Investing decoded: Your guide to financial literacy

Understanding the 1913 Federal Reserve Act and Its Impact3

Origins of the 1913 Federal Reserve Act

The Federal Reserve Act of 1913 emerged from multiple periods of economic uncertainty throughout American history. Before its enactment, the United States had centralized national banks that were mostly controlled by powerful eastern banking institutions. This led to mistrust among rural citizens who favored state-chartered or “free banks” that issued their currency backed by gold.

The National Banking Act of 1863 reinstated nationally chartered banks, providing standardized currency backed by U.S. securities. However, financial instability persisted, leading to market crashes and depressions in 1893 and 1907. Banking reform became a pressing issue, and in 1912, President Woodrow Wilson requested a solution from the House Committee on Banking and Finance. The result was the establishment of a decentralized bank through the 1913 Federal Reserve Act.

Key Features of the Federal Reserve Act

The 1913 Federal Reserve Act created the Federal Reserve System, commonly known as “The Fed,” with the goal of ensuring economic stability in the U.S. through a central bank that oversees monetary policy. The Act outlines the purpose, structure, and function of the Federal Reserve System, and it has been amended several times by Congress.

Before the establishment of the Fed, financial panics were common occurrences due to investors being unsure about the safety of their bank deposits. The 1913 Federal Reserve Act granted the Fed the power to print money and use policy tools to maintain economic stability, fulfilling its dual mandate to maximize employment and maintain stable prices.

The Federal Reserve System consists of 12 regional banks in major cities across the United States. The seven members of the Board of Governors are nominated by the president and approved by the U.S. Senate, with each serving a maximum of 14 years. The law requires that appointments represent all broad sectors of the U.S. economy.

What is the role of the Federal Reserve in setting interest rates?

The Fed does not directly set interest rates. Instead, it adjusts the Federal funds rate, which influences the prime rate used by many lenders. Lenders typically use the prime rate as a base for determining interest rates, adding more to make a profit.

How many Federal Reserve districts are there in the United States?

There are 12 Federal Reserve districts, with Alaska and Hawaii included in district 12.

Impact and Powers of the Federal Reserve

In addition to printing money, the Fed has the authority to adjust the discount rate and the Federal funds rate, as well as buy and sell U.S. Treasuries. The Federal funds rate—the interest rate at which depository institutions lend funds maintained at the Federal Reserve to one another overnight—has a significant impact on available credit and interest rates in the U.S. This measure helps ensure that the largest banking institutions maintain sufficient liquidity.

The Federal Reserve uses its monetary tools to smooth out economic booms and busts and maintain adequate money and credit bases for current production levels. Central banks worldwide employ a tool called quantitative easing to expand private credit, lower interest rates, and stimulate investment and commercial activity. This approach is primarily used during recessions when credit is scarce, such as during and following the 2008 financial crisis.

What did the Federal Reserve Act accomplish?

The Federal Reserve Act established the Federal Reserve System after being passed by Congress in 1913. The Fed was initially created to combat banking “panics” wreaking havoc on the U.S. banking system at the time.

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