Fin 453 - Federal Reserve

Political Perspectives on the Federal Reserve

  • There are strong political divides regarding the Federal Reserve.

    • Far Right (Hardcore Libertarians): They oppose the Federal Reserve because they advocate for a laissez-faire capitalist economy, which is against Keynesianism and government intervention.

    • Far Left (Anarchists): They also reject the Federal Reserve, believing in complete autonomy from formal economic structures.

  • Interestingly, both extremes (alt-left and alt-right) possess similar views on the Federal Reserve despite their considerably different political ideologies.

Personal Reflections on Political Identity

  • The speaker expresses a desire to help listeners maintain their "intellectual virtue" while supporting the idea of the Federal Reserve, reflecting a personal struggle with the stigma surrounding this support.

The Historical Context of the Federal Reserve

  • The Federal Reserve was created on December 23, 1913, a date of considerable significance, as illustrated through the speaker’s mention of the connection to Joseph Smith's birthday.

  • This establishment was not the first instance of a central bank in the U.S.; there were two previous central banks:

    • First Central Bank (1791-1811):

    • Championed by Alexander Hamilton who favorited a strong central bank to manage state debts from the revolutionary war.

    • Thomas Jefferson opposed it, valuing states' rights and fearing federal consolidation of power.

    • The bank had a charter lasting for 20 years, but Jefferson’s presidency led to its dissolution in 1811.

    • Second Central Bank (1816-1836):

    • Following the War of 1812, another central bank was established to manage new debts, again with a 20-year charter.

    • President Andrew Jackson, who was against central banking, allowed this charter to expire in 1836.

The Free Banking Era (1836-1863)

  • Post the expiration of the second central bank, the U.S. entered a chaotic period known as the Free Banking Era:

    • Characterized by the absence of a central bank and federal banking laws.

    • This era was marked by extreme instability, dubbed the Wildcat Banking Era.

  • Key data points from the Free Banking Era:

    • Bank Failures: 50% of banks failed.

    • Redeemability Issues: 16% could not redeem their banknotes for gold & silver.

    • Short Lifespans: The average lifespan of banks was about 5 years.

    • Relevance to Modern Times: The speaker compares the lifespan of free banks humorously to a dog's lifespan, emphasizing their instability.

Hallmarks of the Free Banking Era

  1. Banking Instability:

    • High failure rates with half of banks failing.

    • The situation was so dire that living under this banking system would be considered unfavorable today.

  2. Fluctuations in Money Supply:

    • The absence of a central regulatory body led to erratic fluctuations in currency, causing inflationary issues.

    • Price levels varied greatly, demonstrating extreme volatility compared to today's standards.

  3. Business Cycle Volatility:

    • The economy experienced significant ups and downs, with inconsistent GDP growth rates.

    • The chaotic banking situation likely contributed to these fluctuations.

Establishment of the National Banking Act (1863)

  • The National Banking Act was passed to create a stable banking system post-Free Banking Era, regulating banking practices and issuing a national currency.

  • This act was intended to impose more order after the instability of the Free Banking Era, forcing banks to secure charters.

Data Visualization: Economic Stability Before and After Federal Reserve

  • A graph representation showing risks of recession (blue color) versus economic expansion (white color) highlights a significant shift post-1913.

  • The data indicates a reduction in economic volatility since the Federal Reserve's inception:

    • Fewer recessions and improved overall economic stability since 1913.

    • Reflects a long-term positive trend toward economic stability, with fewer bank failures occurring as a result of the Federal Reserve's policies.

Federal Reserve's Role and Effectiveness

  • Federal Reserve serves as a lender of last resort and works to:

    • Maintain stable prices (affecting inflation).

    • Ensure full employment.

  • Empirical evidence suggests improvements in:

    • Banking Stability: Fewer bank failures than during the Free Banking Era or even the National Banking era prior to the Federal Reserve.

    • Inflation Control: Post-1980 evidence suggests that inflation rates stayed below 6% for extended periods, indicating more effective monetary policy management.

Philosophical Debate on the Role of Government

  • Discussion prompted on which services should ideally be government-provided versus privately managed:

    • Services that protect human rights and manage externalities (both negative and positive) benefit from governmental oversight, emphasizing accountability.

  • Externalities Defined:

    • Negative Externalities: Costs borne by society due to individual actions, e.g., pollution.

    • Positive Externalities: Benefits received by society from individual actions, e.g., vaccinations or public parks.

Conclusions Drawn on Federal Reserve Justification

  • The Federal Reserve’s involvement is seen as necessary for managing economic stability and addressing significant economic challenges post-Great Depression.

  • The historical context, policy results, and philosophical arguments all support the case for the Federal Reserve's existence and continued relevance to macroeconomic health.