Presentation on theme: "Central Banks and the Federal Reserve System"— Presentation transcript:
1 Central Banks and the Federal Reserve System Chapter 13Central Banks and theFederal Reserve System
2 The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design. – F.A. Hayek
3 Historical Development of the Banking System Figure 1
4 Pre-FedThe first Bank of the United States was chartered in 1791 (The Feds Before the Fed by Trask)The Federalistsargued that a national bank was necessary to bolster the credit and assist the fiscal operations of the federal government.3/4 of its capital was composed of government bonds.paper-money was still in its infancy… little was said of the need to regulate the currency.In 1811, Congress ended the first Bank of the U.S.the Jeffersonian Republicans that controlled the House did not renew the charter.A Senate tie was broken by vice president George Clinton (NY)
5 Pre-FedThe second Bank of the United States (The Feds Before the Fed by Trask)Congress declared war on Great Britain in June of 1812 touphold "free trade and sailor’s rights" (or seize Canada?)The Madison administration financed it byborrowing paper money from the banks and individualsprinting interest-bearing treasury notes.a classic Austrian-style boom ensued (inflation and specie was driven from the country).New Englandersrefused to lend money and state militia to the federal governmentContinued to trade with the British in CanadaNE banks vs. non-NE banksAs NE banks accumulated gold, non-NE banks were nearing bankruptcyNE’s currency remained backed by specie, the rest of the nation’s was depreciated bank papernon-NE banks suspended their gold standards when the British invaded the Chesapeake in 1814Inflation exploded as non-NE banks expanded their issueswriters began praising the flexibility, expansibility, and wealth-creating power of the paper currencyThe federal government’s revenue was collected in depreciated bank paper or treasury notes, and bonds could only be sold by offering enormous premiums.
6 Pre-FedThe second Bank of the United States (The Feds Before the Fed by Trask)In 1815, Madison lobbied for a second national bank toremedy the of the consequences of its monetary policiesboost the credit of the governmentprovide a “uniform national currency”pressure the state banks to resume specie paymentscurtail state bank’s excessive note issues.Madison’s critics arguedCongressman Ward (MA): If the gov’t wants banks to resume paying hard money, it could refuse to accept the notes of nonspecie paying banks for the payment ofimport dutiesthe purchase of public landsthe buying of government bondsJohn Randolph of Virginia: the national bank will aggravate rather than remedy the situationSenator William Wells (DE): This bill came out of the hands of the administration ostensibly for the purpose of curtailing the over-issue of Bank paper: and yet it came prepared to inflict on us the same evil, being itself nothing more than a simple paper making machine; and constituting, in this respect, a scheme of policy about as wise, in point of precaution, as the contrivance of one of Rabelais’s heroes, who hid himself in the water for fear of the rain. The disease, it is said, is the Banking fever of the States; and this is to be cured by giving them the Banking fever of the United States.
7 Pre-Fed The second Bank of the United States (continued) In 1816, the charter for the second Bank of the U.S. was approvedhard-money Federalists and Old Republicans opposed itIt was to be capitalized at $35 million$7 million in specie$28 million in government bondsWas it a financial windfall for politically connected bond holders?Paid-in capital $35 million$2 million in specie$21 million in government bonds$12 million in stock notes19 branches opened throughout the nation by the end of the yearIt formed collusive agreements with private banks of the Atlantic citiesIt encouraged southern and western banks to inflateIt backed $43 million with $2 million in specieWith reserves all but depleted by mid-1818, its actions below lead to the panic of :curtailed lendingcontracted their notes to avoid suspending paymentcalled in loansrequired balances due them by the state banks be paid in hard money or national bank notes
8 Pre-Fed The second Bank of the United States (continued) In 1816, the charter for the second Bank of the U.S. was approvedIn the two years previous to the panic of 1825It lent its own notes and accepted state bank paper as payment to increase its circulation and subdued state banksincreased its circulating notes by 105 percent while the state banks did so by only 57 percentDuring the period,it increased its circulation by 64%The banks of NY and PA increased their notes by 29% and 21%, respectivelyThe bank that was charged with regulating other banks inflated at twice their rate.The more it inflated, the more state banks inflatedPresident Jackson withdrew deposits from the Bank of the U.S. in 1833Its federal charter expired in 1836, but survived as a PA state bank (under Nicholas Biddle)It helped fuel the inflation ofIt opposed the resumption of specie paymentsIts inflationary policies soon wrecked the bank and it closed its doors for good in 1841A fractional-reserve profit-making institution’s tendency is to inflateA quasi-government bank’s tendency is to allow government to borrow and finance wars.Samuel Tilden (Sen. NY): “How could a large bank… be expected to regulate beneficially the lesser banks… Has concentrated power been found less liable to abuse than distributed power?”
9 Pre-Fed The second Bank of the United States (continued) Historians and economists have lauded this institution (e.g., Hammond, 1957)beneficial control over the currencyIt successfully regulated and restrained the state banksIt was a good steward of government fundsIt was an example of fruitful private/public partnershipAustrians and hard-money criticsIt was inflationaryIt did not prevent the destructive business cycleIt inhibited the emergence of a system of noninflationary private bankingIt was an institution that behaved much as the Federal Reserve System does today
10 The Federal Reserve System Source: Federal Reserve Bulletin.
11 The Federal Reserve System Established in 1913Regulates banksSupervises the payments systemSets reserve requirementsIs the lender of last resortcomprised of twelve district banksis managed by the Board of Governors (BOG)7 BOG membersappointed by the Presidentconfirmed by the Senateeach serves for 14 years, cannot serve more than 1 complete term, and cannot be removed for political reasons.terms are staggered every two yearsprovides a modicum of certainty to markethinders political influence from elected officials.is funded bycheck-clearing feesinterest collected on loans to commercial banks and governmentHinders political influcence from elected officials
12 The Federal Reserve System Independence of the Fedallows it to pursue policies that are ‘best’ for the economy, not the President or Congressis somewhat limited bythe President appointing and the Senate confirming a board member to serve as chair every four years.submitting biannual reports to Congressbeing annually audited by Government Accountability OfficeBOG members testifying before Congressional committeesBOG members meeting or working with theCouncil of Economic AdvisorsTreasuryFederal Advisory CouncilFederal Deposit Insurance Corporation
13 The Federal Reserve System The Federal Open Market Committee (FOMC)sets monetary policy for the Fedis chaired by the chair of the BOGis comprised of7 members of the BOGthe President of the New York Federal Reserve Bankfour presidents of the other eleven District Bank PresidentsThe first is from Boston or PhiladelphiaThe second is from Dallas, Atlanta, or Kansas CityThe third is from Cleveland, Chicago, or RichmondThe fourth is from San Francisco, Minneapolis, or St. LouisAll sit but only four of the remaining 11 presidents votemeets once every six weeks (on Tuesdays) to set monetary policy:low steady inflation2-3 percent per yearNot bad in the short-run, a $1 turns into a penny over 100 yearsfull-employment5-6 percent unemploymentu = 1 – E/Lreal GDP = potential output if u = un
14 The Federal Reserve System The strongest argument for an independent central bank rests on the view that subjecting it to more political pressures would impart an inflationary bias to monetary policyPolitical pressure would impart an inflationary bias to monetary policyPolitical business cycleCould be used to facilitate Treasury financing of large budget deficits: accommodationToo important to leave to politicians—the principal-agent problem is worse for politiciansProponents of the Fed being controlled the President or Congress argue that it is not wise to allow an elite group that is responsible to no one conducting monetary policyUndemocraticUnaccountableDifficult to coordinate fiscal and monetary policyHas not used its independence successfully
15 The Federal Reserve System The Chairman of the BOG has the power becauseSpokesperson for the Fed and negotiates with Congress and the PresidentSets the agenda for meetingsSpeaks and votes first about monetary policySupervises profIs it wise to have one person with this much power?