The History of the Federal Reserve System
Many people are surprised to learn that the Federal Reserve System is not the first U.S. central bank. Congress made two unsuccessful attempts at central banking before the Federal Reserve was established.
The System's earliest precursor, the First Bank of the United States, was established by Congress in 1791 on a 20-year charter, with the mandate to "manage the government's money and to regulate the nation's credit." The Bank acted as the government's fiscal agent, marketing its securities, holding its revenues, and paying its debts.
The federal government maintained partial control of the Bank, but it was led primarily by private investors. The Bank's main office was located in Philadelphia and its branches were concentrated in large northeastern cities.
The Bank successfully carried out its mandate, but met with considerable opposition. Some Americans feared the Bank because of its size. Some believed it was dominated by narrowly defined private interests. And some criticized its geographic concentration. Congress narrowly defeated the re-chartering of the Bank in 1811.
A number of problems quickly surfaced when the U.S. economy operated without a central bank:
- There was no agency to regulate banking and credit.
- Many private banks began issuing their own currency, but the value of these notes was not strictly controlled, nor was this money uniformly accepted.
- The availability of currency varied widely by region.
- The government lacked a reliable mechanism for marketing its securities and a reliable institution to provide it with banking services.
Four years of bank runs and other economic disruptions convinced Congress that the country needed a central bank, and the Second Bank of the United States was chartered in 1816. Much like its predecessor, the Second Bank was predominantly private ownership and its governance was geographically centralized. Many Americans also viewed this Bank, in the words of then-President Andrew Jackson, as "a concentration of power in the hands of a few men irresponsible to the people." When its charter expired in 1836, the Second Bank of the United States ceased its role as America's central bank.
Again, the country was plagued with a hodgepodge of private currencies issued by commercial banks. Although Congress passed a number of acts aimed at restoring balance to the nation's financial system, the U.S. economy suffered the shocks of bank panics and failures. Following a severe bank panic in 1907, Congress created the National Monetary Commission to study the nation's money and banking system and to recommend changes.
After much debate, Congress passed the Federal Reserve Act, which President Woodrow Wilson signed into law in December 1913. The act established the Federal Reserve Banks, whose purpose would be to furnish an elastic currency for the country and to establish more effective banking supervision. The System was specifically designed to be insulated from short-term political pressures, to be a partnership of public and private control, and to represent regional economies and various sectors of the economy.