Federal Reserve System

Founding

• Established on December 23, 1913, when President Woodrow Wilson signed the Federal Reserve Act
• Created to address banking panics and monetary policy weaknesses that led to economic instability
• Original purpose:
  • Provide an elastic currency (able to expand and contract as needed)
  • Prevent banking panics and maintain financial stability
  • Supervise and regulate banking institutions
  • Act as a lender of last resort during times of financial stress

Monetary Policy

• Dual Mandate: maximize employment and price stability (low inflation)
• Tools used to implement monetary policy:
  • Open Market Operations (buying/selling government securities to increase/decrease money supply)
  • Discount Rate (interest rate at which banks borrow from the Fed)
  • Reserve Requirements (percentage of deposits banks must hold in reserve)
• Monetary Policy Objectives:
  • Inflation targeting: keep inflation low and stable
  • Maximum employment: promote job growth and low unemployment
• Frameworks:
  • Taylor Rule: guideline for setting interest rates based on inflation and GDP growth
  • Forward-Looking Policy: considering future economic conditions when making policy decisions

Crisis Response

• 1913-1920s: Early years marked by struggles to establish credibility and respond to World War I financing needs
• Great Depression (1929-1939):
  • Fed's slow response and restrictive policies exacerbated the crisis
  • Led to significant reforms, including the Banking Act of 1935
• 1970s-1980s:
  • High inflation and unemployment led to the appointment of Paul Volcker as Chairman
  • Tight monetary policy (high interest rates) to combat inflation
• 2007-2008 Global Financial Crisis:
  • Unconventional monetary policies, including quantitative easing and forward guidance
  • Emergency lending facilities and stress tests to stabilize the financial system