Before the founding of the Federal Reserve, the nation was plagued with financial crises. At times, these crises led to "panics," in which people raced to their banks to withdraw their deposits. The failure of one bank often had a domino effect, in which customers of other banks rushed to withdraw funds from their own banks. The nation's banks needed a source of emergency reserves to prevent the panics and resulting runs from driving them out of business.
A particularly severe panic in 1907 resulted in bank runs that wreaked havoc on the fragile banking system and ultimately led Congress in 1913 to write the Federal Reserve Act. Initially created to address these banking panics, the Federal Reserve is now charged with a number of broader responsibilities, including fostering a sound banking system and a healthy economy.
To read the Federal Reserve Act, click here.
President Wilson signing the Federal Reserve Act in 1913.
Although the need for banking reform was undisputed, for decades early supporters debated the delicate balance between national and regional interests. Nationally, the central bank had to make conducting financial transactions between businesses and individuals across regions of the country easier. A stable central bank would also strengthen the United States' standing in the world economy because foreign individuals, business and governments have confidence in doing business within a country that has a responsible central bank and economic system. Regionally, the central bank had to be responsive to the local needs for currency, which could vary across regions. It was a lack of available currency that caused earlier bank panics.
Another important issue was creating a balance between the private interests of banks and the centralized responsibility of government. What emerged with the Federal Reserve System was a central bank under public control, with many checks and balances.
Congress oversees the entire Federal Reserve System. And the Fed must work within the objectives established by Congress. Yet Congress gave the Federal Reserve the autonomy to carry out its responsibilities without political pressure. Each of the Fed's three parts – the Board of Governors, the Regional Reserve Banks and the Federal Open Market Committee – operates independently of the federal government to carry out the Fed's core responsibilities.