Chapter 14

Chapter 14 - Chapter 14 CENTRAL BANKING AND THE FRS In the...

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Chapter 14 - CENTRAL BANKING AND THE FRS In the next three chapters, we look at central banking and monetary policy, to understand the important effect that central banks have on the economy. Central banks regulate the supply of money, which affects what? 1. 2. 3. 4. 5. We look at the structure of central banks and focus on the Federal Reserve Bank (FRB) in the U.S., the largest and most important central bank in the world. The reason that "money" and "banking" go together is because of a) the connection between central banking and money, money supply, monetary policy, and b) the connection between central banking and commercial banking. To implement monetary policy the central bank relies on commercial banks, because monetary policy really works by affecting the amount of bank reserves in the economy. Fed sets monetary policy, but it uses the banking system to implement the policy, which then affects the financial markets - Money, Banking and Financial Markets. ORIGINS OF THE FRB Our banking industry is unique in the world, and so is our central bank, reflecting the long history hostility of the public toward large banks and the fear of centralized power of any kind, including centralized banking power. Remember that the first two attempts at central banking failed in the 18th and 19th centuries (First and Second Banks of the United States). Also, the most important central bank in the world at that time (and the model for central banking) was the Bank of England (chartered in 1694), so there was probably resistance to copying the British model of centralized, concentrated banking authority, given U.S.-British history. There was concern that a single central bank would concentrate power in Washington, D.C., and that large corporations and powerful, rich families on the East coast would have too much control over banking, at the expense of farmers, small businesses, middle-class people in the south, west, midwest, etc. However, bank panics, bank failures and bank runs were also happening on a regular basis, and this was causing concern, especially the bank panic of 1907, which caused substantial losses to thousands of depositors. The concern over a fragile banking system with frequent panics finally outweighed the concern about centralized banking power, and the establishment of the FRB in 1913 followed eight years of debate and compromise. Public support was generated for a central U.S. bank because of two
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unique features of our central banking system, which helped overcome the resistance to centralized federal banking power. 1. Federal Reserve System (FRS) is a decentralized system of district, regional banks that represented the population distribution of the early 1900s. This regional district-based system appealed to U.S. populist sentiments, and local and regional concerns, as an alternative to establishing a central bank located in Washington D.C. or NY, which was not politically feasible. See map page 371. FRS has 12 district
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This note was uploaded on 11/18/2011 for the course ECON 210 taught by Professor Blare during the Fall '10 term at Rutgers.

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Chapter 14 - Chapter 14 CENTRAL BANKING AND THE FRS In the...

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