• Granted monopoly on joint stock banking by Parliament in return for war loans.
• Not an invention of economists, started off as a powerful bank that was able to demand that other banks held deposits in it.
• Did not have government monopoly on note issue, but achieved it through its monopoly power.

• Loosely modeled after Bank of England
• First Bank of the United States 1791-1811, was promoted by Alexander Hamilton
• Second Bank of the United States 1816-
1836. President Andrew Jackson called it a
“dangerous monopoly,” conflict with
Nicholas Biddle, president.
• Suffolk System, Massachusetts

Nineteenth Century Problems and
Solutions
• Privately issued bank notes
• Discounts on notes
• Banking panics associated with business depressions
• National Banking System, 1863, mostly ended panics until 1907.
• 1907 panic saved by J. P. Morgan
• Under National Banking System inflexible money supply, strongly seasonal interest rate
• Led to creation of Federal Reserve

• Created flexible money supply, responding to business situation
• Fed was lender of last resort
• 12 Regional banks, each presides over a district.
• Two in Missouri
• Board of Governors in Washington DC

• 7 members, 14-year terms
• Chairman has 4-year term. Traditional power of the chairman
• Independent of executive and legislative branch. An “independent central bank.”
• Chairman must make semiannual monetary policy reports (Humphrey Hawkins)

• Despite Fed’s lending, a banking panic forced Roosevelt to declare a banking holiday
• Led to establishment of Federal Deposit
Insurance Company (FDIC) opened doors in 1934, funded by premia paid by banks
• No U. S. panics since

• Founded 1998
• Eurozone members and non Eurozone members
• Had to construct Eurozone data for first time
• President Jean-Claude Trichet since 2003
• Otmar Issing

• Currency first issued
January 1, 2002
• “The parallel lines [in
€] “represent the stability of the euro.”

• Toshihiko Fukui, Governor since 2003
• Interest rates have been brought down virtually to zero
• Purchase of government bonds to try to stimulate economy
• Proposals to buy foreign bonds, dollars
• Japanese banks sitting on unlent funds

45000
40000
35000
30000
25000
20000
15000
10000
5000
0
1980
Nikkei Index
Monthly 1984-I to 2004-II
1985 1990 1995
Year
2000 2005 2010

• Inflation often negative
• Gensaki rate zero
• Real rate often substantial, Bank of Japan can do nothing
• Svensson proposal to peg yen at, say, 160 to dollar, unheeded by conservative B of J

• Depository Institutions Deregulation and
Monetary Control Act of 1980: 12% reserves on demand deposits, 3% on time
• Act allows Fed to change reserve requirements, on demand deposits within range 8% and 14%.
• Banks must meet requirements over two-week statement period
• Reserves are in cash or balances with federal reserve. Fedwire

• Federal Reserve Board, President of New
York Fed, and four other reserve bank presidents.
• Meets roughly once a month
• Since 1994, has made immediate announcements of policy decision
• Since 1997 has made immediate announcements of federal funds rate target

• Buys and sells Treasury bills
• August 1999 FOMC gave desk authorization to trade in mortgage-backed securities
• FOMC is studying allowing desk to trade in debt of states, or foreign countries.

• Discount rate is rate on loans Fed makes to member banks.
• Borrowing is a privilege, not a right
• Federal funds rate is rate of interest banks pay to each other when they lend excess reserves.
• Repo rate is collateralized, hence tends to be a little lower.

Changed Definition of
Discount Rate
• Prior to 2003, discount rate was usually 50 basis points lower than the funds rate
• Then, borrowing at discount window carried stigma
• On Jan 9, 2003, Fed raised discount rate above funds rate, eliminating stigma
• Primary discount rate (sound banks) about 100 basis points above funds rate
• Secondary discount rate (banks that do not qualify) 50 points above primary discount rate

Federal Funds Rate and Inflation
Rate Monthly 1954-VII to 2004-I

Real Federal Funds Rate Monthly
1954-VII to 2004-I

• New Fed Chairman Paul Volcker thought inflation had gotten out of hand.
• Created “the great recession” that stopped inflation
• Many foreign countries similar experience

• Fed was misled by inaccurate GDP numbers, didn’t see recession coming.
• First started cutting interest rates Dec. 1990, after recession had been on for six months

• Not brought on by rising interest rates to curb inflationary pressure
• A post-stock-market bubble recession
• Dramatic cuts in rates starting early 2001
• Recession short lived (March-November)
• Housing boom started by rate cuts