president nominates the chairman and vice chairman of the Fed to four year terms, and the U.S. Senate confirms or denies these appointments. The country is divided into twelve regions for separate federal reserve banks, with each regional bank headed by a president.
Interest Rates, Reserve Requirements and the Board of Governors
The Board of Governors for the federal reserve system has seven members, each appointed to a fourteen year term. No two board members serve the same term, as each term is flighted with a two-year separation between members, and no two board members can come from the same federal reserve bank region.
More than 85 members have served on the Board of Governors since 1914, but from 1913 through 1935 the correct term for these members was Board of Directors. The Banking Act of 1935 changed how the federal reserve system worked, with the Board of Directors renamed the Board of Governors, and added the requirement that the president nominate the chairman from the sitting Board of Governors, with approval required by the U.S. Senate.
The Board of Governors decides two aspects of monetary policy: the discount rate and reserve requirements, affecting the rate at which the Fed loans money to banks and the amount of funds banks must have on hand compared to liabilities on bank books. The Fed can increase interest rates to check speculation, purchase bonds to lower interest rates, and act in a variety of ways to increase or decrease the money supply in the U.S., managing economic expansion and contraction.
The Fed Today
According to the Board of Governors of the Federal Reserve System, the Fed has four primary functions:
- conducting the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates
- supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers
- maintaining the stability of the financial system and containing systemic risk that may arise in financial markets
- providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation’s payments system
Most of these functions ties in to ending, or at least muting, bank panics that were a frequent part of the U.S. economy in the late 1800s and early 1900s. The expansion of the Fed’s responsibilities into the 21st century, and its high profile in the financial media, is far removed from its original role as written nearly one hundred years ago.
- Meltzer, Allan H. A History of the Federal Reserve: Volume 1: 1913-1951. The University of Chicago Press: 2003.
- Wells, Donald R. The Federal Reserve System: A History. McFarland Books: 2004.
- Historical Beginnings: The Federal Reserve