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The Federal Reserve System ECO 473 Money & Banking Dr. D. Foster I. Its History, Functions & Structure II. Fed Policy Tools & Goals Slide 2 The Origins of U.S. Central Banking 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) 18371865 The Free-Banking period. The Civil War & Greenbacks - a fiat money. 17911836 Slide 3 18651912 The Gold Standard (1875). Brief foray into bimetalism. Panics of 1873, 1893 and 1907 Federal Reserve Act of 1913 Slide 4 Central Banking The Bank of England Created in 1694 Bought govt 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 (Natl 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. Slide 5 Central Banking - The 1 st and 2 nd 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. 2 nd BUS inflates, then deflates in 1819. The bank was saved, but the people ruined.The bank was saved, but the people ruined. Jackson kills the 2 nd BUS. Slide 6 The Free Banking Era: 1836-1863 Van Buren sets up Independent Treasury System. Came and went and lasted only until Civil War. Fedl government held only specie, not paper. Decentralized banking 1836-1862. Still heavily regulated. State banks required to hold state govt. 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. Slide 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-natl bank notes. Bought govt debt & issued notes. The rise & fall of Jay Cooke. State banks benefit by holding reserves in natl notes. Didnt stop periodic panics. Slide 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. Slide 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. Slide 10 The Federal Reserve Banking System Board of Governors of the FRS 7 members, equal standing... but, includes Secretary of the Treasury and Comptroller of the Currency. Problems Problems: Only using discount window, Each District Bank sets its own policy. Purpose Purpose: 1.Develop, supervise & control the nations money. 2.Serve as a national check-clearing system. 3.Serve as depository for federal govt. funds. Slide 11 The Federal Reserve Banking System Slide 12 The Early Fed, 19131935 The Great Depression - Failure of the Fed The Great Depression - Failure of the Fed Initially increased liquidity, but pulled back. By 1933, 33% of banks fail, MS fallen 33%. Accommodates the Treasury Dept. during WWI. 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. Slide 13 The Fed - version 2.0, 1935 Serves as a lender of last resort. Serves as a lender of last resort. Board of Governors reconstituted: Board of Governors reconstituted: All 7 member selected by President/Senate confirms. Cant 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) Federal Open Market Committee (FOMC) 12 members; primary policy-making body. Slide 14 The Evolution of the Modern Fed WWII - working for the U.S. Treasury WWII - working for the U.S. Treasury Federal ReserveTreasury Accord (1951) Federal ReserveTreasury Accord (1951) Leaning Against The Wind Leaning Against The Wind Martin (1953-1970) The technocratic Fed The technocratic Fed Burns (1970-1978)... the political business cycle Coping with inflation Coping with inflation Volcker (1979-1987) Keeping the economy stable? Keeping the economy stable? Greenspan (1987-2006) Coping with recession Coping with recession Bernanke (2006-2014) Yellen (2014-?) Slide 15 The Feds Balance Sheet THE FEDS 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 Slide 16 The Feds Balance Sheet - 2005 782,003 The Consolidated Balance Sheet of the Federal Reserve System ($ Millions, as of January 31, 2005) Slide 17 Slide 18 2012 Slide 19 The Federal Reserve System ECO 473 Money & Banking Dr. D. Foster I. Its History, Functions & Structure II. Fed Policy Tools & Goals