The Federal Reserve recently made a move that affects nearly every American: it lowered its key interest rate. This decision is more than just a momentary blip in our news cycle; it’s a dramatic demonstration of the power of a single institution on our daily lives, and whose very existence was once bitterly debated in American politics. The Fed, as it is often referred, is the central bank for the United States. It impacts the lives of every American household, but most don’t understand what it is and its effect on the money we earn, save, and spend. To truly understand why the Fed exists and why its actions matter so much today, we need to look back to when America was a financial Wild West.
Nearly every country in the world, and certainly every developed industrialized nation, has a central bank. The one thing they all have in common is that they serve as banker to their own governments. Others may also act as a bank for bankers, issue a common currency, regulate banks, and act as a “lender of last resort” for banks in financial trouble.
Despite their common functions, each country’s central bank operates in different ways stemming from their unique history. Here in the United States, the Federal Reserve’s unique structure has been shaped by our country’s experiments with central banking. The road to a permanent central bank in the United States was long, winding, and marked by intense political friction over the concentration of financial power. Rooted in the colonial experience, Americans have a deep-seated anxiety toward institutions that could centralize wealth and authority.
The First Bank of the United States, championed by the nation’s first Treasury Secretary, Alexander Hamilton, was chartered in 1791. Its mission was to manage the government’s finances, issue currency, and provide a stable credit system. However, opponents, led by Thomas Jefferson, viewed it as an unconstitutional tool of the financial elite. When its 20-year charter expired in 1811, Congress refused to renew it by the narrowest of margins, by a single vote in each chamber.
Following the economic instability caused by the War of 1812, the Second Bank of the United States was chartered in 1816. Yet, it too became a casualty of politics when President Andrew Jackson passionately opposed the bank, viewing it as a symbol of aristocratic privilege, and its charter expired in 1836.
For the next eight decades, operating without a central bank, Americans endured a period of financial instability marked by recurring banking panics. In those days, if people heard a rumor that a local bank was in trouble, they would all rush to withdraw their money—a “bank run.” Because banks only kept a fraction of deposits on hand, the panic would often cause the bank to fail, spreading fear and collapsing the local economy.
The breaking point came with the devastating Panic of 1907. With no official government mechanism to step in, the country was saved from total collapse only by the intervention of one powerful private citizen, banker J.P. Morgan. The realization that the entire US economy had to rely on the goodwill and personal fortune of one man was seen as unacceptable.
This crisis led Congress to form a commission. In 1910, on the remote Jekyll Island, Georgia, a group of powerful bankers and politicians met in absolute secrecy to design a new banking system. After significant political compromise, their draft eventually became the framework for the modern Federal Reserve. On December 23, 1913, President Woodrow Wilson signed the Federal Reserve Act into law, creating the Federal Reserve System.
The Fed’s original purpose was simple: to end banking panics by providing currency and acting as the “lender of last resort.” But the new system quickly faced its first great test- and failed. The Great Depression of the 1930s saw the Fed stand by as thousands of banks failed, dramatically shrinking the money supply and deepening the economic catastrophe.
In the wake of this disaster, Congress passed the Banking Act of 1935 to dramatically reform the Fed and centralize its policymaking in the Federal Open Market Committee (FOMC)— the group that makes interest rate decisions today. In 1977, Congress formally established the Fed’s “dual mandate,” directing it to pursue two objectives for monetary policy: achieving maximum employment and maintaining price stability. This dual focus defines its modern mission and guides the interest rate decisions that make headlines today.
From its reluctant origins in the ashes of financial panics to its current role as a global economic pillar, the Federal Reserve remains our nation’s most powerful economic institution. Its development teaches us about the interplay between power, politics, economics, and risk. Its actions are a direct result of a long, contentious, and essential journey to stabilize America’s financial pulse and future.
This material has been prepared for informational purposes only, and is not intended to provide or be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.
