How the Federal Reserve was formed

The Federal Reserve is widely regarded as one of the most important financial institutions in the world. The Fed can be a kind help or a severe challenge, and its style is usually the function of the Federal Reserve Board of Governors. Its monetary policy decisions can not only make waves in the US market, but also in the world.

In this article, we will study the formation of the Federal Reserve and track its history of angering the market, then turn the market around and push it to new highs.

Key points

  • Although the United States early tried to form a central bank by Alexander Hamilton after the Revolutionary War, these efforts failed due to political infeasibility.
  • In the panic of 1907, at the urging of JP Morgan Chase and other famous financiers, Congress finally enacted the Federal Reserve Act in 1913, establishing the Federal Reserve as the central bank of the United States.
  • Since then, the Fed has played a vital role in guiding U.S. monetary policy and avoiding economic challenges.

The United States before the Fed

Before the establishment of the Federal Reserve, the financial situation in the United States was much more unstable. Panic, seasonal cash crunch and high bank failure rates have made the U.S. economy a riskier place for international and domestic investors to invest capital. The lack of reliable credit hinders the growth of many sectors including agriculture and industry. However, the Americans did not want a central bank in the early days because they thought it was based on the model of the Royal Crown and the Bank of England. The New America does not want to be portrayed as Britain, and it also supports a more decentralized state-by-state approach to its political economy.

Nevertheless, there are some early attempts. The first Secretary of the Treasury Alexander Hamilton played an important role in the establishment of the first national bank in the United States, the Bank of America. The building is located in Philadelphia’s Independence National Historical Park. It was completed in 1797 and is now a National Historic Landmark. It was one of the four major financial innovations at the time, including the U.S. government’s assumption of national war debts, the establishment of a mint, and the collection of federal excise taxes. Hamilton’s purpose of taking these measures is to establish financial order, national credit and solve the legal currency problem.

However, this first attempt at the Central Bank of the United States was short-lived, and its charter was not updated (later re-established in just a few years, as the second bank in the United States, its lifespan was even shorter). Hamilton proposed the establishment of the Bank of America in 1790 and opened it in Philadelphia the following year. In April 1792, it opened a branch in New York, which was the second bank on Wall Street. The franchise period of the First Bank of the United States is 20 years (1791-1811).

JPMorgan Chase and the Panic of 1907

After decades of no central bank, JPMorgan Chase finally forced the government to implement the central bank plan it had considered intermittently for nearly a century. During the banking panic of 1907, Wall Street turned to JPMorgan Chase to guide the country through the crisis, which might push the economy to the brink of total collapse and depression. Morgan was able to convene all the major players in his mansion and order all their funds to flow into the system, so that banks surfaced, and then companies surfaced, until the panic passed.

The fact that the government attributed its economic survival to private bankers forced the necessary legislation to establish a central bank and the Federal Reserve.

Learn from europe

Between 1907 and 1913, senior bankers and government officials in the United States formed the National Monetary Committee and traveled to Europe to learn about the operation of the central bank. They came back with a good impression of the British and German systems, based on them, and added some improvements collected from other countries. Congress finally passed the Federal Reserve Act of 1913, which created the current Federal Reserve System. Congress enacted the “Federal Reserve Act” to establish economic stability in the United States by introducing a central bank to supervise monetary policy. The law stipulates the purpose, structure, and function of the Federal Reserve System. Congress can amend the Federal Reserve Act, and it has done so many times.

The Federal Reserve Act of 1913, signed into law by President Woodrow Wilson, gave 12 Federal Reserve Banks the ability to print money to ensure economic stability. The Federal Reserve system created a dual mission to maximize employment and keep inflation low. Therefore, the Fed was given power over the money supply and the economy. Although the public and many forces within the government are calling for the establishment of a central bank that prints money on demand, President Wilson was swayed by Wall Street’s arguments against a system that would lead to rampant inflation. So the government created the Federal Reserve, but it is by no means under government control.

Great Depression

The government soon regretted the freedom it gave the Fed during the 1929 collapse and refused to prevent the subsequent Great Depression.

Even now, the debate over whether the Fed can prevent the depression is still going on, but there is no doubt that it could have alleviated and shortened the depression by providing lower interest rates for farmers to continue planting and enterprises to continue production. High interest rates may even cause uncultivated fields to become dusty. By restricting the money supply during bad times, the Fed starves many individuals and companies that could have survived.

Recovery after the war

It was World War II, not the Federal Reserve, that brought the economy out of the depression. The war also benefited the Fed, expanding its power and the amount of capital it was required to control for its allies. After the war, as the U.S. economy entered a bull market and almost never stopped until the 1960s, the Federal Reserve kept interest rates low to eliminate some bad memories of the Great Depression.

Inflation or unemployment?

Stagflation and inflation hit the United States in the 1970s and dealt a heavy blow to the economy, but the damage to the public far exceeds the damage to the enterprise. The Nixon administration intermittently ended the relationship between the state and the gold standard, making the Federal Reserve more important in controlling the value of the U.S. dollar. The big question facing the Fed is whether inflation or unemployment is better for the United States.

By controlling interest rates, the Fed can make corporate credit easier to obtain, thereby encouraging corporate expansion and job creation. Unfortunately, this will also increase inflation. On the other hand, the Fed can slow down inflation by raising interest rates and slowing down the economy, leading to unemployment. The history of the Federal Reserve is every chairperson’s answer to this core question.

Greenspan Times

Alan Greenspan took over the Federal Reserve a year before the infamous 1987 crash. When we think of a crash, many people think that the 1987 crash was not so much a real crash as a glitch—a non-event closer to panic. This is only because of the actions of Alan Greenspan and the Federal Reserve. Like JPMorgan Chase in 1907, Alan Greenspan assembled all the necessary leaders and kept the economy running.

However, through the Federal Reserve, Greenspan used low interest rates as an additional weapon to help companies tide over the crisis. This marked the first time the Fed had operated as the creator originally envisioned 80 years ago.

Following Greenspan, the Fed had to survive the 2008 financial crisis and the Great Recession under the leadership of Ben Bernanke and Janet Yellen. Then, during Trump’s presidency, Jerome Powell led the Fed through a period defined by the central bank’s lack of independence, political inclination to lower interest rates, and the expansion of the Fed’s balance sheet.

Bottom line

Criticism of the Fed continues. In the final analysis, these arguments focus on people’s impressions of economic managers. You can have a Federal Reserve that supports the economy with ideal interest rates, leading to low unemployment (which may cause problems in the future), or you can have a Federal Reserve that provides very little help, and ultimately forces economics to save itself. The ideal Fed is willing to do both. Although there have been calls for the abolition of the Fed as the U.S. economy matures, the Fed is likely to continue to guide the economy for many years to come.

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