History of monetary policy in the United States
This article is part of a series on |
Banking in the United States |
---|
Monetary policy in the United States is associated with
Background
Instruments of monetary policy have included short-term interest rates and bank reserves through the monetary base.[1]
With the creation of the Bank of England in 1694, which acquired the responsibility to print notes and back them with gold, the idea of monetary policy as independent of executive action began to be established.[2] The goal of monetary policy was to maintain the value of the coinage, print notes which would trade at par to specie, and prevent coins from leaving circulation. The establishment of central banks by industrializing nations was associated then with the desire to maintain the nation's peg to the gold standard, and to trade in a narrow band with other gold-backed currencies. To accomplish this end, central banks as part of the gold standard began setting the interest rates that they charged, both their own borrowers, and other banks who required liquidity. The maintenance of a gold standard required almost monthly adjustments of interest rates.
During the 1870–1920 period, the industrialized nations set up central banking systems, with one of the last being the Federal Reserve in 1913.[3] By this point the role of the central bank as the "lender of last resort" was understood. It was also increasingly understood that interest rates had an effect on the entire economy, in no small part because of the marginal revolution in economics, which demonstrated how people would change a decision based on a change in the economic trade-offs.
Antebellum history
In the first half of the 19th century, many of the smaller commercial banks within New England were easily chartered as laws allowed to do so (primarily due to open franchise laws). The rise of commercial banking saw an increase in opportunities for wealthy individuals to become involved in entrepreneurial projects in which they would not involve themselves without a guaranteed return on their investment. These early banks acted as intermediaries for entrepreneurs who did not have enough wealth to fund their own investment projects and for those who did have wealth but did not want to bear the risk of investing in projects. Thus, this private banking sector witnessed an array of insider lending, due primarily to low bank leverage and an information quality correlation, but many of these banks actually spurred early investment and helped spur many later projects. Despite what some may consider discriminatory practices with insider lending, these banks actually were very sound and failures remained uncommon, further encouraging the financial evolution in the United States.
Early attempts to create a national bank
In 1781, an act of the Congress of the Confederation established the Bank of North America in Philadelphia, where it superseded the state-chartered Bank of Pennsylvania founded in 1780 to help fund the American Revolutionary War. The Bank of North America was granted a monopoly on the issue of bills of credit as currency at the national level. Prior to the ratification of the Articles of Confederation & Perpetual Union, only the States had sovereign power to charter a bank authorized to issue their own bills of credit. Afterwards, Congress also had that power.
In 1791, Congress chartered the First Bank of the United States to succeed the Bank of North America under Article One, Section 8. However, Congress failed to renew the charter for the Bank of the United States, which expired in 1811. Similarly, the Second Bank of the United States was chartered in 1816 and shuttered in 1836.
Jacksonian Era
The
The charter of the Second Bank of the United States (B.U.S.) was for 20 years and therefore up for renewal in 1836. Its role as the
Apart from a general hostility to banking and the belief that specie (gold and/or silver) were the only true monies, Jackson's reasons for opposing the renewal of the charter revolved around his belief that bestowing power and responsibility upon a single bank was the cause of inflation and other perceived evils.
During September 1833, President Jackson issued an
1837–1863: "Free Banking" Era
Prior to 1838 a bank charter could be obtained only by a specific legislative act, but in that year New York adopted the Free Banking Act, which permitted anyone to engage in banking, upon compliance with certain charter conditions. The
Numerous banks that were started during this period ultimately proved to be unstable.[6] In many Western states, the banking industry degenerated into "wildcat" banking because of the laxity and abuse of state laws. Bank notes were issued against little or no security, and credit was over extended; depressions brought waves of bank failures. In particular, the multiplicity of state bank notes caused great confusion and loss. The real value of a bank bill was often lower than its face value, and the issuing bank's financial strength generally determined the size of the discount.
Late 19th century
National Bank Act
To correct such conditions, Congress passed (1863) the National Bank Act, which provided for a system of banks to be chartered by the federal government. The National Banking Acts of 1863 and 1864 were two United States federal laws that established a system of national charters for banks, and created the United States National Banking System. They encouraged development of a national currency backed by bank holdings of U.S. Treasury securities and established the Office of the Comptroller of the Currency as part of the United States Department of the Treasury and authorized the Comptroller to examine and regulate nationally chartered banks.
Congress passed the
Bimetallism and the gold standard
Toward the end of the nineteenth century, bimetallism became a center of political conflict. During the civil war, to finance the war the U.S. switched from bimetallism to a fiat currency,
The Panic of 1893 was a severe nationwide depression that brought the money issue to the fore. The silverites argued that using silver would inflate the money supply and mean more cash for everyone, which they equated with prosperity. The gold advocates countered that silver would permanently depress the economy, but that sound money produced by a gold standard would restore prosperity.
Bimetallism and "
Bryan gave his famous "Cross of Gold" speech at the National Democratic Convention on July 9, 1896. However, his presidential campaign was ultimately unsuccessful; this can be partially attributed to the discovery of the cyanide process by which gold could be extracted from low grade ore. This increased the world gold supply and caused the inflation that free coinage of silver was supposed to bring. The McKinley campaign was effective at persuading voters that poor economic progress and unemployment would be exacerbated by adoption of the Bryan platform.
20th century
The Federal Reserve System
The
The legislation provided for a system that included a number of regional Federal Reserve Banks and a seven-member governing board. All national banks were required to join the system and other banks could join. Congress created Federal Reserve notes to provide the nation with an elastic supply of currency. The notes were to be issued to Federal Reserve Banks for subsequent transmittal to banking institutions in accordance with the needs of the public.
The Federal Reserve Act of 1913 established the present day
Abandonment of the gold standard
To deal with deflation caused by the
Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century. The Bretton Woods system was the first example of a fully negotiated monetary order intended to govern monetary relations among independent nation-states.
Setting up a system of rules, institutions, and procedures to regulate the international monetary system, the planners at Bretton Woods established the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), which today is part of the World Bank Group. The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate by tying its currency to the U.S. dollar and the ability of the IMF to bridge temporary imbalances of payments.
Nixon shock
In 1971, President
Inverted yield curves to tame inflation
The Federal Reserve has used the Federal funds rate as a primary tool to bring down inflation (quantitative tightening) or induce more inflation (quantitative easing) to get to get to their target of 2% annual inflation.[11] To tame inflation the Fed raises the FFR causing shorter term interest rates to rise and eventually climb above their longer maturity bonds causing an Inverted yield curve which usually predates a recession by several months which is deflationary. [12][13]
21st century
In August 2020, after undershooting its 2% inflation target for years, the Fed announced it would be allowing inflation to temporarily rise higher, in order to target an average of 2% over the longer term.[14][15] It is still unclear if this change will make much practical difference in monetary policy anytime soon.[16]
Trends in central banking
The central bank influences interest rates by expanding or contracting the monetary base, which consists of
A central bank can only operate a truly independent monetary policy when the exchange rate is floating. If the exchange rate is pegged or managed in any way, the central bank will have to purchase or sell foreign exchange. These transactions in foreign exchange will have an effect on the monetary base analogous to open market purchases and sales of government debt; if the central bank buys foreign exchange, the monetary base expands, and vice versa. But even in the case of a pure floating exchange rate, central banks and monetary authorities can at best "lean against the wind" in a world where capital is mobile.
Accordingly, the management of the exchange rate will influence domestic monetary conditions. To maintain its monetary policy target, the central bank will have to sterilize or offset its foreign exchange operations. For example, if a central bank buys foreign exchange (to counteract appreciation of the exchange rate), base money will increase. Therefore, to sterilize that increase, the central bank must also sell government debt to contract the monetary base by an equal amount. It follows that turbulent activity in foreign exchange markets can cause a central bank to lose control of domestic monetary policy when it is also managing the exchange rate.
In the 1980s, many economists [who?] began to believe that making a nation's central bank independent of the rest of executive government is the best way to ensure an optimal monetary policy, and those central banks which did not have independence began to gain it. This is to avoid overt manipulation of the tools of monetary policies to effect political goals, such as re-electing the current government. Independence typically means that the members of the committee which conducts monetary policy have long, fixed terms. Obviously, this is a somewhat limited independence.
In the 1990s, central banks began adopting formal, public inflation targets with the goal of making the outcomes, if not the process, of monetary policy more transparent. In other words, a central bank may have an inflation target of 2% for a given year, and if inflation turns out to be 5%, then the central bank will typically have to submit an explanation.
The Bank of England exemplifies both these trends. It became independent of government through the
The debate rages on about whether monetary policy can smooth
See also
- Causes of the Great Depression
- Criticism of the Federal Reserve
- Great Contraction
- Monetary policy
- Monetary policy of the United States
- History of banking in the United States
- Ohio idea
References
- ^ Bordo, Michael D., 2008. "monetary policy, history of," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract and pre-publication copy.
- ^ "Bank of England founded 1694". BBC. March 31, 2006.
- ^ "Federal Reserve Act". Federal Reserve Board. May 14, 2003.
- ^ Goddard, Thomas H. (1831). History of Banking Institutions of Europe and the United States. Carvill. pp. 48–50.
- ^ "A lesson from the free banking era". Federal Reserve Bank of St. Louis - Regional Economist. 1996.
- ^ "Wildcat Banking, Banking Panics, and Free Banking in the United States" (PDF). [permanent dead link]
- ^ https://query.nytimes.com/gst/abstract.html?res=9D07EEDE133EE63BBC4153DFB3668382669FDE No Peace with Greenbacks, New York Times, May 9, 1879.
- ^ "Archived copy" (PDF). Archived from the original (PDF) on 2012-11-20. Retrieved 2014-02-20.
{{cite web}}
: CS1 maint: archived copy as title (link) - ^ Under the gold standard, the Federal Reserve was prevented from lowering interest rates and was instead forced to raise rates to protect the dollar.
- ^ Meltzer, Allan H. (2004). "A History of the Federal Reserve: 1913–1951": 442–446.
{{cite journal}}
: Cite journal requires|journal=
(help) - ^ "The Fed's target for inflation is a made-up number that lacks any concrete evidence. That's kind of the point". Fortune. Retrieved 2023-03-09.
- ^ "Inverted Yield Curve: Definition, What It Can Tell Investors, and Examples".
- ^ "Here's what the inverted yield curve means for your portfolio". CNBC. 31 October 2022.
- ^ "Powell announces new Fed approach to inflation that could keep rates lower for longer". CNBC. 27 August 2020.
- ^ "Speech by Chair Powell on new economic challenges and the Fed's monetary policy review".
- ^ "Fed Strategy".
- ^ "The Case Against the Fed". June 5, 2009.
Further reading
- Cameron, Rondo. Banking in the Early Stages of Industrialization: A Study in Comparative Economic History (1967)
- Grossman, Richard S. Unsettled Account: The Evolution of Banking in the Industrialized World Since 1800 (Princeton University Press; 2010) 384 pages. Considers how crises, bailouts, mergers, and regulations have shaped the history of banking in Western Europe, the United States, Canada, Japan, and Australia.
- Hammond, Bray, Banks and Politics in America, from the Revolution to the Civil War, Princeton : Princeton University Press, 1957.
- History of Money and Banking in the United States.Full text (510 pages) in pdf format