History of the Central Bank

Video Transcription

Hi, and welcome to macroeconomics. This is Kate. This tutorial is on the history of the central bank. As always, my key terms are in red, and any examples are in green. In this tutorial, we'll talk about the debate among our founding fathers over whether there should be a central banking system or not. We'll talk about the problems that occurred when our country did not have a centralized bank.

So one of the last straws that lead to our Revolutionary War in the United States was when England really tried to place our colonies under the control of its own bank of England. So because of that, a lot of our founding fathers, like Thomas Jefferson, were really, really opposed to any type of central bank. At the same time though, there were others, like Alexander Hamilton, who recognized, eh, we kind of need a central bank. So we're going to talk about some of the issues and some of this back and forth. The opposition to the central bank and then the need for the central bank.

So the basic idea here is that throughout the 1800s, control is really going to go back and forth from some type of centralized banking system to a system like Thomas Jefferson wanted, that gave states the rights to regulate their own banking. We did have a first, and then again, a second bank of the United States. There were charters for each of these. But there was also a free banking era, which is this idea that states should have the rights to regulate their own banking.

Well, when there was this free banking era, there were some problems that occurred. So when states had the right to regulate their own banks, some of the issues-- I'm just going to list a lot of them. One of the issues was that banks lent out way too much money. On the next slide, I'll talk about one of your key terms, which is reserves, with that.

Different banks are going to issue different currencies. Bankers printed more money, and that caused inflation. There were bank runs and panics. So when people would not have confidence in the system, they would all run to the banks demanding all of their money, and then it wouldn't be there. So that would create a bigger panic situation where there were a ton of bank runs throughout the country.

Wildcat banks were these banks kind of located on the edges of settled areas, and they often failed. So they were called Wildcat banks. There was a lot of fraud where banks were cheating customers. And one example here is during the Civil War, the official currency issued was called the greenbacks. And at the same time, the Confederacy was issuing their own currency, which was backed by cotton, and it ended up becoming completely worthless as the South was losing the war.

So like I said, when banks were lending out too much money, this deals with the key term of reserves. Reserves are a portion of deposits required to be held by a bank. And they're usually kept to maintain reserve requirements. And these are set by our Fed today. But back then, when states were regulating their own banking systems, they either didn't have reserve requirements, meaning they didn't require their banks to hold a certain portion of funds on hand, or they were all different. So this really varied during that free banking era.

So people started kind of realizing a need for a common currency, since all of the banks were printing and issuing their own currency. It became really difficult to know the value of any given bank's notes. This is just an example of the bank here printing their own dollar. It doesn't look anything like our dollars today, it looked different from other bank's dollars. So they were all printing their own notes.

Currency traders at that time could actually-- this is interesting-- they could actually make a living by traveling back and forth between cities and trading currency. So for example, you could purchase an Atlanta currency in New York City at a discount, and then go to Atlanta and use it to purchase currency that was printed in New York at a discount. And the only reason that this was really possible was because it would take weeks and weeks and weeks for people to find out about a bankrupt bank in a city far away. So you could get this currency at a discount and sell it and trade it. And so this was actually, a living was made by people doing this.

So since every bank's notes were different, it was really difficult for people to buy anything when they were traveling any kind of distance. It wasn't necessarily difficult so much for people who were in one certain place all the time. But for anybody traveling, because of the information gap, the length of time it took for people to get information, this was really difficult.

And so people realized that a central bank could actually issue a common currency for everyone to use, and then this would no longer be a problem. So a central bank is a central banking authority that's typically charged with the regulation of money supply and interest rates. So they determine a lot of things and set some regulations.

In this tutorial, we talked about the debate among the founding fathers-- some really were opposed to a central bank, some were more for it. And we looked at those problems that occurred when our country did not have a centralized bank. All of those problems then led to the recognition that a central banking system was going to be important.

Thanks so much for listening. Have a great day.