Question

When Congress established the Federal Reserve in 1913 , what was its main responsibility? When did Congress broaden the Fed's responsibilities?

Short answer

In 1913, Congress established the Federal Reserve with its main responsibility being the creation of a safer and more stable monetary system in the U.S., predominantly through regulation of monetary policy. Congress broadened the Fed's responsibilities after the Great Depression in 1935.

Step-by-step solution

Understanding the purpose of Fed's establishment

The Federal Reserve System, also known as the Fed, was established by Congress in 1913. Its main responsibility was to provide the nation with a safer, flexible, and more stable monetary and financial system. This was done primarily through the regulation of monetary policy, which involved managing inflation, regulating the banking institutions, maintaining the stability of the financial system and providing financial services to depository institutions, the U.S. government, and foreign official institutions.

Identifying the time when Fed's responsibilities were broadened

Congress broadened the Federal Reserve's responsibilities following the Great Depression in 1935. An amendment to the Federal Reserve Act gave the Fed more power to influence money and credit conditions in the economy. The amendment created the Federal Open Market Committee as a separate legal entity, gave it responsibility for open-market operations, and started the use of reserve requirements as a monetary policy tool.

Key concepts

Monetary Policy

Monetary policy involves the management of a country's money supply and interest rates by its central bank—in this case, the Federal Reserve System, or simply the Fed. The goal of monetary policy is to achieve macroeconomic objectives such as controlling inflation, consumption, growth, and liquidity. By adjusting the level of funds available to the economy and the cost of borrowing, the Fed can influence economic activity.
To conduct monetary policy, the Fed uses several tools:

• Open Market Operations (OMO): Buying and selling government securities to influence the level of bank reserves and interest rates.
• Discount Rate: The interest rate charged to commercial banks for borrowing funds from the Federal Reserve.
• Reserve Requirements: The portion of deposits that banks must hold as reserves and cannot loan out.

By utilizing these tools, the Fed seeks to stabilize the economy and mitigate the risk of economic downturns.

Great Depression

The Great Depression was a severe worldwide economic downturn that took place during the 1930s. It was the longest and most widespread depression of the 20th century, deeply impacting the United States and many other countries. The economic collapse led to high unemployment rates, a decrease in industrial production, and deflation.
This period highlighted the inadequacies of the existing financial systems and prompted significant changes in how monetary policy was conducted. The economic hardship led Congress to amend the Federal Reserve Act in 1935, giving more power and flexibility to the Fed to prevent future economic crises.
The changes included enhancing the Fed's ability to influence money supply and credit conditions, which were crucial to fostering economic recovery and stability. The lessons learned from the Great Depression continue to shape economic policy decisions today.

Federal Open Market Committee

The Federal Open Market Committee (FOMC) is a crucial component of the Federal Reserve System. Created in 1935, it was formed to address the monetary policy challenges exposed during the Great Depression. The FOMC is charged with overseeing the nation’s open market operations, which are key to influencing the money supply and credit conditions in the economy.
Composed of 12 members, including the Board of Governors and Federal Reserve Bank presidents, the FOMC meets regularly to determine the direction of monetary policy. The decisions made by the FOMC are critical as they directly affect interest rates and the availability of credit, thereby influencing overall economic activity.
The FOMC aims to achieve maximum employment, stable prices, and moderate long-term interest rates, aligning with the broader goals of the Fed. Its strategic decisions are instrumental in guiding the economic direction of the United States.

Reserve Requirements

Reserve requirements are regulations concerning the minimum amount of reserves a bank must hold against deposits. They serve as a critical tool within the realm of monetary policy. The Federal Reserve uses this instrument to control how much money banks can lend, thus impacting the overall money supply in the economy.
By adjusting reserve requirements, the Fed can influence the economic activity directly:

• Increased Reserve Requirements: Banks must hold more money, reducing the amount available for lending, potentially slowing economic growth.
• Decreased Reserve Requirements: Banks hold less capital and can lend more, often stimulating economic growth.

The strategic adjustment of reserve requirements provides the Fed with a powerful lever to control inflation and ensure a stable financial environment. This tool is part of a broader set of policies designed to help stabilize the economy and promote sustainable growth.