Leadership and Independence at the Federal Reserve
What was the "peg" and what was it supposed to do?
- Massive borrowing was required to finance the war effort. The Federal Reserve kept interest rates low to facilitate bond issues throughout the war. - During wartime when gov't needed finances, would implement low interest rates to encourage borrowing thus they maintain low "peg" rates on bonds
How did the Banking Act of 1935 change the structure and power of the Board?
- This was taking the power from the individual Reserve Banks "which put the bankers interest ... over the public interest." By empowering the central Federal Reserve Board in Washington by giving it control over both open market operations and the appointment of Reserve Bank governors themselves. This plan would introduce certain attributes of a real central bank capable of energetic and positive actions without calling for a drastic revision of the whole Federal Reserve Act. The Board would now consist of seven presidential appointees without a Treasury secretary or comptroller of currency. The Board's 2 leaders would have 14 year terms with the Chairmen serving 4 years at a time. - Federal Reserve Board now consists of 7 presidential appointees called "governors" without Treasury secretary or comptroller of the currency. Instead the boards 2 leader were retitled "Chairman" and "Vice Chairman." Also reorganized FOMC to have 7 member board plus five Reserve Bank Presidents. Advantage that new structure would concentrate monetary powers among wider group rather than just one public body
What happened within weeks of Alan Greenspan becoming Fed Chair in 1987 and how did the Fed respond?
American Stock Market crash, Dow Jones fell 22.6% in October(largest one day decline ever). Fed responded by expanding open market purchases and encourage bankers to keep credit flowing to provide extra liquidity to the market
Why did bankers object to government (public) control over the monetary system?
Bankers believed that gov't control of the monetary system would push to pursue political ends instead of economic and political stability.
Congress issued "Greenbacks" during the Civil War - what else did the series of National Bank Acts do?
Banking Acts of 1863, 1864, 1865: authorized new federally chartered banks to issue national banknotes backed by US debt and tied to safe securities to function as national currency, Taxed state banknotes out of existence, created new office in Comptroller of the Currency to regulate national banks and print their banknotes
What two events at the end of twentieth century and the beginning of the twenty-first century dramatically affect the economy and how did the Fed respond?
By 2000 technology boom ended when technology stocks (internet stocks) fell sharply leading to recession to which the fed responded by lowering I rates. Second event was Sept. 11th attacks after the Fed kept I rates low and lowered the Federal funds rate (bank borrowing) from 6.5% to 1%. Managed to tame inflation. Began to raise I rates in 2004 as economy strengthened.
What did President Roosevelt and the new Congress do in 1933?
Came into a collapse in the banking system so ordered closure of every bank including Federal Reserve Banks. Signed Emergency Banking Act to give his administration more control over Federal Reserve member banks. Kept dollar on gold standard but prohibited use of gold as currency and made every American cash in gold. Banking Act of 1933: establish deposit insurance, separate commercial and investment banking, and create Federal Open Market Committee (FOMC) to streamline open market operations
Why did the business community praise Volcker?
Chairman Volcker received praise for finally beating stagflation through targeting inflation and maintaining a monetarist view of focusing on money supply instead of I rates.
What was the "real bills" doctrine?
Closely linked to Warburg's elastic currency, real bills doctrine stated that commercial debts tied to physical goods (distributor's debt to a manufacturer) would make up the ideal backing for an elastic money supply
How did the United States economy perform in the Clinton/Greenspan 1990s?
Economy begin weak despite low interests rates (Bush accuse Greenspan of losing him the election bc. I rates not low enough), In 1994 Greenspan raise I rates despite low inflation and economy faces surprising subsequent boom
Why did the Federal Reserve not adopt an activist stance in the early of the Great Depression?
Fed believed the economic downturn and significant liquidations were necessary to cleanse the economy from the excesses of the roaring '20s
What was Volcker's general approach to monetary policy and what were his specific October 1979 policy actions?
General approach to monetary policy was to announce money supply targets in advance and strive to meet them but adjust if necessary. 1979: Tame inflation by raising discount rates and raising required reserves. Therefore, reform OMO to target money supply instead of interests rates
What were the good and bad results of Volcker's policies?
Good: curbed inflation, by 1983 inflation down from 10% to 3% over period of 2 years Bad: sparked numerous bank failures and produced a recession
Why did Milton Friedman want to eliminate the Federal Reserve?
Historical evidence of Fed failuters, facilitated inflation in two World wars and after, played a part in deepening great depression, failed at preventing banking panic
In normal times, how would the Fed had dealt with inflation?
In normal times Fed would tighten credit to combat inflation. Instead focused on stopping rising wages and prices (still targeted at inflation but done through different measures)
How was the Federal Reserve Bank the "lender of last resort"?
In times of crisis, Federal Reserve Bank expected to lend to commercial banks that were temporarily illiquid but deemed fundamentally solvent. "Under Federal Reserve should see no more financial panics"
What was Volcker's "monetarism"?
Monetarists prefer stable, predictable growth in the money supply as best result and adjusting to short term fluctuations would only cause further instability.
How the "discount window" work and what did the Reserve Bank use it to do?
Most important monetary tool of Reserve Banks. Lent cash to commercial banks in exchange for qualifying short-term assets (notes, drafts, bills) as collateral. Sold at a discount making slightly less than face value of asset. Could expand or contract money supply by lowering or raising interests rates affecting borrowing at the discount window
What did J.P. Morgan do to get the country's financial system through the panic of 1907?
Panic began with the collapse of share price in United Copper leading to bank run beginning with Mercantile National Bank. The financier, JP Morgan, created group from financial sector to try to stop panic. Arranged $13 million in support for Trust Company of America and directed $35 million of US Treasury funds to NY banks. Gathered $40 to support NYSE and $30 million for NY city itself
Paul Warburg thought America suffered from an "inelastic" money supply - what was this and why this a problem?
Paul Warburg, prominent German Investment Banker, believed that an inelastic Money supply is one that is unresponsive to changes in the demand for money. Lead to high fluctuations in interest rates over the course of a year
Since Morgan's efforts succeeded, why were people concerned about what he did?
People fear for power Morgan possesses since they stopped the crisis singlehandedly. Power shouldn't be in the hands of a private interest
The 1913 Federal Reserve Act - what did the preamble say, what was the structure of member banks, what were the rules for the member banks, what was the role of the Federal Reserve Board, who was in control of everything?
Preamble: establishment of federal reserve banks, provide for elastic currency, afford means of rediscounting commercial paper, establish a more effective supervision of banking in the US Member Banks: 12 Federal reserve banks, all federally chartered banks (and state banks) would subscribe to their regional Federal Reserve Bank Member Bank Rules: Required to maintain reserves equal to 12-18% for demand deposits and 5% for time deposits Federal Reserve Board: consisting of the Secretary of Treasury, Comptroller of currency, five others appointed by president and confirmed by senate
President Nixon and Fed Chair Arthur Burns had to deal with "stagflation" - what was stagflation, why was this a puzzle, what did past experience suggest
Stagflation is when inflation and unemployment move in the same direction. It was a puzzle because typically unemployment falls and inflation rises when economy growing and opposite true when weakening. There was no past experience didn't know for sure how to deal with this.
What were the "open market operations" the Fed introduced in the 1920s?
The Fed uses "open market operations" to increase and decrease the money supply. It either sells government securities (bonds, notes, bills) to banks or buys these securities from banks. Banks that are part of the Federal Reserve System need to buy and sell when told to do so by the Fed.
What was the argument over the peg and how was the argument resolved with actions in January and March 1951?
Worry that low peg rate would allow Treasury to continue high spending resulting in inflation. Also deprived the Fed of its only real tool of OMO, in this case could not curb overexpansion if rates stay low. Resolved when Fed let one type of gov't bond price drop causing subsequent increase in interest rates
