AP Economics
Mr. Bernstein
Module 26:
The Federal Reserve System:
History and Structure
February 19, 2015
AP Economics
Mr. Bernstein
Federal Reserve System: History and Structure
• Objectives - Understand each of the following:
• The history of the Federal Reserve System
• The structure of the Federal Reserve System
• How the Federal Reserve System has responded to
major crises
2
AP Economics
Mr. Bernstein
The Multiplier: An Informal Introduction
• Central Banks oversee and regulate the banking
system, control the monetary base
• Our current Central Bank is the result of legislation
following periods of financial crisis
• Laws are designed to protect
borrowers and lenders and
minimize risks of panic
• Federal Reserve System was
Created in 1913
3
AP Economics
Mr. Bernstein
Crisis in American Banking at Turn of 20th
Century
• Lack of trust could spark “runs” on banks and
deplete their reserves, becoming a self-fulfilling
prophecy
• The Panic of 1907 led to creation of Fed
• Centralized control of reserves
• Required all deposit-accepting institutions to maintain
adequate reserves and open books for inspection by
regulators
• Monopoly on ability to print money
4
AP Economics
Mr. Bernstein
Structure of the Federal Reserve System
• 14-person Board of Governors and 12 regional
Federal Reserve Banks
5
AP Economics
Mr. Bernstein
Current Chairman of the Federal Reserve System
Janet Yellen
6
AP Economics
Mr. Bernstein
Structure of the Federal Reserve System
• 14-person Board of Governors are appointed by
the President and approved by the Senate
• Serve 14-year terms to reduce political pressure
• Chairman serves 4-year terms
• Federal Reserve Bank of New York conducts open
market operations
• FOMC (Federal Open Market Committee) makes
decisions about monetary policy; includes Board
of Governors plus 5 regional bank presidents
7
AP Economics
Mr. Bernstein
Effectiveness of the Federal Reserve System
• Despite Fed, some bank runs and the Great
Depression happened
• Further laws were created in 1930s and 40s
• Notable was the Glass-Steagall Act of 1932,
separating banks from other financial activities
• Beginning in the 1980s, some of these safeguards
were rolled back
• Use of leverage, new financial instruments often
beyond Fed control and contribute to crises
8
AP Economics
Mr. Bernstein
Financial Crisis of 2008: Factors Beyond Fed Control
• Government policies encouraging bank lending in disadvantaged
neighborhoods
• Mortgage bankers incentivized to close deals
• ARM mortgages offering low payments for 2-5 years only
• Low down payments allowing home buyers high leverage
• Fraud by both mortgage bankers and home buyers
• Low interest rates encouraging investors to purchase bundles of
bad mortgages in complicated securities to gain yield
• Bond rating agencies incentivized to allow gaming of these
complicated securities to achieve deceptively high ratings
• Wall Street compensation structures incentivizing executives to
book short-term profits and take massive longer-term risks
• Ended badly when housing price bubble began to roll over
9
AP Economics
Mr. Bernstein
Financial Crisis of 2008: Fed Response
• Signal to markets intent to assist, reduce
uncertainty
• Fed Balance Sheet used to protect banks and
near-money funds from runs
• Bear Stearns, Lehman Brothers, and moral hazard
• Still fighting hangover
10