1775-1791: U.S. Currency
To finance the American Revolution, the Continental Congress printed the new nation's first paper money. Known as "continentals," the fiat money notes were issued in such quantity they led to inflation, which, though mild at first, rapidly accelerated as the war progressed. Eventually, people lost faith in the notes, and the phrase "Not worth a continental" came to mean "utterly worthless."
1791-1811: First Attempt at Central Banking
At the urging of then Treasury Secretary Alexander Hamilton, Congress established the First Bank of the United States, headquartered in Philadelphia, in 1791. It was the largest corporation in the country and was dominated by big banking and money interests. Many agrarian minded Americans uncomfortable with the idea of a large and powerful bank opposed it. When the bank’s 20-year charter expired in 1811 Congress refused to renew it by one vote.
1816-1836: A Second Try Fails
By 1816, the political climate was once again inclined toward the idea of a central bank; by a narrow margin, Congress agreed to charter the Second Bank of the United States. But when Andrew Jackson, a central bank foe, was elected president in 1828, he vowed to kill it. His attack on its banker-controlled power touched a popular nerve with Americans, and when the Second Bank’s charter expired in 1836, it was not renewed.
1836-1865: The Free Banking Era
State-chartered banks and unchartered “free banks” took hold during this period, issuing their own notes, redeemable in gold or specie. Banks also began offering demand deposits to enhance commerce. In response to a rising volume of check transactions, the New York Clearinghouse Association was established in 1853 to provide a way for the city’s banks to exchange checks and settle accounts.
1863: National Banking Act
During the Civil War, the National Banking Act of 1863 was passed, providing for nationally chartered banks, whose circulating notes had to be backed by U.S. government securities. An amendment to the act required taxation on state bank notes but not national bank notes, effectively creating a uniform currency for the nation. Despite taxation on their notes, state banks continued to flourish due to the growing popularity of demand deposits, which had taken hold during the Free Banking Era.
1873-1907: Financial Panics Prevail
Although the National Banking Act of 1863 established some measure of currency stability for the growing nation, bank runs and financial panics continued to plague the economy. In 1893, a banking panic triggered the worst depression the United States had ever seen, and the economy stabilized only after the intervention of financial mogul J.P. Morgan. It was clear that the nation’s banking and financial system needed serious attention.
1907: A Very Bad Year
In 1907, a bout of speculation on Wall Street ended in failure, triggering a particularly severe banking panic. J.P. Morgan was again called upon to avert disaster. By this time, most Americans were calling for reform of the banking system, but the structure of that reform was cause for deep division among the country’s citizens. Conservatives and powerful “money trusts” in the big eastern cities were vehemently opposed by “progressives.” But there was a growing consensus among all Americans that a central banking authority was needed to ensure a healthy banking system and provide for an elastic currency.
1908-1912: The Stage is Set for a Decentralized Central Bank
The Aldrich-Vreeland Act of 1908, passed as an immediate response to the panic of 1907, provided for emergency currency issue during crises. It also established the national Monetary Commission to search for a long-term solution to the nation’s banking and financial problems. Under the leadership of Senator Nelson Aldrich, the commission developed a banker-controlled plan. William Jennings Bryan and other progressives fiercely attacked the plan; they wanted a central bank under public, not banker, control. The 1912 election of Democrat Woodrow Wilson killed the Republican Aldrich plan, but the stage was set for the emergence of a decentralized central bank.
1912: Woodrow Wilson as Financial Reformer
Though not personally knowledgeable about banking and financial issues, Woodrow Wilson solicited expert advice from Virginia Representative Carter Glass, soon to become the chairman of the House Committee on Banking and Finance, and from the Committee’s expert advisor, H. Parker Willis, formerly a professor of economics at Washington and Lee University. Throughout most of 1912, Glass and Willis labored over a central bank proposal, and by December 1912, they presented Wilson with what would become, with some modifications, the Federal Reserve Act.
1913: The Federal Reserve System is Born
From December 1912 to December 1913, the Glass-Willis proposal was hotly debated, molded and reshaped. By December 23, 1913, when President Woodrow Wilson signed the Federal Reserve Act into law, it stood as a classic example of compromise—a decentralized central bank that balanced the competing interests of private banks and populist sentiment.
1914: Open for Business
Before the new central bank could begin operations, the Reserve Bank Operating Committee, comprised of Treasury Secretary William McAdoo, Secretary of Agriculture David Houston, and Comptroller of the Currency John Skelton Williams, had the arduous task of building a working institution around the bare bones of the new law. But, by November 16, 1914, the 12 cities chosen as sites for regional Reserve Banks were open for business, just as hostilities in Europe erupted into World War I.
1914-1919: Fed Policy During the War
When World War I broke out in mid-1914, U.S. banks continued to operate normally, thanks to the emergency currency issued under the Aldrich-Vreeland Act of 1908. But the greater impact in the United States came from the Reserve Banks’ ability to discount bankers acceptances. Through this mechanism, the United States aided the flow of trade goods to Europe, indirectly helping to finance the war until 1917, when the United States officially declared war on Germany and financing our own war effort became paramount.
1920s: The Beginning of Open Market Operations
Following World War I, Benjamin Strong, head of the New York Fed from 1914 to his death in 1928, recognized that gold no longer served as the central factor in controlling credit. Strong’s aggressive action to stem a recession in 1923 through a large purchase of government securities gave clear evidence of the power of open market operations to influence the availability of credit in the banking system. During the 1920s, the Fed began using open market operations as a monetary policy tool. During his tenure, Strong also elevated the stature of the Fed by promoting relations with other central banks, especially the Bank of England.
1929-1933: The Market Crash and the Great Depression
During the 1920s, Virginia Representative Carter Glass warned that stock market speculation would lead to dire consequences. In October 1929, his predictions seemed to be realized when the stock market crashed, and the nation fell into the worst depression in its history. From 1930 to 1933, nearly 10,000 banks failed, and by March 1933, newly inaugurated President Franklin Delano Roosevelt declared a bank holiday, while government officials grappled with ways to remedy the nation’s economic woes. Many people blamed the Fed for failing to stem speculative lending that led to the crash, and some also argued that inadequate understanding of monetary economics kept the Fed from pursuing policies that could have lessened the depth of the Depression.
1933: The Depression Aftermath
In reaction to the Great Depression, Congress passed the Banking Act of 1933, better known as the Glass-Steagall Act, calling for the separation of commercial and investment banking and requiring use of government securities as collateral for Federal Reserve notes. The Act also established the Federal Deposit Insurance Corporation (FDIC), placed open market operations under the Fed and required bank holding companies to be examined by the Fed, a practice that was to have profound future implications, as holding companies became a prevalent structure for banks over time. Also, as part of the massive reforms taking place, Roosevelt recalled all gold and silver certificates, effectively ending the gold and any other metallic standard.
1935: More Changes to Come
The Banking Act of 1935 called for further changes in the Fed’s structure, including the creation of the Federal Open Market Committee (FOMC) as a separate legal entity, removal of the Treasury Secretary and the Comptroller of the Currency from the Fed’s governing board and establishment of the members’ terms at 14 years. Following World War II, the Employment Act added the goal of promising maximum employment to the list of the Fed’s responsibilities. In 1956 the Bank Holding Company Act named the Fed as the regulator of bank holding companies owning more than one bank, and in 1978 the Humphrey-Hawkins Act required the Fed chairman to report to Congress twice annually on monetary policy goals and objectives.
1951: The Treasury Accord
The Federal Reserve System formally committed to maintaining a low interest rate peg on government bonds in 1942 after the United States entered World War II. It did so at the request of the Treasury to allow the federal government to engage in cheaper debt financing of the war. To maintain the pegged rate, the Fed was forced to give up control of the size of its portfolio as well as the money stock. Conflict between the Treasury and the Fed came to the fore when the Treasury directed the central bank to maintain the peg after the start of the Korean War in 1950.
President Harry Truman and Secretary of the Treasury John Snyder were both strong supporters of the low interest rate peg. The President felt that it was his duty to protect patriotic citizens by not lowering the value of the bonds that they had purchased during the war. Unlike Truman and Snyder, the Federal Reserve was focused on the need to contain inflationary pressures in the economy caused by the intensification of the Korean War. Many on the Board of Governors, including Marriner Eccles, understood that the forced obligation to maintain the low peg on interest rates produced an excessive monetary expansion that caused inflation. After a fierce debate between the Fed and the Treasury for control over interest rates and U.S. monetary policy, their dispute was settled resulting in an agreement known as the Treasury-Fed Accord. This eliminated the obligation of the Fed to monetize the debt of the Treasury at a fixed rate and became essential to the independence of central banking and how monetary policy is pursued by the Federal Reserve today.
1970s-1980s: Inflation and Deflation
The 1970s saw inflation skyrocket as producer and consumer prices rose, oil prices soared and the federal deficit more than doubled. By August 1979, when Paul Volcker was sworn in as Fed chairman, drastic action was needed to break inflation’s stranglehold on the U.S. economy. Volcker’s leadership as Fed chairman during the 1980s, though painful in the short term, was successful overall in bringing double-digit inflation under control.
1980: Setting the Stage for Financial Modernization
The Monetary Control Act of 1980 required the Fed to price its financial services competitively against private sector providers and to establish reserve requirements for all eligible financial institutions. The act marks the beginning of a period of modern banking industry reforms. Following its passage, interstate banking proliferated, and banks began offering interest-paying accounts and instruments to attract customers from brokerage firms. Barriers to insurance activities, however, proved more difficult to circumvent. Nonetheless, momentum for change was steady, and by 1999 the Gramm-Leach-Bliley Act was passed, in essence, overturning the Glass-Steagall Act of 1933 and allowing banks to offer a menu of financial services, including investment banking and insurance.
1990s: The Longest Economic Expansion
Two months after Alan Greenspan took office as the Fed chairman, the stock market crashed on October 19, 1987. In response, he ordered the Fed to issue a one-sentence statement before the start of trading on October 20: “The Federal Reserve, consistent with its responsibilities as the nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.” The 10-year economic expansion of the 1990s came to a close in March 2001 and was followed by a short, shallow recession ending in November 2001. In response to the bursting of the 1990s stock market bubble in the early years of the decade, the Fed lowered interest rates rapidly. Throughout the 1990s, the Fed used monetary policy on a number of occasions including the credit crunch of the early 1990s and the Russian default on government securities to keep potential financial problems from adversely affecting the real economy. The decade was marked by generally declining inflation and the longest peacetime economic expansion in our country’s history.
September 11, 2001
The effectiveness of the Federal Reserve as a central bank was put to the test on September 11, 2001 as the terrorist attacks on New York, Washington and Pennsylvania disrupted U.S. financial markets. The Fed issued a short statement reminiscent of its announcement in 1987: “The Federal Reserve System is open and operating. The discount window is available to meet liquidity needs.” In the days that followed, the Fed lowered interest rates and loaned more than $45 billion to financial institutions in order to provide stability to the U.S. economy. By the end of September, Fed lending had returned to pre-September 11 levels and a potential liquidity crunch had been averted. The Fed played the pivotal role in dampening the effects of the September 11 attacks on U.S. financial markets.
January 2003: Discount Window Operation Changes
In 2003, the Federal Reserve changed its discount window operations so as to have rates at the window set above the prevailing Fed Funds rate and provide rationing of loans to banks through interest rates.
Summer 2007 - Summer 2009: The Great Recession
The crisis in global financial markets that began during the summer of 2007 became particularly severe during 2008. Early on, the Federal Reserve responded by expanding its lending to banks that were experiencing shortages of liquidity through its standard discount window. In addition, the Federal Reserve introduced several emergency lending programs that were designed to address financial institutions’ needs for short-term liquidity, to help alleviate strains in many markets, and to support the flow of credit to households and businesses. The Federal Reserve established dollar liquidity swap arrangements with several foreign central banks to address global dollar funding pressures. Another way that the Federal Reserve responded to the crisis was through adjustments to its traditional policy tool, the federal funds rate.
Beginning in the fall of 2007, the FOMC began cutting its target for the federal funds rate and, by the end of 2008, the target had been reduced from a level of 5¼ percent to a range of 0 to ¼ percentage point. Although the Federal Reserve’s initial responses to the crisis helped financial markets to recover and function more normally, the recession in the U.S. economy was particularly severe and long-lasting. With the federal funds rate near zero, the FOMC turned to two less-conventional policy measures—forward guidance and large-scale asset purchases—to provide additional policy accommodation to support economic activity and stem disinflationary pressures.
The FOMC’s use of forward guidance influenced expectations about the future course of monetary policy. Because households and businesses can use this information in making decisions about spending and investment, forward guidance about future monetary policy can influence financial and economic conditions today. Over the course of several years, the FOMC used various forms of forward guidance and, by December 2012, the FOMC’s statement pointed to economic conditions that the Committee expected to see before it began to consider raising its target range for the federal funds rate.
The Great Recession ended June 2009, per the External LinkNational Bureau of Economic Research. The recession lasted 18 months, the longest of any recession since World War II. The Federal Reserve’s response to the economic turmoil and economic weakness took unprecedented actions in monetary policy which cut it to zero and made credit available to institutions and markets that they never previously intervened.
July 2010: Dodd Frank Act
Financial market conditions improved notably in the fall of 2010, partly in response to actual and expected increases in monetary policy accommodation. In addition, later in the year, the tenor of incoming economic news strengthened and the downside risks to economic growth appeared to recede. On July 21, 2010, the Dodd Frank Wall Street Reform and Consumer Protection Act was enacted to regulate financial markets and protect consumers in the wake of the financial crisis.
2012-2014: The Fed’s Balance Sheet
In terms of large-scale asset purchases, during the Great Recession and in October 2014, the Federal Reserve purchased longer-term securities through a series of programs with the aim of putting downward pressure on longer-term interest rates, easing broader financial market conditions, and thus supporting economic activity and job creation. These purchases reduced the cost and increased the availability of credit for households and businesses. Reflecting on the FOMC’s multiyear asset purchase programs and decision to reinvest maturing and prepaying securities, total assets of the Federal Reserve increased significantly by the end of 2014, from $870 billion in August 2007 to about $4.5 trillion, or 25 percent as a ratio to nominal GDP.
Activity was held down in the first half of 2011 by temporary factors, particularly supply chain disruptions stemming from the earthquake in Japan and the dampening effect of higher energy prices on consumer spending. As the effects of these factors waned over the second half of 2011, economic activity picked up. The FOMC took a number of steps during the second half of 2011 and early 2012 to provide extra monetary policy accommodations to support a stronger economic recovery through price stability. FOMC modified rate guidance which included post meeting statements, increasing the average maturity of the Federal Reserve’s securities holdings, and shifting the reinvestment of principal payments on agency securities from Treasury securities to agency-guaranteed mortgage-backed securities (MBS). The FOMC continued to provide additional monetary accommodation during the second half of 2012 by both strengthening its forward guidance regarding the federal funds rate and initiating additional asset purchases. The Fed also continued its’ program to extend the average maturity of its Treasury holdings and began purchasing additional agency-guaranteed mortgage-backed securities (MBS) at a pace of $40 billion per month.
At the end of October 2014, the FOMC ended the asset purchase program that began in September 2012 after having made further measured reductions in the pace of its asset purchases. The FOMC raised the target range for the federal funds rate to 0.25 to 0.50 percent—the so-called “liftoff.” This was the first step in the FOMC’s process of normalizing monetary policy. The labor market improved further during the second half of 2013 and into early 2014 as the economic recovery strengthened.
February 2014: Janet Yellen
Janet Yellen became chair of the Board of Governors of the Federal Reserve System. The U.S. financial system continued to strengthen. Capital and liquidity profiles at large bank holding companies improved further. In addition, the Federal Reserve and other agencies took further steps to enhance the resilience of the financial system, including strengthening capital regulations for large financial institutions and issuing a final rule implementing the Volcker rule, which restricts such firms' proprietary trading activities.
2015-2019: New Monetary Policy Tools
By 2015, the economic expansion had been ongoing for several years and unemployment had declined noticeably. In addition, labor market conditions were projected to continue to improve, and inflation was projected to move up to 2 percent. With this backdrop, the FOMC decided that it would begin normalizing the stance of monetary policy to continue to foster its macroeconomic objectives. The term “normalization” refers to steps the FOMC took to return both short-term interest rates as well as the size and composition of the Federal Reserve’s balance sheet to more-normal levels. To be transparent about this process and allow market participants to prepare for Federal Reserve normalization actions, the FOMC made public its policy normalization principles and plans. In particular, the Fed announced the plan to first raise the federal funds rate from near zero and then to normalize the size and composition of the balance sheet. To that end, the Committee gradually raised its target range for the federal funds rate between December 2015 and December 2018.
By the end of 2018, the federal funds rate target range stood at 2¼ to 2½ percent. In terms of balance sheet policy, the FOMC began reducing the size of its asset holdings in late 2017 by gradually phasing out the reinvestment of maturing and prepaying securities. By early 2019, the Federal Reserve’s balance sheet declined to a bit under 20 percent as a ratio of nominal GDP. As in the period prior to the 2007–09 financial crisis, during this period, the FOMC normalized the stance of policy by adjusting the level of short-term interest rates up in response to the observed and expected future paths for the unemployment rate and inflation. However, after several years of increasing the target range for the federal funds rate, the level of interest rates remained much lower than in the past. Many factors contributed to this lower level—well-anchored inflation expectations, demographics, globalization, slower productivity growth, and greater demand for safe assets. In this lower interest rate environment, the risk of shocks to the economy that could push the federal funds rate to the effective lower bound, was much higher than before the financial crisis. And, in fact, the FOMC found itself swiftly lowering the policy target range to the effective lower bound in early 2020, at the onset of the COVID-19 pandemic, and turning to tested, additional policy tools—forward guidance and balance sheet policy.
2020 and Beyond: Global Pandemic
The COVID -19 outbreak caused tremendous human and economic hardship across the country and around the world. As a result, the sharp decline in economic activity and a surge in job losses, with the unemployment rate, which had been at a 50-year low, soaring to a postwar record high. The disruptions to economic activity in the U.S. and abroad significantly affected financial conditions and impaired the flow of credit to U.S. households and businesses.
The Federal Reserve’s initial response to these extraordinary developments was guided by its mandate to promote maximum employment and stable prices as well as its role in fostering the stability of the financial system. The actions and programs introduced were targeted at supporting the flow of credit to households, businesses, and communities. In March 2020, the FOMC lowered the policy interest rate to near zero. It also introduced forward guidance, which evolved to signal that the Committee expected to maintain this near-zero target range until the economy was essentially at the FOMC’s employment and inflation goals.
In addition to these steps, the Federal Reserve took forceful measures in four areas: 1. open market operations to restore market functioning; 2. actions to improve liquidity conditions in short-term funding markets; 3. programs, in coordination with the Treasury Department, to facilitate more directly the flow of credit; and 4. measures to encourage banks to use their substantial capital and liquidity buffers built up over the past decade to support the economy during this difficult time. Many of these measures increased the size of the Federal Reserve’s balance sheet; total assets stood near $7 trillion or 35 percent as a ratio of nominal GDP by mid-2020.