Formation of The Federal Reserve System

From 1836, when the charter of the Second Bank of the United States was permitted to lapse, until the formation of the Federal Reserve, the functions associated with a central bank were either performed by the Treasury Department or else were left undone. As we will see, the greater part of central banking functions fell into the latter class. This absence of a central bank was not a sort of oversight; it was deeply engrained in American culture. In the view of many Americans, a central bank was not only unnecessary, the country could do better without one. A central bank had indeed been founded within three years of the adoption of the Constitution, but it was never popular and was allowed to lapse at first opportunity, as was its successor a quarter-century later.

The Federal Reserve System, the third effort in the United States to provide the functions of a central bank, came

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o its knees. These panics had some similarity to recessions in the modern sense, in that the underlying conditions for them were often the result of natural business fluctuations. These fluctuations were exacerbated by the tendency of every boom to produce a wave of speculation, which collapsed during the following bust. The cycle was further sharpened, dramatically so, by the banking crisis that accompanied every burst speculative bubble. Bank failures could in an instant wipe out the savings of thousands or millions of customers who had themselves played no part in speculative fever. Apart from the outright failure of banks, the contractionary cycles were exacerbated by the efforts of banks to protect themselves from failure. The basic means of such protection was for a bank to increase its reserve ratio, calling in loans and refusing to lend more. The effect was to decrease the money stock in circulation, and therefore the liquidity of the economy. Every contraction thus triggered a period of "tight money," driving up interest rates, further slowing economic activity, and thus deepening the downturn. The financial panic of 1907 was exceptionally steep; indeed, it was the deepest before the Great Depression, though the
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Approximate Word count = 7092
Approximate Pages = 28 (250 words per page)

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