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Section 1 The Federal Reserve System

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Objectives

After studying this section you will be able to:

1. Understand banking history in the United States.
2. Explain why the Federal Reserve Act of 1913 led to further reform.
3. Explain the structure of the Federal Reserve System.

Section Focus

To stabilize the nation's banking system, Congress created the Federal Reserve System in 1913. The Federal Reserve is owned by individual member banks. It is overseen by a small but powerful Board of Governors. As a private institution serving a public function, the Federal Reserve is a central bank relatively free from government control.

Key Terms

• Board of Governors
• monetary policy
• Federal Reserve Districts
• Federal Advisory Council (FAC)
• Federal Open Market Committee (FOMC)

The American banking system is a compromise between supporters and opponents of a central bank. As a symbol of this compromise, the Federal Reserve System is the privately owned, publicly controlled central bank of the United States.

Banking History

As you read in Chapter 10, the issue of a central bank has been debated hotly since 1790, when Federalists lined up in favor of a central bank. The first bank of the United States issued a single currency. It also reviewed banking practices and helped the federal government carry out its duties and powers. Partly because of the continued debate over state versus federal powers, however, the first bank lasted only until 1811. At that time, Congress refused to extend its charter.

Congress established the Second Bank of the United States in 1816 to restore order in the monetary system. However, many people feared that a central bank placed too much power in the hands of the federal government. Political opposition toppled the Second Bank in 1836 when its charter expired.

A period of confusion followed. States chartered some banks, while the federal government chartered and regulated others. Reserve requirements—the amount of reserves that banks are required to keep on hand—were difficult to enforce, and the nation experienced a series of serious bank runs. The Panic of 1907 finally convinced Congress to act.

The nation's banking system needed to address two issues. First, consumers and businesses needed access to increased sources of funds to encourage business expansion. Second, banks needed a source of emergency cash to prevent depositor panics that resulted in bank runs.

The Federal Reserve System is headed by the Federal Reserve Board of Governors. The first Federal Reserve Board of Governors, here, was seated in 1914.

Federal Reserve Act of 1913

Congress created the National Monetary Commission (NMC) in 1908 to propose solutions to the nation's banking problems. Based on the NMC's recommendations, Congress passed the Federal Reserve Act in 1913. The resulting Federal Reserve System, now often referred to simply as “the Fed,” was composed of a group of twelve independent regional banks. This central group of banks could lend to other banks in times of need.

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