U.S Banking and Federal Reserve History:
The Federal Reserve is the central banking system of the United States of America and is undoubtedly the most powerful monetary establishment in the entire world. Pretty much everyone alive in America has only lived in the era of the Federal Reserve Bank, but it was not always that way. Before 1913, there was no Federal Reserve Bank and the banking process in America was a real serious work in process. Federalreserveeducation.org said that people in the early history of America were very afraid of a powerful central bank. In 1791, the United States Congress started the First Bank of the United States and it was a very powerful bank that was under a lot of controversy. The bank had a 20-year charter and was not renewed once that 20 years was up. The next attempt at a central bank actually included 2 separate central banks and this created even more controversy than the last attempt. There was so much controversy that Andrew Jackson vowed to get rid of the flawed system. Once this happened there was a time of free banking and this can be defined as a time where basically anyone with a good amount of money could open up his or her own bank. These banks could run as long as they could issue notes that were redeemable in gold or specie. As time went on, the National Banking Act made it so that these banks and their notes had to be backed by Government securities. This was not a well working system because these banks had poor currency efficiency due to the fact that only the value of U.S Treasury bonds changed the currency. People began to withdrawal their money from these banks and as the panic got worse and worse, it all led to President Woodrow Wilson signing the Federal Reserve Act on December 23rd, 1913. A quote from federalreserveeducation.org described this as a classic example of compromise and, “a decentralized central bank that balanced the competing interests of private banks and populist sentiment”. The Federal Reserve era began and began looking like another failed system and then went under a lot of scrutiny during the Great Depression. Many people thought that the Federal Reserve should have stimulated the economy more and should have pursued more policies that could have lessened the profundity of the Depression (federalreserveeducation.org). The Great Depression was a really good learning opportunity for America when it came to banking. Adding to this, the Federal Deposit Insurance Corporation (FDIC) was created to back up their money and monetary policy was used more effectively.
Federal Reserve Structure:
The Federal Reserve has a complicated structure that includes a lot of people and moving parts that make it function like it does. The Federal Reserve website outlines its structure has having 1 Central Bank, 3 key entities, and 5 key functions. The 3 key entities include the Federal Reserve Board of Governors, the 12 Federal Reserve Banks, and the Federal Open Market Committee. These 3 entities conduct the nation’s monetary policy, maintain the stability of the financial system, supervise and regulate financial institutions, foster payment and settlement system safety and efficiency, and promote consumer protection and community development (federalreserve.gov). The Board of Governors is in place to study economic issues, as well as serve on the FOMC so that they can express the monetary policy of the U.S. They are appointed to a 14-year term by the President and then confirmed by the U.S. Senate. Fedfocus is a website that gives new and information about the Federal Reserve Banks and they describe that Board of Governors as playing a vital role in the system and “by law, the appointed members must yield a ‘fair representation of the financial, agricultural, industrial and commercial interests and geographical divisions of the country’” (frbservices.org). Although the term limit is 14 years, a governor can be appointed to complete another person’s term and then be appointed for a full 14-year term after that. To go along with these governors, a chair and vice chair are appointed by the President and serve 4 year teams and they are required to tell the Congress the Federal Monetary Policy 2 times every year.
The Federal Reserve is split up into 12 districts and the 12 Federal Reserve banks that are in the United States outline this. The reserve banks are very important because it helps the Board of Governors consider all the aspects of the American economy and reaching out to every region of the United States effectively gets this job done. That is why this aspect has not changed since its creation in 1913. The website for the federal reserve bank of Atlanta gives information of the 12 districts and says that the 12 regional reserve banks get together about every 12 weeks with some of the Board of Governors to go over how the economy is acting. This meeting is called the Federal Open Market Committee or the FOMC (frbatlanta.org).
FOMC:
The Federal Open Market Committee meets eight times every single year so that they can go over the economy and set important interest rates. They also decide whether or not they should increase or decrease the money supply based on the Fed’s buying and selling government securities. The operations that the FOMC directly affect the federal funds rate and this can influence the entire economy as well as overall monetary conditions. The FOMC has 7 members of the Board of Governors, the president of the FRB of New York, as well as 4 of the presidents of the Regional Federal Reserve Banks. The 4 presidents are decided on by a 1-year rotation and although only 4 of them vote, they all attend the meetings of the FOMC anyways so that they can give information about their district. There is also a chair of the FOMC who is currently Janet Yellen and she is basically the voice of the Federal Reserve. Janet Yellen is well known to be more concerned with the unemployment rate rather than the inflation rate. These two topics are normally at the top of the discussion when these meetings occur. Yellen wants to do what she can to control the unemployment rate and get more people into the workforce making money for themselves rather than taking it from the government.
The Federal Funds rate is a big topic of discussion when concerning the FOMC because they direct affect it and have to make predictions that the whole country is listening to. The Federal Funds rate is described by federalreserve.gov as the, “interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight”. Depending on how this rate is influenced, it can also effect other short and long-term interest rates, foreign exchange rates, as well as employment and prices of goods and services (federalreserve.gov).
The two charts about were posted by the Federal Reserve to show the FOMC’s target federal funds rate and the percent change and level of the Interest rate. Over the past 2 years they have increased by 25 back to try and get to 1. During the financial crisis in 2008 this level started out as high as 3.5 and it has since decreased significantly. The chart below shows the significant drop off since 2007 and where we are now as we begin to rise up to a stable point in our system. Although the real rate is not exactly the target rate, the FOMC does what it can to try and keep the actual rate as close to the Target Rate as possible. The interest rate dropped so much because of the reserves we used to prevent a large collapse of our financial system.
Strategic Role during and after The Great Recession:
In the summer of 2007, a financial crisis occurred and it led to what is known as the Great Recession. The housing market in America crashed after a large boom a lot of securities that were backed with mortgages and derivatives lost their value significantly. The housing market in America had just experienced the biggest increase in home prices over the span of 8 years going into the time of recession. Following this, home prices fell about 30% over the 3-year period of recession due to the fact that the houses were not worth the kind of loan that was made to originally buy them. (Federalreservehistory.org). This Great Recession was described by Investopedia as the worst financial crisis since the famed Great Depression. During this time, “the United States alone shed more than 7.5 million jobs, causing its unemployment rate to double. Further, American households lost roughly $16 trillion of net worth as a result of the stock market plunge” (Investopedia.com). On top of all of this, GDP fell 4.3% and the unemployment rate rose from 5% to 9.5% during the time of the Great Recession. Another reason for the recession had to do with lenders giving high-risk borrowers, with bad credit, mortgages and this made the demand for homes greater (Federalreservehistory.org). Many people were in a panic and looked towards the FOMC for answers to this huge dilemma. The FOMC, headed by Chairman Ben Bernanke, did respond to this crisis and they acted aggressively by creating multiple programs that were made to support the liquidity of financial institutions and adopt much better conditions in our financial markets, which changed the Fed’s balance sheet significantly (federalreserve.gov). One of the big changes that they did was bring down the target interest rate of the Federal Funds Rate to nearly 0%, which helped promote liquidity and gave out $7.7 trillion of emergency loans to banks. Many believe that the aggressiveness of the Federal Reserve helped prevent even more damage to the economy from a global scale (Investopedia.com).
Although a lot of the crisis-related programs are now closed and not in place, the Federal Reserve and FOMC have continued to put regulations in place to make sure that a crisis like this never happens again. The Federal Reserve has stated that over recent years, they have taken action to make, “substantial purchases of longer-term securities aimed at putting downward pressure on longer-term interest rates and easing overall financial conditions” (Federalreserve.org). This shows that they are trying to fulfill their statutory objective for monetary policy (which will be discussed more in the next section). Even though they are making efforts to stop something like this from ever happening again, many people still feel as if our current financial system is still broken and flawed. It has now been up to Janet Yellen and the current FOMC to try and put people at ease as much as they possibly can.
Monetary Policy: