The Federal Reserve Explained—[AP Macroeconomics Review]

Summary

The Federal Reserve, often referred to as "the Fed," is the central banking system of the United States, established in 1913 following the financial panic of 1907. The Fed's main purpose is to provide financial stability by safeguarding reserves, overseeing banks, and controlling the issuance of currency. Key historical episodes such as the Great Depression, the savings and loan crisis of the 1980s, and the 2008 financial crisis highlight its evolving role and challenges. It operates through structures like the Board of Governors and regional Federal Reserve Banks, and it uses tools such as reserve requirements, the discount rate, and open market operations to steer monetary policy.

Highlights

• The Federal Reserve, or "Big Daddy bank," was created after the 1907 panic to stabilize the banking system. 📊
• Key financial crises, including the Great Depression and 2008 recession, shaped the Fed's role. 📉
• The Fed operates with a mix of governmental oversight and private sector functions. 🤝
• Monetary policy tools include reserve requirements, the discount rate, and open market operations. 💸
• The history of banking crises underscores the Federal Reserve's crucial role in economic stability. 💡

Key Takeaways

• The Federal Reserve was established in 1913 as a response to bank failures and aims to stabilize the economy. 📉
• The Board of Governors and 12 regional banks make up the unique structure of the Fed. 🏦
• The Fed's main tools for monetary policy include reserve requirements, the discount rate, and open market operations. 💼
• Economic crises like the Great Depression and the 2008 recession show the Fed's importance and challenges. 📉
• Despite regulations, financial crises have recurred, highlighting ongoing economic risks. ⚠️

Overview

In a fun and engaging video, Heimler's History dives into the birth and functions of the Federal Reserve System. With origins tracing back to the infamous financial panic of 1907, the Fed was formally established in 1913 to centralize and stabilize the U.S. banking system. It serves not only as a regulator but also as a protector ensuring the financial equilibrium after various financial upheavals, from the Great Depression to the 2008 financial crisis.

The Fed's structure is neither purely governmental nor entirely private, consisting of the Board of Governors and 12 regional Federal Reserve Banks. This setup provides both a national overview and local insight, enabling better surveillance and control of financial practices to prevent mishaps like those witnessed during bank runs and economic meltdowns. Through its tools—reserve requirements, the discount rate, and open market operations—the Fed manages the nation’s money supply and strives for economic stability.

Continuous learning seems to be a theme for the Fed, as past economic blunders have not always prevented future crises. The history of the Federal Reserve is a fascinating saga of responses to financial disasters, highlighting both its successes and areas for improvement. This storytelling approach translates complex economic concepts into understandable and relatable content, making it an educational delight for those interested in understanding the forces behind monetary policy.

Chapters

• 00:00 - 00:30: Introduction to the Federal Reserve The chapter introduces the concept of the Federal Reserve, likening smaller community banks to 'baby banks' and the Federal Reserve to the 'big old daddy bank.' The chapter aims to explore the identity and functions of the Federal Reserve, beginning with a historical perspective on its origins, particularly referencing the year 1907 while noting that the Federal Reserve is not mentioned in the Constitution.
• 00:30 - 02:00: History of the Federal Reserve Establishment The chapter delves into the events leading up to the establishment of the Federal Reserve, focusing on a series of banking failures. It highlights how a few bank-like entities known as trusts engaged in reckless financial behavior, resulting in significant losses. As rumors of these losses spread, depositors rushed to withdraw their funds, only to find them depleted. This narrative demonstrates the banking system's fragility during that period, where banks, lacking full reserves, could not satisfy the sudden demand for withdrawals, indicating a need for a central banking system to prevent such crises.
• 03:00 - 04:00: Great Depression and FDIC Formation The chapter discusses the events leading up to the Panic of 1907, highlighting how a rush of people attempting to withdraw their money from banks and trusts caused widespread panic. Due to the lack of sufficient funds, many people were unable to recover their money. In response, prominent figures like John D. Rockefeller, other wealthy individuals, and the US Treasury Secretary pooled together cash to inject into the banks, reassuring people that they could access their money. This intervention was instrumental in calming the panic, although the initial crisis led to significant financial unrest.
• 04:00 - 05:00: Savings and Loan Crisis of the 1980s The formation of the Federal Reserve System was influenced by the panic of 1907. This financial crisis convinced policymakers of the need for a centralized banking system. Consequently, the Federal Reserve System was established in 1913 with the intent to enforce banks to maintain sufficient reserves for depositors. Additionally, it was tasked with the oversight of banking operations to prevent risky behaviors and was exclusively authorized to issue currency.
• 05:00 - 07:00: 2008 Financial Crisis Overview The chapter discusses the unique structure of the Federal Reserve in the U.S. economy. It explains that the Fed is neither a completely government nor entirely private entity. The Federal Reserve comprises two main components: the Board of Governors and the 12 regional Federal Reserve Banks. It notes that the Board of Governors consists of seven members appointed by the President and approved by the Senate, serving 14-year terms, which helps insulate them from political pressures when shaping monetary policy.
• 07:00 - 09:00: Functions of the Federal Reserve This chapter discusses the structure and functions of the Federal Reserve, particularly focusing on the role of the twelve regional Federal Reserve banks. These banks are responsible for monitoring private banks to ensure they comply with federal standards and maintain adequate reserves. Although federal regulation was established in 1913, the chapter highlights that bank failures can still occur. The current chair of the Federal Reserve, as mentioned, is Jerome Powell.
• 09:00 - 10:00: Monetary Policy Tools The chapter discusses the events leading to the establishment of the Federal Deposit Insurance Corporation (FDIC), highlighting the 1929 stock market crash and bank failures. It explains how the inability of banks to meet depositor demands contributed to the Great Depression and how President Franklin Delano Roosevelt created the FDIC as a solution.
• 10:00 - 11:00: Conclusion and Video Outro The chapter discusses the measures taken by the federal government to ensure the safety of people's bank deposits, particularly up to an amount of $2,500, to prevent crises similar to past banking failures. It explains that if a bank fails to meet its depositors' demands, the federal government would intervene to return the depositors' money. However, by 1980, the memory of past banking crises had faded, and the effectiveness of related legislations had diminished, which set the stage for potential financial issues in the late 1970s and early 1980s.

The Federal Reserve Explained—[AP Macroeconomics Review] Transcription

• 00:00 - 00:30 hi and welcome back to Hine was just your economics addition in the last video we talked about banks and how they create money and here in America all the little baby banks that you see in your community actually have a big old daddy bank and that's called the Federal Reserve and in this video we're gonna look at what the Fed is and what it does let's get to it so let's begin with some history where did the Federal Reserve come from and it's not in the Constitution so why do we have it well back in 1907 things went very bad
• 00:30 - 01:00 for banks I'll leave all the details out but all you really need to know is that a few bank like entities called trusts got a little reckless and ended up losing metric but loads of money and when all their depositors heard rumors about the loss they rushed to the trust to withdraw their money and found that it was gone that doesn't sound like a big deal so one trust went under well when rumors started spreading that this one trust failed more and more people got twitchy and decided to go get their money out of the banks - and if you'll recall banks don't keep all the money that is deposited in them they'll own
• 01:00 - 01:30 most of it out so as the hordes of people descended upon the banks and the trust to withdraw their money they were only able to recover a little if any of it and that led to the panic of 1907 now has it happened to wealthy oil tycoon by the name of john d rockefeller along with a few other wealthy people and the US Treasury Secretary PO need up a bunch of cash and gave it to banks so that the people who wanted their money could get it and once people were relatively assured that they can get their money if they wanted it the panic died down but even so the panic of 1907 resulted in a
• 01:30 - 02:00 four-year deep economic recession that led to 8% unemployment so the panic of 1907 convinced policymakers that a more centralized banking system was necessary and so in 1913 the Federal Reserve System was born its role was to compel banks by federal force to hold on to adequate reserves for its depositors additionally it provided oversight to banks to assure that they would not continue engaging in such risky behavior and finally the Federal Reserve was endowed with the sole right to issue
• 02:00 - 02:30 currency in our economy now the structure of the Fed is a little bit difficult to classify it's not quite a government entity and it's not quite a private entity but it basically has two components that you need to know about the Board of Direct in the 12 regional Federal Reserve banks the Board of Governors has seven presidentially appointed members that must be approved by the Senate now the members of this board serve for 14 year terms and all of this is so that the board is technically insulated from political pressure to influence monetary policy in one direction or the other and
• 02:30 - 03:00 as of this recording the current chair of the Fed is Jerome Powell hey Jerome and then there are the twelve regional Federal Reserve banks and here's a map to show you where they are in the regions where they serve now one of the major jobs of these regional banks is to keep tabs on private banks to make sure that they're complying with federal standards and not being stupid and the chief stupidity the Fed seeks to regulate is that banks hold on to a reasonable amount of its deposits now despite all this federal regulation that came into being in 1913 bank failure was still possible because banks still have
• 03:00 - 03:30 the option of loaning out most of their funds and the nation discovered this quite devastatingly in October of 1929 in that month the stock market crashed and people made runs on banks to withdraw their money even with the federal regulations in place banks failed because they couldn't meet the demands of depositors and we got ourselves into the Great Depression so Franklin Delano Roosevelt who happened to be president during this time decided to remedy this problem and establish the FDIC or the Federal Deposit Insurance Corporation and the FDIC was there to
• 03:30 - 04:00 ensure people's deposits so that if people put money into the bank up to $2,500 they could be assured that the federal government had their back if the bank couldn't meet the depositors demands for money than the federal government would step in and give them their deposits and I'm sure after that we're never going to get into a crisis like that again but by 1980 most people had lost the memory of all those bleak banking days of the past and all the legislation that was passed to prevent such crises had really lost its teeth so in the late 70s and early eighties
• 04:00 - 04:30 lending institutions called savings and loans which existed to take deposits and turn them into mortgage loans for homebuyers began engaging in risky real estate lending and long story short a large number of these savings and loans failed but that's okay right because now we got the Federal Reserve to bail them out except what all those savings and loans fail those debts became the debts of the federal government and as you know Big Daddy government does not have a job you see the reason why Big Daddy government can remain in the lifestyle to which he has become a custom is because we humble taxpayers
• 04:30 - 05:00 send him our monthly payments so as it turns out the savings and loan failures of the 1980s cost the American taxpayers about one hundred and twenty four billion dollars but I'm sure that we learned our lesson after the 1980s I mean after 1907 and in the 1930s and in the 1980s there's no way the financial system could fail like that again would that be hilarious if we were like that if you were alive in 2008 you know in fact we did not learn our lessons so
• 05:00 - 05:30 from about 2001 to 2003 the American economy was in recession and we went ahead during that recovery and planted the seeds for a new economic crisis in 2003 the Fed set the interest rates at historically low levels and that led to a boom in the housing market and as the housing market boomed financial institutions began again engaging in risky behavior this time subprime lending now I don't mean to be a fundamentalist but usually the way the world works is that if somebody can't afford a thing they can't get it I mean if a guy walks into a jewelry store off
• 05:30 - 06:00 the street and says hey I want that Rolex and the owner says can you afford it and the guy says no I live in a cardboard box in the street outside your store can't afford it all things being equal the owner is not going to sell that watch to that man and in general banks loan up mortgages and amounts that people can safely repay given their current amount of income but since the housing market was growing at an incredible pace and property values continued to rise banks and investors started loaning out mortgages to people who could in no way afford it based on their current income but they did so
• 06:00 - 06:30 because they thought well property values are rising and if they default on their loan we'll just sell the house and make up the difference and so for several years in the early 2000s the guy from the street walks into the jewelry store asks if he can buy the watch and then when the owner says can you afford it and the guy says no the owner says hmmm alright I'll take a risk that you can afford it just make sure you pay me back later but wouldn't you know what that growing bubble eventually burst and property value started declining and people began to fall ting on their loans wholesale and could not repay their
• 06:30 - 07:00 mortgages and as Rizzo the economy went into a deep years long recession and so now I'm sure that we in the Fed and the banks have learned our lessons and this will never happen again you so crazy okay so that's what the Federal Reserve is now let's talk about what the Federal Reserve does there are basically four functions of the Federal Reserve first the Fed provides financial services to depository institutions which is to say that the Fed is the bankers bank if you want to make a financial transaction you just go down to your local bank if your bank wants to
• 07:00 - 07:30 do the same thing then they go to the Fed so the Federal Reserve holds reserves clears checks provides cash and transfers funds to banks second the Fed supervises and regulates banking institutions which basically means it's a watchdog over all our nation's private banks to make sure they're not engaging an overly risky behavior third the Fed maintains the stability of the financial system basically this just means that the Fed is responsible for providing liquidity to banks and to provide for their flourishing and fourth the Fed conducts monetary policy and since this
• 07:30 - 08:00 is the most important of the feds responsibilities we're gonna spend some time here basically in order to conduct monetary policy which is essentially the feds decisions about how much money is in the economy the Federal Reserve has three tools at its disposal reserve requirements the discount rate and open market operations let's begin with the reserve requirements the reserve requirement just says how much money banks are required to hold on to so that if you go to the bank and demand your money back they at least have some on hand banks are required to hold on to some of their reserve cash so if the Fed
• 08:00 - 08:30 decides that the reserve requirement is 10% that means that banks when they get a deposit have to hold on to 10% of that but can loan the other 90% out so if the Fed wants more money in the economy then they can lower the reserve requirement say to 5% and that means that banks have to hold on to only 5% of their deposits and they can loan 95% out and vice versa if the Fed wants less money in the economy they can raise the reserve requirement next the Fed can use the discount rate to steer monetary policy so what happens in the case when a bank doesn't have enough funds to meet the
• 08:30 - 09:00 reserve requirement well in that case they can borrow money from the Fed to replenish their supply and the discount rate is the rate at which the Fed makes those loans to other banks usually the just raise a little bit higher than the normal interest rate to discourage banks from doing this kind of thing so the higher the discount rate the less likely banks are to borrow money but the lower the discount rate the more likely banks are to borrow money from the fish and finally the tool that they most often use to steer monetary policy is open market operations so in a previous video I told you about government bonds these
• 09:00 - 09:30 are like short-term IOUs that the government sells to commercial banks so that they can raise money to pay its bills so if the Fed wanted to increase the money supply in our economy they would facilitate the buying of bonds because when they buy bonds they're putting money into circulation and taking bonds out of the economy and if the Fed wanted to decrease the money supply all they would need to do is sell bond and the reason why that decreases the money supply is because now bonds are in the hands of investors instead of money and that ladies and gentlemen is what the Federal Reserve is and what the Federal Reserve does I will see you next
• 09:30 - 10:00 time all right thanks for watching another economics video now I unlike the Fed don't have the tools to increase the circulation of this video except to ask you to like it if you indeed liked it and if you click that little like button this circulation will increase if you want to see more videos like this in more videos covering all things US history world history government and beyond then subscribe and come along [Music]