America's Central Banks

Key Takeaways

  • A central bank is a bank under some degree of government control that is responsible for influencing the money supply, interest rates, inflation, and other macroeconomic outcomes like output and employment. A central bank is usually the lender of last resort, the institution that can (and should) add liquidity and confidence to the financial system at the outbreak of panics and crises. On a quotidian basis, central banks also may clear checks, regulate banks and/or other financial institutions, and serve as the national government's bank.
  • Early in its history, the United States was home to two privately owned central banks, the Bank of the United States and the Second Bank, that acted as a lender of last resort and regulated commercial banks by returning their notes to them for redemption in base money (then gold and silver). Although economically effective, both were politically unpopular so when their twenty-year charters expired, they were not renewed. From 1837 until the end of 1914, the United States had no central bank, but the Treasury Department fulfilled some of its functions.
  • A country can do without a central bank if it is on fixed exchange rates, such as the gold standard, or otherwise gives up discretionary monetary policy, as when countries dollarize or adopt a foreign currency as their own. In such cases, other institutions fulfill central banking functions: government departments regulate financial institutions, commercial banks safeguard the government's deposits, a currency board administers the fixed exchange rate mechanism, clearinghouses established by banks clear checks, and so forth.
  • The Treasury Department did not act as a lender of last resort, however, so recurrent banking crises and financial panics plagued the economy. When J. P. Morgan acted as a lender of last resort during the Panic of 1907, political sentiments shifted and the Federal Reserve system emerged out of a series of political compromises six years later.