How did the Federal Reserve evolved since 1913?
The development of the Federal Reserve came out of the
Aldrich-Vreeland Act of 1908 that was in response to the 1907 panic, which
provided emergency currency. It established the National Monetary Commission to
come up with a long-term plan to address future financial crisis and they
suggested a banker-controlled plan versus a decentralized central bank. With
the election of Woodrow Wilson, also known as the father of public
administration, solicited advice from Virginia Rep. Carter Glass (Federal
Reserve, 2016; Heritage Foundation 2016).
Rep. Glass eventually became the chairman of the House
Committee on Banking and Finance. Glass partnered with H. Parker Willis to come
up with a central bank proposal. In December of 1912, they presented President
Wilson with the Federal Reserve Act. In 1913, President Wilson signed the
Federal Reserve Act into law. In 1914 the central bank began operations, then
from 1914 to 1919 WWI broke out, and banks were able to operate normally
because of emergency currency issued under the Aldrich-Vreeland Act of 1908. In
the 1920, after WWI Benjamin Strong was the head of the New York Fed from 1914
till his death in 1928. He realized that gold could no longer be what
controlled credit. Strong during his chairmanship encouraged relationships with
other central banks in other countries, particularly the Bank of England
(Federal Reserve, 2016).
The stock market crashed in October of 1929. In Milton Friedman’s
film “Freedom to Choose,” he said that the bank failures in the South and
Midwest created a recession, however it did not become a crisis till it reached
New York, and the failure of the Bank of the United States started the domino
effect of “bank runs,” (customers withdrawing their money from banks) in New
York and across the country. From 1930 – 33 10,000 banks failed. The Federal
Reserve at the time that was created to help prevent the eventual depression
did not do enough to help intervene, by preventing the failure of the Bank of
the United States (Federal Reserve, 2016).
The Great Depression changed the way the Federal Reserve
would respond to economic crisis with the passing of the Glass-Steagall Act,
which called for the separation of commercial and investment banks and also
providing securities for Federal Reserve notes. The Act also established the
Federal Deposit Insurance Corporation (FDIC), and President Roosevelt also
ended the gold standard. After WWII the Treasury-Fed Accord was created so the
Fed was not obligated to monetize the debt of the Treasury at a fixed rate.
This was essential in how monetary policy is followed by the Fed today. In the
80’s there was a move to deregulate banks, and in 1999 the Gramm-Leach-Bliley
Act passed which overturned the Glass-Steagall Act of 1933. This helped pave
the way for the mortgage crisis, because of sub-prime loans and complex
derivatives in 2007 and recession following the failure of both Lehman Brothers
and Washington Mutual (Wigan, 2007; Federal Reserve, 2016). To help prevent the
2008 recession to turn into a depression the Fed stepped in and used
unconventional policy tools to save the banking industry and climb out of the
recession faster.
What does Ben Bernanke, past chair of the Federal Reserve; think about how the Fed is now coping with the post-2008 crisis
Bernanke is no longer the chair of the Federal Reserve and
last year was on a book tour promoting his book, “The Courage to Act.” He
believes that the recovery from the crisis was put on the Fed to fix when there
should have been more done by Congress and political leaders, who were refusing
to provide more stimulus measures. Because of the government shut downs and
lack of quick and decisive action from Congress it slowed growth and delayed
the recovery (Fernandes, 2015).
Bernanke is critical of Congress trying to
create legislation that would give Congress the ability to set interest rates
and not the Fed. He notes that the current political climate which is very
polarized would only create deadlocks in Congress on important economic issues
(Fernandes, 2015).
How, from Bernanke’s point of view, there is a direct
connection between the Great Depression and this recent mortgage crisis
Barnanke states, “September and October of 2008 was the
worst financial crisis in global history, including the Great Depression”
(Egan, 2014, para. 1). Barnanke had written several papers on the Great
Depression. David Jones, a former Fed economist said, “The solvency of the
whole banking system was in question” (Egan, 2014, para. 15). The effects of
the mortgage crisis were far reaching, and overseas banks were in need of
saving, too. The difference between the Fed of the Great Depression and the Fed
of the Great Recession was the response to the crisis. Barnanke’s Fed responded
aggressively after Lehman Brothers and Washington Mutual both went bankrupt.
Because 12 of the biggest financial institutions were at risk of failure all at
the same time. Barnanke learned from the mistake of the Fed’s response or lack
of during the 1930s. He knew if they did not act and intervene by providing the
billions of bailout and stimulus dollars needed to save the banks and the
economy, we would have been looking at a crisis that would have surpassed the
Great Depression (Egan, 2014; Fernandes, 2015).
What risks in current monetary policy may be with
respect to the long-term performance of the American economy.
The slowdown in global economic growth has contributed to
the rising dollar and declining commodity prices. Net exports have made
noticeable negative contributions to U.S. growth. Our aging population, savings
rates globally increasing, lower productivity, lower interest rates around the
world, is deterring structural investments and capitol stock which can lead to
secular stagnation or lack of economic growth. Lower potential for growth means
lower returns on investments (Evans, 2016).
Moreover, the incoming labor force does not match the needed
experience of retiring baby boomers which can also effect slower economic growth.
Monetary policies can do little to address labor force trends or technological
progress. The policies that were enacted after the Great Recession has helped
to slowly build our current economy back to pre-recession numbers however
long-term growth will depend on the U.S. to increase productive resources
(Evans, 2016). In conclusion, our current monetary policies will need to
address slow long-term growth.
References
Egan, M. (2014). 2008: Worse than the Great Depression?
Retrieved September 16, 2016 from http://money.cnn.com/2014/08/27/news/economy/ben-bernanke-great-depression/
Evans, C.L. (2016). The Implications of Slow Growth for
Monetary Policy. Retrieved September 16, 2016 from https://www.chicagofed.org/~/media/publications/speeches/2016/04-05-implications-monetary-policy-evans-credit-suisse-hong-kong-print-pdf.pdf
Federal Reserve (n.d.). History of the Federal Reserve.
Retrieved September 15, 2016 from https://www.federalreserveeducation.org/about-the-fed/history
Fernandes, D. (2015). Promoting book in Boston, Ben Bernanke
defend Fed. Retrieved September 15, 2016 from https://www.bostonglobe.com/business/2015/10/13/ben-bernanke-defends-fed-actions-during-financial-crisis/vVGrnnjNwDlPmk1yR7r14N/story.html
Friedman, M. (1980). Anatomy of a Crisis: Free to Choose.
YouTube Video. Retrieved September 16, 2016 from https://www.youtube.com/watch?v=SWVoPrntBso
The Heritage Foundation (2016). Woodrow Wilson on
Administration. Retrieved September 15, 2016 from http://www.heritage.org/initiatives/first-principles/primary-sources/woodrow-wilson-on-administration
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