U.S. Federal Reserve Banking System

U.S. Federal Reserve Banking System
U.S. Federal Reserve Banking System

The Federal Reserve is the system of banking used since 1913 in the United States. Until the Federal Reserve Act of 1913, the U.S. banking system fell under the domain of the Civil War United States Banking Act. Historically, the United States used a central banking system.

Federal statute legislated the First Bank of the United States in 1791 and the Second Bank in 1816. A free banking era without a central bank reigned from 1837 to 1862, followed by the 1863 National Banking Act.

The panic of 1907, however, revealed the weaknesses of the Civil War legislation and, mixed with the national impetus to improve government that came with the progressive era, a push began to organize a more appropriate institutional structure for a national bank.

The panic of 1907 illustrated the inflexibility of monetary policy under the Civil War–era structure. Monetary reserves were located in New York City and a handful of other larger cities. The location of reserves made it difficult to mobilize and distribute funds in geographically appropriate locations.

The progressive response, familiar in many other areas of governance, gained momentum in the banking system, and a demand for a more responsive and organized way of dealing with monetary issues blossomed. In 1913 Democrats and Republicans disagreed over the institutional structure necessary to address the difficulties revealed by the Panic of 1907.

Republicans preferred a third national bank of the United States. The bank would be owned and run by the commercial banking community, who would issue a central currency. On the other hand, the Democratic solution emerged from the Pujo Committee.

Federal Reserve building
Federal Reserve building

Arsène P. Pujo argued that the power of financial monopolies rested in the hidden vaults of Wall Street. Hence, Democrats called for a system that was more decentralized, privately owned, and free from the control of the bankers of Wall Street.

Woodrow Wilson signed the Federal Reserve Act into law in 1913. According to many historians, the Federal Reserve became the most significant economic legislation between the Civil War and the New Deal.

The Federal Reserve system that resulted carried the United States through World War I and heralded progress of the United States toward the modern economic age. At the end of the day, however, the legislation failed in its primary purpose—preventing economic depression.

Out of the legislation of 1913 came a Federal Reserve Board. The board members were appointed by the president and oversaw a nationwide network of 12 regional reserve districts—each serviced by its own central bank: Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.

In turn the regional banks were owned by member financial institutions. The Federal Reserve Board assured a great degree of public control over the regional centers. Finally, the Federal Reserve Act empowered the board to issue "Federal Reserve Notes" as legal tender in the United States.

The Federal Reserve (Fed) also engages in a number of responsibilities necessary for economic well-being. It supervises all member banks and creates the mechanisms needed to control monetary policy. The Fed also controls the amount of currency produced and destroyed in close partnership with the Mint and Bureau of Engraving and Printing.

An important final point with regard to the Federal Reserve is its status as an independent agency. The Second Bank of the United States, during the 1830s, evolved into a political weapon used by Jackson and his Democratic supporters against the Whig Party. The intent and result of the 1913 legislation was to make the Federal Reserve independent of the executive branch.

The decisions of the Federal Reserve are subject to the guidelines of the Freedom of Information Act, but the actions taken by the Fed need not be ratified by the president or anyone else in the executive branch.

The result has been an independence that allows the chair of the Fed and the Federal Reserve Board the latitude to implement far-reaching policies instead of the knee-jerk reactions common to partisan politics.

Oversight of each Federal Reserve Bank is provided by the overall Board of Governors, who are appointed by the president and confirmed by the Senate. Members of the board are limited to one 14-year term and can only be removed by the president of the United States for cause.