The Federal Reserve System - Research Paper Example

?History and purpose of the Federal Reserve System: Then and Today History and those visionaries must always be regarded with gratitude because they were the ones who have laid the foundation through which America achieved its status today. For instance, there is the sophistication of the current American financial system that effectively provides the capacities and requirements of the contemporary corporate-industrial system. This was made possible thanks to economic theorists of old such as Thorstein Veblen and Joseph Schumpeter who have espoused arguments and principles that eventually became antecedents of economic change and innovations. An offshoot of the vision-driven innovations was the establishment of the Federal Reserve System or more informally known today as the Fed. It is the central bank of the United States, a unique governmental entity mandated to safeguard the economy. This paper is an investigation of this agency – its story and its importance to America. History The aftermath of the Civil War, in addition to the instability and conflict happening elsewhere, specifically, in Europe, led to the critical environment that required the foundation of an agency such as the Federal Reserve System. The turmoil of the period created instability in the American domestic banking sector. A series of banking panics occurred in the years 1873, 1884, 1893 and 1907. The panic of 1907 is particularly regarded as the most severe, prompting bankers to clamor for a centralized banking. The crisis was serious because by that year, the number of banks operating in the US was nearly twenty five thousand and that approximately seven thousand were under national law (Preston, 204). The lack of centralization posed a crippling problem especially in area of regulation, control and unity necessary in taking effective actions. According to Rothbard (2008), “the bankers found that the helpful centralization of the national banking system was not sufficient,” and that a central bank was required to play the role of the lender of last resort – one who would always ready to bail out banks in trouble (230). The fundamental reasoning is that the lack of regulation and control in a sector characterized by rapidly expanding supply and flow of money is in always in danger of contracting and collapsing every time panics, crisis and depressions occur in the economy. The general consensus back then was to abandon the laissez faire attitude and adopt the progressive approach by establishing the central bank, which would have an absolute monopoly of note issue and reserve requirements in addition to ensuring a multilayered pyramiding on top of its notes and the responsibility of helping banks in distress and controlling currency movements (Rothbard 2008, 233). Through the efforts and recommendations of the National Monetary Commission, the Federal Reserve Act was enacted. The Act clearly stated that its primary aim is “to provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision in the United States, and for other purposes” (Grey 2002, 10). Oppositions The passage of the Act, however, was met with resistance coming from several sectors. The most pervasive of these was the critics’ perception that centralized economic institutions were equated with the ‘money-power’ or the north-eastern financial establishment. They were opposed to the idea of a central bank, fearing that it would most certainly come under its influence. There was also the argument that a central bank would reduce the private bank’s influence. Opposition also was not confined to the banking sector alone. There are those who raise questions about the need for Congress to fund the central bank given the fact that banking is an entirely private enterprise. The reason for this is that other sectors raised the problem of trustworthiness of bankers and the banking industry with their values exclusively guided by profit and greed. The New York Times, for example, wrote against the act, positing that it “reflects the rooted dislike and distrust of banks and bankers that has been for many years a great moving force in the Democratic Party… The measure goes to the very extreme in establishing absolute political control over the business of banking” (Hafer 2005, 127). The debate was intense and protracted, finally forcing policymakers to balance all interest before the Act was passed into law in December 1913. Through his examination of the process, Thomas (2005), noted: The act achieved a delicate balance and diffusion of power in three different areas: (1) between government and private sector; (2) among various geographic regions of the nation and between rural and urban interests; and (3) among bankers, the non-bank business sector, and the rest of society (288). The Board of Governors called for by the act provided the mechanism for centralization, while the Federal Banks balanced this centralized authority because of their autonomy. The Federal Reserve is also different from all of governmental agencies because it is partly controlled by the private sector. The Board is a federal agency but the Reserve Banks are not and this is in addition to the fact that Federal Reserve does not follow the familiar federal structure of a “top-down” hierarchy (GAO 1996, 22). The Government’s Role The Act required the foundation of up to twelve Federal Reserve Banks that would serve as policy coordinators of the Federal Reserve Board headquartered in Washington. Hafer explained that the Federal Reserve authority rests on the policymaking power of the system given to the hands of the reserve banks and that “the banks were given a direct role in solving the problems that had confronted the nation’s banking system” (127). The Board of Governors shared power and responsibilities with the Federal Reserve Banks in may areas of cooperation. This, however, will change as years pass and circumstances forced policymakers to introduce a series of amendments. In 1930, for example, an amendment transferred a significant amount of authority from the Federal Reserve Banks to the Board of Governors. A series of amendments also followed, further expanding the role of the government when it was finally determined that the Federal Reserve has important and broad impacts on the national economic and financial policy. For instance, during the 1930s the amendment was introduced to centralize decision-making and create the Federal Open Market Committee. Furthermore, there are key laws enacted separate of it that affect the Federal Reserve Act. As listed by Grey, they include: the Banking Act of 1935; the Employment Act of 1946; the 1970 amendments to the Bank Holding Company Act; the International Banking Act of 1978; the Full Employment and Balanced Growth Act of 1978; the Depository Institutions Deregulations and Monetary Control Act of 1980; the Financial Institutions Reform, Recovery, and Enforcement Act of 1989; and the Federal Deposit Insurance Corporation Improvement Act of 1991 (10). The Federal Reserve Today The Federal Reserve System today is classified as an independent central bank because it is exempted- or that its policies are not subject to presidential approval. The institution, however, is under congressional oversight. This is not surprising because the legislature funds the institution and has, therefore, has the power to scrutinize its activities. This is particularly in the context of the framework of the overall purposes of economic and financial policies of the government. According to Grey, the most appropriate description of the Federal Reserve System is that it is “independent within the government” (10). The current basic structure of the System includes the Board of Governors, whose seven members are appointed by the president and confirmed by the Senate, the 12 federally chartered corporations known as Federal Reserve Banks. Essentially, the Federal Reserve today is mandated to stabilize the United States’ economy through the control of interest rates and the currency supply. This is very different from the Federal Reserve System’s original mandate, which was more on the basic responsibilities. The massive responsibility today, explained Thomas, “evolved based on experience, development of macroeconomic analysis, and legislation” (288). Criticisms The Federal Reserve System today has its share of critics. This is not surprising because the regulatory powers of the agency affect many people and organizations. The fundamental argument against is the accusation of bias, that by monopolizing or controlling a particular aspect, it supposedly discriminate those that are adversely affected. For instance, the bank was accused of monopolizing deposits and discriminating against farmers and small businesses in favor of speculators, the packers and the middlemen (Wright 1980, 260). Any sector or individual could attack the System with this accusation. Another serious and legitimate criticism against the Federal Reserve System is that one aimed at its autonomy. Many people believe that it has too much independence for an organization given so much authority over the American economy, spanning the economic well-being individuals, groups and businesses. According to Mastrianna (2009), even some economists seek to restrict such autonomy because it is believed that in some instances, the Federal Reserve only worsens economic conditions by stabilizing the economy through the rigid control of the monetary policy (309). Conclusion The Federal Reserve System is a crucial component of the American economy. Its regulatory power ensures that stability is maintained and crises are averted. In instances wherein financial crash occurs such as what happened back in 2008, the Federal Reserve has the capability to introduce and enforce corrective reforms. Since its inception and establishment, the System has acquired massive power and responsibilities over the American economy and economic policy. There are, unarguably some missteps and, indeed, the System, is not entirely perfect. But, so far, it has been effective in pursuing its mandate, which is to ensure the prosperity of America even in times of crises. Works Cited Government Acconting Office. Federal Reserve System: Current and Future Challenges Require Systemwide Attention. Washington, D.C.: DIANE Publishing Company, 1996. Grey, George. Federal Reserve System: background, analyses and bibliography. New York: Nova Publishers, 2002. Hafer, Rik. The Federal Reserve System: an encyclopedia. Westport, CT: Greenwood Publishing Group, 2005. Mastrianna, Frank. Basic Economics. New York: Cengage Learning, 2009. Preston, Howard. History of banking in Iowa. Ayer Publishing, 1980. Rothbard, Murray. Mystery of Banking. Auburn, Alabama: Ludwig von Mises Institute, 2008. Thomas, Lloyd. Money, banking, and financial markets. New York: Cengage Learning, 2005. Wright, Ivan. Bank Credit and Agriculture. New York, Arno Press, Inc., 1980. Read More