The Fed Under Alan Greenspan

Bankers prior to the establishment of the Federal Reserve would establish lines of credit with larger banks. In the event of a run, the smaller bank would draw on the line of credit. In times of panic, large numbers of depositors would demand to withdraw their money, and only the largest Wall Street banks, with millions of dollars in reserve, could guard against this. In the early twentieth century, people were running to withdraw all their cash from their accounts, this may seem dramatic, almost theatrical to people today. Nevertheless, to people living in an economically unstable society, they were an expected occurrence. The banks were independent rivals, the amount of currency in circulation was fixed, and there was no element of trust between the depositor and the bank. However, in an attempt to avoid bank runs, they were storing their money for the inevitable, which meant they did not lend any money out, bringing the economy to a standstill. The credit system of the country had ceased to operate, and thousands of firms went into bankruptcy. Something had to be done that would provide for a flexible amount of currency as well as provide cohesion between banks across the United States. A large regulated bank, like the Federal Reserve, could make this happen which was to establish banks as a united force working for the people instead of independent agencies working against each other. By providing a flexible amount of currency, banks did not have to hoard their money in fear of a bank run, so there was no competitive edge to see who could keep the most currency on hand and a more expansionary economy was possible.

President Wilson passed the Federal Reserve Act into law December twenty-third, nineteen thirteen, which created the Federal Reserve System and converted central banking into a government monopoly. All nationally chartered banks were required to maintain reserves with a regional Federal Reserve Bank. The regional reserve banks would be managed not for profit and in the "public interest," by political appointees. The Act divided the country into twelve districts, each district with its own banking "center." The banks within each district were then divided up with respect to size, so that small banks, medium banks, and large banks all have the same voting power. An appointed board of governors would oversee all bank operations within their respective districts, and the Federal Reserve would control the distribution of all currency. The Federal Reserve Act also required that all nationally chartered banks must be members of the Federal Reserve System. However, it was not met without criticism. It was said to have reflected the rooted dislike and distrust of banks and bankers that has been for many years and there should not be absolute political control over the business of banking. Despite some strong opposition it was made clear that although government influence would be present, it was designed to be free from personal or party politics. The public, much quicker than Wilson had anticipated, as he described the Act as a "constitution of peace" for the private businesses of the nation, accepted the Act quickly. The Act was not perfect, however, and the last sentence of the Act states: "The rights to amend, alter, or repeal this Act is hereby expressly reserved." In fact, an overlying theme of the Federal Reserve Act was one of uncertainty; and many of the provisions used language like "under the rules and regulations to be specified by the Federal Reserve Board," and "subject to review and determination of the Federal Reserve Board." The rules had to be developed as the game was learned. The Federal Reserve Act helped to stabilize the volatile banking system. No longer were banks independent organizations working against each other. Now they were secure interrelated operations. The Federal Reserve Act worked because it eliminated the competition to hoard money between the banks and put the power into the hands of the government. Now, credit could be made available to expanding businesses, jobs could be created, and the banks would no longer have to worry about bank runs "running" them out of business. Because of the Federal Reserve Act, the economy could once again become expansionary with confidence.

The Federal Reserve has many division incorporated into it so there is a constant balance of power and no one sect has too much power. The Fed consists of a board of governors, twelve Federal Reserve Banks, the Federal Open Market Committee (FOMC), the Federal Advisory Council, and a Consumer Advisory Council. When the Federal Reserve Act was passed, it was designed with an overall purpose to oversee the economy. The Federal Reserve acts as the government's bank in maintaining the Treasury Department's checking account and clears U.S. Treasury checks. The Fed processes a wide range of electronic payments for the government, such as Social Security and payroll checks as well as issue, transfer, and redeems U.S. Treasury securities and conducts Treasury securities auctions. The Fed also regulates the nation's financial institutions to ensure their financial soundness and compliance with banking, consumer, and other applicable laws and has the responsibility for writing rules and enforcing a number of major laws that offer consumers protection in their financial dealings. The Federal Reserve acts as a lender to provide credit to depository institutions to help them adjust to unexpected changes in the deposits due to seasonal or emergency reasons. Depository institution are kept running by services that the twelve reserve banks offer. The twelve reserve banks store currency for the depository banks, discard worn and damaged currency, and replace it with new currency. The reserve banks also sorts checks that are written for other banks and transfer it to the appropriate bank. By far the most important job the Federal Reserve has is maintaining a sound monetary policy.

The high rate of inflation, in the early nineteen-seventies, caused the government to adopt a disastrous policy of direct controls on wages and prices. These controls not only screwed up the functioning of markets in allocating resources, leading to widespread shortages, but these controls did not seem to even cause a decrease in inflationary expectations as some people had hoped. Then the negative innovations in productivity hit, mainly in the form of "supply shocks", resulting from sharp increases in world oil prices. History has proven that negative innovations in productivity cause unemployment to be temporarily higher so the Fed attempted to counteract this increase in unemployment, but was unsuccessful because the Fed was too concerned about inflation, which resulted in an increase in both unemployment and an even higher rate of