Why Was the Federal Reserve Created?

According to “What Is the Purpose of the Federal Reserve System?,” Congress created the Federal Reserve to provide the nation with a stable, safe and flexible financial system. The Federal Reserve Act lists three key objectives – maximum employment, stable prices and moderate long-term interest rates.

Congress established the Federal Reserve in response to several financial panics in the late 19th and early 20th centuries. A particularly severe one in 1907, caused when a failed takeover bid sent United Copper company’s stock price tumbling, led to the failure of Knickerbocker Trust Co., one of the country's largest banks. Following Knickerbocker’s failure, banks across the country refused to issue credit and began hoarding cash.

In 1907, the United States didn’t have a central bank that could issue paper money on demand, instead relying on dollars tied to private banks’ investments in government bonds. Without a steady supply of cash, the economy itself began to fail. Working with the Secretary of the Treasury, private banker and Wall Street financier John Pierpont Morgan proposed a solution for the Trust Company of America, another big bank also facing failure. Finding the trust illiquid but not insolvent, Morgan and his banking colleagues bailed it out. Morgan brokered similar agreements at other trusts, insisting they agree to insure their weakest members. This collaboration of private banks evolved into the Federal Reserve System, a nationwide network steered by a national board of directors charged with setting interest rates and controlling credit.