Federal Reserve Act

Explanation and Analysis of the Document

The purpose of the Federal Reserve Act, portions of which are reproduced here, is “to provide for the establishment of Federal Reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper [that is, allowing banks to convert assets in the form of short-term loans to businesses into money], to establish a more effective supervision of banking in the United States, and for other purposes.” To that end, the act creates a Reserve Bank Organization Committee consisting of the secretary of the Treasury, the secretary of agriculture, and the comptroller of the currency. The committee’s job was to establish what would become the nation’s twelve Federal Reserve banks, each representing a Federal Reserve district. Each of these banks, in turn, would have its own branches, boundaries, and board of directors. All nationally chartered banks are required to become members of the Federal Reserve System, to purchase stock in its regional Federal Reserve bank, and to set aside reserve currency in its regional bank. In turn, every member bank is entitled to certain services, in particular, access to discounted loans. State-chartered banks are allowed, but not required, to purchase stock in the Federal Reserve bank in its region. Supervising the system is the Federal Reserve Board, later renamed the Board of Governors of the Federal Reserve System. The board’s powers are enumerated in Section 11.

A key provision of the Federal Reserve Act is contained in Section 13:

Any Federal reserve bank may receive from any of its member banks, and from the United States, deposits of current funds in lawful money, national-bank notes, Federal reserve notes, or checks and drafts upon solvent member banks, payable upon presentation; or, solely for exchange purposes, may receive from other Federal reserve banks deposits of current funds in lawful money, national-bank notes, or checks and drafts upon solvent member or other Federal reserve banks, payable upon presentation.

This provision ensures that the system is in fact a system, one that permits the free flow of money and credit; promotes stable employment, prices, and interest rates; and moderates the effects of boom-and-bust cycles and seasonal fluctuations in the nation’s economy.

Perhaps the one provision of the Federal Reserve Act that is most noticeable to members of the public is the Federal Reserve’s authority to issued Federal Reserve notes—the paper currency people carry in their wallets—as legal tender. Section 16 states that “the said notes shall be obligations of the United States and shall be receivable by all national and member banks and Federal reserve banks and for all taxes, customs, and other public dues.” At the time, each Federal Reserve bank was required to maintain “reserves in gold of not less than forty per centum against its Federal reserve notes in actual circulation.” Indeed, the world’s largest stash of gold is located not in the legendary Fort Knox but in a vault beneath the Federal Reserve Bank of New York.