The History of the Federal Reserve

The United States has a central bank called the Federal Reserve. Congress passed the Federal Reserve Act in 1913, which created the Federal Reserve as this country's bank. The Federal Reserve has several different purposes, most of which are connected with keeping the country's financial system and banks stable. The Federal Reserve monitors and maintains the U.S. banking system by overseeing the money supply. Some people simply refer to the Federal Reserve as "the Fed." When you hear either term, you will know that you are hearing a conversation about the United States' central bank.

History of the Fed

President Woodrow Wilson signed the Federal Reserve Act on December 23, 1913. The years leading up to this point had been difficult for America. Financial crises in 1895 and again in 1907 had forced the United States to turn to private individuals for help. Members of Congress realized that the United States needed a safety net to help when financial emergencies happened. Congress worked on developing a banking system that would handle these difficult times. Lots of different committee members disagreed about the way to set up this system. A representative named Carter Glass worked to come up with a plan for a new banking system. Under this proposed system, regional banks would help coordinate and maintain the system. Glass also proposed a special agency that would supervise the banks. A Federal Reserve Board would be in charge of the banks, with the president appointing people to this board. After much haggling between the House of Representatives and the Senate, the bill finally passed and landed on President Wilson's desk for his signature.

World War I began in 1914, but the new banking system in the United States operated without problems. The United States entered World War I in 1917, which made it necessary for new financing efforts to pay for the war. Several years later, in 1923, a recession loomed for the United States. The leader of the New York Fed, Benjamin Strong, directed a major buyout of government securities, called "open market operations." This move demonstrated how effective open market operations were for keeping credit available for consumers. The Federal Reserve began actively using open market operations to set monetary policies.

The Depression and the End of the Gold Standard

When the stock market crashed in 1929 and the Great Depression followed, thousands of banks across the country closed down. This left many Americans without money. A number of banking acts were passed after the Great Depression ended, some of which changed banking practices and put protections in place for consumers. President Franklin Roosevelt even recalled gold and silver certificates, which ended the gold standard. Ending the gold standard meant that the country's monetary system would no longer be backed by gold. This was the beginning of the fiat monetary system and inflation. Fiat money is a special type of money with a value that's based on the consumers' faith in the issuer. Fiat money value can go up or down at the whim of the entity that issued it. In a period of inflation, more money is available, but it has less value. When this happens, people usually respond by spending a lot of money. As spending goes up, the amounts of things people want to buy actually become limited. When this happens, the retailers usually decide to raise their prices to keep people from buying out all of their goods. Over time, prices go up for everything and not just the hot items in demand. People begin to need a higher income so they can keep buying the things they need.

Modern Issues and Concerns

Fed Chairman Paul Volker worked hard to end inflation during the 1980s. The Monetary Control Act set important rules about reserve requirements for banks, and it instituted other banking reforms. The decade of the 1990s was expansive for the stock market, and inflation got better. This time of positive growth ended in 2001. To help the country recover, the Federal Reserve lowered interest rates. After the terrorist attacks on September 11, 2001, the Fed reduced interest rates further and made major loans to banks to prop up the country's economy. More changes have happened since this time, including the Check Clearing for the 21st Century Act, which reduced the number of paper checks that have to be returned to consumers. Central banking in America has to continue evolving to keep up with changing times and expanding technology.

With the current inflation in the United States, some politicians think that drastic measures are necessary. One proposed solution is to raise interest rates. With higher interest rates, people won't borrow as much money, and they will pay back their current loans more quickly. Eliminating these loans will get this borrowed money out of circulation, which should help correct inflation. Returning the country to the gold standard would eliminate fiat money and could also help stabilize prices. A growing number of politicians and citizens also support a movement to audit the Federal Reserve. Politicians such as Rand Paul and Bernie Sanders support this campaign. This bill seeks to change current laws regarding how and when audits happen for the Federal Reserve. An audit is a special examination of financial activities conducted by an outside party. The proposed bill wants to force the Federal Reserve to be accountable for its board and its activities.