- The Fed kept money too tight, worsening the downturn. Historians later admitted the Fed’s actions contributed to the severity of the Depression. - Result: In 1935, Congress centralized authority by strengthening the Board of Governors.

Understanding the Federal Reserve: History, Roles, and Impact — Summary

Q: Why the Fed Was Created

- **Early 1900s banking crises**: Frequent bank runs caused depositors to lose money because banks kept only a fraction of deposits in cash. - **Panic of 1907**: Private financiers like J.P. Morgan bailed out banks, highlighting the need for a public institution to provide stability. - **Legislative response**: Business and political leaders convened to design a central bank that could act in emergencies, leading to the Federal Reserve Act of 1913.

Q: Structure of the Federal Reserve System

- **12 regional Reserve Banks** located across the country (e.g., New York, San Francisco, Kansas City, St. Louis) to diffuse power and reflect regional economic conditions. - **Board of Governors** in Washington, D.C.: Seven members appointed by the President and confirmed by the Senate, overseeing the entire system. - **Federal Open Market Committee (FOMC)**: Consists of the Board of Governors plus five Reserve Bank presidents (the New York president and four rotating members). The FOMC sets monetary policy, including the target interest rate.

Q: 1970s Inflation and the Dual Mandate

- **Great Inflation**: Prices rose to nearly 15% due to poor policies and external shocks. - **1978 Legislation**: Gave the Fed a dual mandate—stable prices and maximum employment—recognizing that these goals can conflict. - **Political pressure**: Early 1970s Fed chair Arthur Burns faced pressure from President Nixon not to raise rates before the election.

The Wall Street Journal

Jan 12, 2026

•

3 min read

Understanding the Federal Reserve: History, Roles, and Impact

Introduction

The Federal Reserve (the Fed) is the United States' central bank, responsible for managing the money supply, setting interest rates, and overseeing the financial system. Though the Treasury prints the physical dollars, the Fed distributes them and controls how much money circulates in the economy.

Why the Fed Was Created

Early 1900s banking crises: Frequent bank runs caused depositors to lose money because banks kept only a fraction of deposits in cash.
Panic of 1907: Private financiers like J.P. Morgan bailed out banks, highlighting the need for a public institution to provide stability.
Legislative response: Business and political leaders convened to design a central bank that could act in emergencies, leading to the Federal Reserve Act of 1913.

Structure of the Federal Reserve System

12 regional Reserve Banks located across the country (e.g., New York, San Francisco, Kansas City, St. Louis) to diffuse power and reflect regional economic conditions.
Board of Governors in Washington, D.C.: Seven members appointed by the President and confirmed by the Senate, overseeing the entire system.
Federal Open Market Committee (FOMC): Consists of the Board of Governors plus five Reserve Bank presidents (the New York president and four rotating members). The FOMC sets monetary policy, including the target interest rate.

Evolution Through Crises

The Great Depression

The Fed kept money too tight, worsening the downturn. Historians later admitted the Fed’s actions contributed to the severity of the Depression.
Result: In 1935, Congress centralized authority by strengthening the Board of Governors.

1970s Inflation and the Dual Mandate

Great Inflation: Prices rose to nearly 15% due to poor policies and external shocks.
1978 Legislation: Gave the Fed a dual mandate—stable prices and maximum employment—recognizing that these goals can conflict.
Political pressure: Early 1970s Fed chair Arthur Burns faced pressure from President Nixon not to raise rates before the election.

Paul Volcker’s Tightening (1979‑1982)

Appointed by President Carter, Volcker raised the federal funds rate to about 20%.
Resulted in a recession with unemployment above 10%, but successfully broke the inflationary spiral.
Over the next three decades, the U.S. economy outperformed many peers, cementing the Fed’s credibility and political independence.

The 2008 Financial Crisis and Ben Bernanke

Unprecedented actions: Near‑zero interest rates, massive purchases of mortgage‑backed securities, and large loans to non‑bank institutions.
These measures prevented a second Great Depression and expanded the Fed’s role beyond traditional banking functions.
Dodd‑Frank: Congress granted the Fed additional regulatory authority over the banking system.

COVID‑19 Pandemic

The Fed revived its crisis playbook: buying assets, extending credit to a broader set of institutions, and dramatically increasing the money supply.
Demonstrated the Fed’s willingness to act swiftly during national emergencies.

Current Role and Ongoing Debate

The Fed now acts as a “stop‑gap” for many parts of the financial system, making rapid decisions without direct political fallout.
Critics argue that a small group of unelected officials wield outsized influence over the economy, effectively outsourcing monetary policy from elected leaders.
Supporters contend that independence shields monetary policy from short‑term political pressures, leading to more stable long‑term outcomes.

Recent Policy Action

In response to rising inflation, the FOMC recently raised its policy interest rate by a quarter‑percentage point, illustrating its continued role in balancing price stability and employment.

Conclusion

The Federal Reserve began as a reaction to early 20th‑century banking panics and has grown with each subsequent crisis—Great Depression, 1970s inflation, 2008 recession, and COVID‑19. While its expanded powers have sparked debate over democratic accountability, the Fed remains a central pillar of U.S. economic stability, capable of swift, decisive action when markets and the broader economy are under stress.

The Federal Reserve, born out of early banking crises, has evolved into a powerful, independent institution that shapes U.S. monetary policy and stabilizes the economy, but its unelected authority continues to fuel debate over democratic oversight.

Takeaways

Early 1900s banking crises: Frequent bank runs caused depositors to lose money because banks kept only a fraction of deposits in cash.
Panic of 1907: Private financiers like J.P. Morgan bailed out banks, highlighting the need for a public institution to provide stability.

Educational Value

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Full Transcript

- [Narrator] At the top
of any US dollar bill,
you'll see this.
That's because even though the bill
may have come from the Treasury,
the Federal reserve is who
actually distributes it.
- They're the ones that's charged
with managing the currency
in circulation in our economy.
- [Narrator] In other words,
they can kind of print money.
- Money printer go brr, right?
That was a popular meme
in 2020 when the Fed
was creating money outta thin air.
- [Narrator] The Federal
reserve is in many ways
in charge of the US economy.
As a former chairman once said,
"They're the economy
chaperone who has ordered
the punch bowl removed just when the party
was really warming up."
Which means they know their decisions,
like raising interest rates,
aren't always popular.
- The Fed is just this poorly understood
and really important
institution in our country.
It's important for people to know
what's going on in the economy.
They should understand
why we have the Fed,
why it does what it does,
and what role it plays in the country.
- [Narrator] So let's explain.
How did the Fed get put
in charge of the punch?
The Fed, as we know, it
has evolved over time,
after responses to financial crises
gave it more and more responsibility.
So let's start with
why the Fed was created
in the first place.
In the early 1900s, bank
runs were pretty common.
If a bank, a private business
went out of business,
that meant everyone lost their deposits.
Fearful, people would
run to their healthy bank
to withdraw their money.
Only banks didn't keep
that much cash handy,
so they'd fail, causing
more people to fearfully run
to their bank.
And back then there was
nowhere for these banks
to get more cash to stop these runs.
After a large run in 1907,
wealthy bankers like JP
Morgan, put up their own money
to essentially bail them out.
- After that panic in 1907,
business and political
leaders got together and said
maybe this isn't the best
way to run a modern economy,
to rely on a few wealthy
individuals doing the right thing
in a time of crisis.
And so discussions began
about creating a central bank,
or what became the Federal Reserve System.
- [Narrator] In 1913, the
Federal reserve was created to be
the United States Central Banking System.
Basically a bank for banks.
It's 12 separate Federal
reserve banks set up
all across the country.
- You had a lot of distrust
still in the country
over having one bank.
The idea was that it
might be too powerful.
So, you could go to different
parts of the country
and say, well, the power
won't be in New York.
It won't be in Washington, it'll be here.
There'll be a bank in Atlanta.
There'll be a bank in Kansas City.
There'll be a bank in San
Francisco and Minneapolis.
- [Narrator] And two in Missouri.
- There was a senator from
Missouri who was instrumental
in creating the Federal Reserve System.
And lo and behold, there's a Fed Bank
in St. Louis and in Kansas City.
- [Narrator] The idea was
they would each represent
different regions of the country,
and would independently
set their own policies
and interest rates on the money
banks would keep with them.
There was also a president
put in charge of each bank.
Then, the Great Depression hit.
It's widely agreed by historians
that the Federal Reserve Banks in action
and them keeping the circulation of money
and lending too tight,
made the Depression worse.
And by widely agreed,
nearly a century later,
a Fed governor said, "We did it."
- There were concerns even
before the Great Depression
that the political compromise
that had been necessary
to create this thing
had created too much decentralized power.
Nobody really was in charge.
- [Narrator] So in 1935, Congress put the
Washington based Board
of Governors in charge.
It would be a group of seven people
from different parts of the
country, including a chairman,
each nominated by the President
and confirmed by the Senate,
just like a Supreme Court Justice.
They oversee the Federal
Reserve System, these banks.
They also serve on the
Federal Open Market Committee,
the FOMC, which also includes
five bank presidents,
one from New York and four that rotate.
This is the group of
people who get together
and decide things like interest rates.
- When you talk about a Fed meeting,
you're talking about
a meeting of the FOMC.
The terms become interchangeable,
because there are certain
things that the FOMC does.
There are certain things
that the Fed Board does,
and they all kind of blend together.
- [Narrator] So that's how we got to
the basic foundation of the Fed.
But the Fed as we know it today,
with its many responsibilities,
was built from responses to
even more financial crises.
Let's start with inflation in the 70s,
and in 1978, when Congress gave the Fed,
or really the FOMC, two main priorities.
- The Fed was given a dual
mandate to focus on stable prices
and maximum employment.
Now sometimes those goals
conflict with each other.
When you're trying to crush inflation,
sometimes you're gonna do
things that cause unemployment
to go up, but the mandate really said
the Fed should take both of
these objectives into account
when they set policy.
- [Narrator] This was because in the 70s,
inflation was really high.
Called the Great Inflation
now, a mix of bad luck
and bad policies saw inflation
reach nearly 15 percent.
- There were concerns
that the Fed succumbed
to political pressure in the early 1970s
because the Fed chair at
the time, Arthur Burns,
was friendly with the president
and Nixon did not want him
to raise interest rates
before his reelection in 1972.
So the whole experience
of the Great Inflation
reinforced this idea that we should have
politically independent central banking
that generally, when you kept politics out
of the FOMC boardroom, you
had better economic outcomes.
- [Narrator] In 1979,
President Jimmy Carter
put Paul Volcker in charge of the Fed,
and he raised interest rates,
a lot, to nearly 20 percent.
Unemployment skyrocketed
and rose above 10 percent,
and people blamed the Fed.
- Home builders would mail two by fours
to the Fed and say, "Stop these
oppressive interest rates."
They would mail keys for cars
and houses to the Fed saying,
"These are homes and cars
that aren't being sold."
There were were tractors that protested,
driving around at the Fed's headquarters.
History has vindicated the
moves of the Volcker Fed.
He's lionized today as this
figure who did something
that was really hard and really unpopular.
But if you look at the US economy
over the 30 years that followed,
the US economy performed better
than most other advanced economies.
- [Narrator] The Fed gained credibility
because it was politically independent,
since politics don't always
make great economic policies.
And when the 2008
financial crisis arrived,
the Fed Chairman, Ben Bernanke,
learned from lessons of the past.
- The bold measures the
Fed took in response
to the recent financial
crisis, reflected in part
its determination to avoid repeating
the same sorts of mistakes
it made before and during
the Great Depression of the 1930s.
- [Narrator] Those bold
measures included things
the Fed had never done before,
like dropping interest rates
to near zero for the first time.
In addition to managing the currency
and circulation and the
occasional treasury security,
it started loaning money, a
lot of money to non-banks.
It also got into new markets,
buying things like mortgage securities,
all this to pump money into the economy.
This got the Fed even
more involved in parts
of the financial system,
beyond just currency and interest rates.
- One of the things Bernanke
was well regarded for
was that he just threw
everything against the wall
to see what would stick.
He made sure that it didn't get worse.
We call it the Great Recession
and not the second Great Depression.
- [Narrator] And Congress
also gave it more authority
of oversight and regulation
of the banking system
through Dodd-Frank, and just
kind of by default of inaction.
- Government spending retreated
after the stimulus in 2009.
And so there was this saying
that the Fed had become
the only game in town.
If you needed to stimulate your economy,
you weren't gonna be able to
cut taxes or spend more money
because Congress didn't wanna do that.
What ended up happening
was that financial markets,
to a greater and greater degree,
began to hang on every word
and every utterance of the Fed chair,
because now monetary policy
was just so important
to the markets,
and also to the economic
outlook for the country.
- [Narrator] Then came COVID.
The Fed took from the
Great Recession Playbook.
It bought those same assets.
It began loaning more money
to even more non-banks,
and it raised the amount of
money in circulation, brr.
- What you see is a central
bank that during periods
of severe stress, really,
you know, national emergency,
is willing to do quite a lot to make sure
that the economy and the
financial system holds together.
- [Narrator] Including
when inflation rises.
- Today, in support of these goals,
the FOMC raised its policy interest rate
by one quarter percentage point.
- [Narrator] The Federal
reserve began as a response
to a financial crisis, and has only grown
with each one since.
Although, not always without criticism.
- The time has come, let's end the Fed.
- [Narrator] The Fed is
primarily still a bank for banks,
but it has also become the stop gap
for most other parts of
the financial system.
They can make decisions quickly
and without political fallout.
- To the extent you have a
handful of unelected people
making huge decisions about the economy.
It's something that Congress
and the White House,
our elected leaders, have
really decided over many decades
to really outsource this to the Fed.
- [Narrator] Basically,
it's easier for the parents
to rely on the chaperone.
(gentle music)

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