History of the Federal Reserve

When World War I broke out in mid-1914, U.S. banks continued to operate normally, thanks to the emergency currency issued under the Aldrich-Vreeland Act of 1908.

Before the new central bank could begin operations, the Reserve Bank Operating Committee, comprised of Treasury Secretary William McAdoo, Secretary of Agriculture David Houston, and Comptroller of the Currency John Skelton Williams, had the arduous task of building a working institution around the bare bones of the new law.

Following World War I, Benjamin Strong, head of the New York Fed from 1914 to his death in 1928, recognized that gold no longer served as the central factor in controlling credit.

During the 1920s, Virginia Representative Carter Glass warned that stock market speculation would lead to dire consequences. In October 1929, his predictions seemed to be realized when the stock market crashed, and the nation fell into the worst depression in its history. From 1930 to 1933, nearly 10,000 banks failed.

In reaction to the Great Depression, Congress passed the Banking Act of 1933, better known as the Glass-Steagall Act, calling for the separation of commercial and investment banking and requiring use of government securities as collateral for Federal Reserve notes.

The Banking Act of 1935 called for further changes in the Fed’s structure, including the creation of the Federal Open Market Committee (FOMC) as a separate legal entity, removal of the Treasury Secretary and the Comptroller of the Currency from the Fed’s governing board and establishment of the members’ terms at 14 years.

The Federal Reserve System formally committed to maintaining a low interest rate peg on government bonds in 1942 after the United States entered World War II.

The 1970s saw inflation skyrocket as producer and consumer prices rose, oil prices soared and the federal deficit more than doubled. By August 1979, when Paul Volcker was sworn in as Fed chairman, drastic action was needed to break inflation’s stranglehold on the U.S. economy.

The Monetary Control Act of 1980 required the Fed to price its financial services competitively against private sector providers and to establish reserve requirements for all eligible financial institutions.

Two months after Alan Greenspan took office as the Fed chairman, the stock market crashed on October 19, 1987. In response, he ordered the Fed to issue a one-sentence statement before the start of trading on October 20: “The Federal Reserve, consistent with its responsibilities as the nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system."

The effectiveness of the Federal Reserve as a central bank was put to the test on September 11, 2001 as the terrorist attacks on New York, Washington and Pennsylvania disrupted U.S. financial markets.

In 2003, the Federal Reserve changed its discount window operations so as to have rates at the window set above the prevailing Fed Funds rate and provide rationing of loans to banks through interest rates.

During the early 2000s, low mortgage rates and expanded access to credit made homeownership possible for more people, increasing the demand for housing and driving up house prices.