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The Federal Reserve

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					ONCE UPON A TIME THERE WAS A BANK RUN…
A CLIP FROM IT’S A WONDERFUL LIFE…
THE BANK PANIC
One scenario….

1.Demand for money increases
2.Country banks withdraw “reserves”
  from Urban banks
3.Urban banks call in loans to meet
  demands of country banks
4.Credit issue collapses
ELASTICITY OF MONEY

Money supply was inelastic.
In other words, the money supply did not expand
   rapidly enough when a crisis occurred.
The National Banking system lacked
   coordination and organization. Check clearing
   activities were slow and expensive and
   reaction to crisis was decentralized.
THE 1907 BANK PANIC

The 1907 panic resulted in mass bank
  failure, a self-imposed bank holiday,
  failure of several major New York banks,
  and an unemployment rate of 20%.
J.P. MORGAN AND THE BANK PANIC OF 1907
• The reaction of J.P. Morgan in 1907
 Pooled bank funds
 Rationed credit
• Morgan’s ideas followed from the work of the Bank of
  England, which Morgan was familiar with.
• In essence, Morgan fulfilled the function of a Central
  Bank, which did not exist at the time.
• And this led to the Federal Reserve (established in
  1913).
 TWO FEDERAL RESERVE LINKS



The Federal Reserve
Overview of Federal Reserve (pdf)
 THE FEDERAL RESERVE


Charter did not expire.
The Fed is a bankers’ bank, not a public institution.
Banks were required to hold reserves at their district federal reserve
   bank (Suffolk system)
FDIC did not appear till after 1933 (New York Safety Fund). Originally
   this was rejected by the bankers in 1913.
Purpose:          To create an elastic money supply. The “dream” was
   not realized until the work of Benjamin Strong, who in the 1920s
   essentially invented the idea of open market operations.
   STRUCTURE OF THE FED
   FROM DAVID COLANDER (2010)




Board of Governors of the Federal
  Reserve System                                            Regional Reserve Banks and
• 7 members appointed by the                                  Branches
                                            Oversees        • 12 regional Federal Reserve
  president and confirmed
                                                              banks
• Chairman and vice chairman                                • 25 branches of Federal Reserve
  designated by the president and                             banks
  confirmed by the Senate
                                Federal Open Market Committee
                                • 7 members of the Board of
                                  Governors
                                • 5 Federal Reserve bank presidents

                   Chief policymaking body of the Federal Reserve System
                                  Open market operations
                                      Provides services
           Financial institutions                           Federal government

        12-8
 FEDERAL RESERVE DISTRICTS
   FROM DAVID COLANDER (2010)




                                   Minneapolis
                                                                            Boston
                                                                           New York
                                                Chicago
                                                             Cleveland    Philadelphia
                  San Francisco                                  .
                                                                         Washington DC
                                  Kansas City
                                                 St. Louis               Richmond


                                                             Atlanta
*Alaska and Hawaii are              Dallas
under the jurisdiction of
the Federal Reserve
Bank of San Francisco




       12-9
   DUTIES OF THE FED
   FROM DAVID COLANDER (2010)


Conducts monetary policy
Supervises and regulates financial institutions
Lender of last resort to financial institutions
Provides banking services to the U.S. government
Issues coin and currency
Provides financial services such as check clearing to commercial
  banks, savings and loan associations, savings banks, and
  credit unions.




         12-10
      MONETARY POLICY
        FROM DAVID COLANDER (2010)




      M                i             I   Y

Expansionary
monetary policy




       M                   i         I   Y


Contractionary
monetary policy


           12-11
THE GOLD STANDARD

By 1900 the U.S. had joined much of Europe in
  abandoning a bimetallic system and officially
  adopting the gold standard. In essence, the
  gold standard is a fixed exchange rate system
  that must be defended via actions of the
  Central Bank or Treasury. The fixed rate is not
  established by law, but via actions on the
  open market.
 GOLD STANDARD EXAMPLE



Demand for French goods rises relative to U.S. goods. This leads to an
  increase in the demand for francs and a falling demand for U.S.
  dollars. This will cause the value of the franc to rise relative to the
  dollar.
A U.S. importer buying goods from France now has two options.
 Exchange dollars for francs on the currency market. Of course, these
  francs are now expensive.
 Buy gold with dollars, ship the gold to France, and exchange the gold
  for francs at the official exchange rate.
GOLD STANDARD EXAMPLE
If the cost of shipment is relatively low, gold will
    flow into France and gold will leave the U.S.
This will increase the monetary base in France
    and lower the monetary base in the U.S.
Consequently, prices will rise in France and fall
    in the U.S.
This will cause demand for French goods to fall
    and demand for U.S. goods to rise, actions
    that will restore the official exchange rate.
GOLD STANDARD ADVANTAGES
The gold standard prevented nations from printing money to acquire
   goods. Nations could only tax or borrow to meet the needs of the
   government. Thus discipline was imposed on government.
Such discipline inspired confidence in the economics of these nations.
Disadvantage of the gold standard: As gold flowed out of your nation,
   prices would fall. These declines in the money supply and prices
   could cause recessions.
WHY WOULD A DECLINE IN PRICES CAUSE AN ECONOMIC DOWNTURN?
   Key is how firms interpret a decline in demand.
The gold standard basically ended during World War One when the
   international trading system collapsed. After World War I efforts
   were made to revise the system. The onset of the Great Depression
   caused nations to abandon this system.
DEPARTING THE GOLD STANDARD
 SOURCE: KRUGMAN (10-9-09)
 HTTP://KRUGMAN.BLOGS.NYTIMES.COM/2009/10/09/MODIFIED-GOLDBUGISM-AT-THE-WSJ/
 HTTP://WEB.MIT.EDU/KRUGMAN/WWW/GOLDBUG.HTML