Federal Reserve System

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Federal Reserve System

Seal Federal Reserve System headquarters (Eccles Building)
Headquarters Washington, D.C.
Chairman Ben Bernanke
Central Bank of United States
Currency U.S. dollar
ISO 4217 Code USD
Base borrowing rate 0.5%
Base deposit rate 3.5%
Website federalreserve.gov
Public finance

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The Federal Reserve System (also known as the Federal Reserve, and informally as the Fed) is the central banking system of the United States. This system was conceived by several of the world's leading bankers in 1910[1][2][3][4] and enacted in 1913, with the passing of the Federal Reserve Act. The passing of the Federal Reserve Act was largely a response to prior financial panics and bank runs, the most severe of which being the Panic of 1907.[5][6][7] Over time, the roles and responsibilities of the Federal Reserve System have expanded and its structure has evolved.[6][8] Events such as the Great Depression were some of the major factors leading to changes in the system.[9] Its duties today, according to official Federal Reserve documentation, fall into four general areas:[10]

1. Conducting the nation's monetary policy by influencing monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates.
2. Supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system, and protect the credit rights of consumers.
3. Maintaining stability of the financial system and containing systemic risk that may arise in financial markets.
4. 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.

The Federal Reserve System is subject to the Administrative Procedure Act,[11] and so is legally obligated to inform the public about its organization, procedures and rules. In addition, the Act requires the Fed to establish uniform standards for the conduct of formal rule-making and adjudication.

According to the board of governors: "It is not 'owned' by anyone and is 'not a private, profit-making institution'. Instead, it is an independent entity within the government, having both public purposes and private aspects."[12] In particular, the US Government does not own shares in the Federal Reserve System nor its component banks, but does take all of its profits after salaries are paid to employees, a dividend is paid to member banks that is 6% of their capital investment, and surplus is put in a capital account. The government also exercises some control by appointing its highest-level employees and setting their salaries.

According to the Fed, there are presently five parts of the Federal Reserve System:[13]

1. The presidentially appointed Board of Governors, a governmental agency in Washington, D.C.
2. The Federal Open Market Committee (FOMC), which oversees Open Market Operations, the principal tool of national monetary policy.
3. Twelve regional privately-owned Federal Reserve Banks located in major cities throughout the nation, which divide the nation into 12 districts, acting as fiscal agents for the U.S. Treasury, each with its own nine-member board of directors.
4. Numerous other private U.S. member banks, which subscribe to required amounts of non-transferable stock in their regional Federal Reserve Banks.
5. Various advisory councils.[14]

The structure of the central banking system in the U.S. is unique in the world, in that an entity outside the central bank creates the currency. This other entity is the U.S. Department of the Treasury.

History

Central banking in the United States

In early 1781 the Articles of Confederation & Perpetual Union were ratified so that Congress had the power to issue bills of credit. It passed an ordinance later that year to incorporate a privately subscribed national bank following in the footsteps of the Bank of England. However, it was thwarted in fulfilling its intended role as a nationwide central bank due to objections of "alarming foreign influence and fictitious credit," favoritism to foreigners and unfair competition against less corrupt state banks issuing their own notes, such that Pennsylvania's legislature repealed its charter to operate within the Commonwealth in 1785.

Four years after the U.S. Constitution was ratified, the government adopted another central bank - the First Bank of the United States - but it was ultimately shut down under President Madison due to a failure in passing a recharter. The Second Bank of the United States, the "second" central bank, met a similar fate when its charter expired under President Jackson. Both banks were, again, based upon the Bank of England,[15] but increased Federal power, granted by the constitution gave them more control over currency. Political opposition to central banking was the primary reason for shutting down the banks, and concerns over corruption lingered. Ultimately, the third national bank was established in 1913 and still exists to this day. The time line of central banking in the United States is as follows:[16][17][18]

• 1791–1811

First Bank of the United States

• 1811–1816

No central bank

• 1816–1836

Second Bank of the United States

• 1837–1862

Free Bank Era

• 1846-1921

Independent Treasury System

• 1863–1913

National Banks

• 1913–Present

Federal Reserve System.

Creation of First and Second Central Bank

The first U.S. institution with central banking responsibilities was the First Bank of the United States, chartered by Congress and signed into law by President George Washington on February 25, 1791 at the urging of Alexander Hamilton. This was done despite strong opposition from Thomas Jefferson and James Madison, among numerous others. The charter was for twenty years and expired in 1811 under President James Madison.

In 1816, however, Madison revived it in the form of the Second Bank of the United States. Early renewal of the bank's charter became the primary issue in the reelection of President Andrew Jackson. After Jackson, who was opposed to the central bank, was reelected, he pulled the government's funds out of the bank. Nicholas Biddle, President of the Second Bank of the United States, responded by contracting the money supply to pressure Jackson to renew the bank's charter forcing the country into a recession, which the bank blamed on Jackson's policies. Interestingly, Jackson is the only President to completely pay off the national debt. The bank's charter was not renewed in 1836. From 1837 to 1862, in the Free Banking Era there was no formal central bank. From 1862 to 1913, a system of national banks was instituted by the 1863 National Banking Act. A series of bank panics, in 1873, 1893, and 1907, provided strong demand for the creation of a centralized banking system.