The US had a national bank during the first few decades after its birth before it was abolished. Today, we have the Federal Reserve. What are the differences between the Federal Reserve and a National Bank (specifically, with regard to their intervention policies and powers for acting within the economy)? Solution The two Banks of the United States (the First and Second) were nothing like the modern Federal Reserve system. For example, the First was prohibited from buying government bonds (one of the main roles of the Federal Reserve system is to buy and sell government bonds). Further, neither of the national banks had any role in regulating the banking system. They were simply the only interstate banks allowed. All other banks had to be confined to one state. The national banks primary impact on the money supply was to require smaller banks to pay them in silver and gold to redeem checks deposited in the national banks. By contrast, the Federal Reserve system actively regulates banks, requiring them to maintain a percentage of their deposits as reserves. It actively sets two rates: the rate at which it loans money to banks to cover reserve shortages (called the discount rate) and the rate it pays on excess reserves. The latter power is relatively new. Previously the Federal Reserve did not pay interest on excess reserves. The Federal Reserve also sets a target for the funds rate, which is the average rate at which banks loan money to each other. The funds rate target is what most people mean when they refer to the Federal Reserve setting interest rates. The Federal Reserve has two main ways to affect the funds rate. First, it publishes a target rate for the average. Second, it buys and sells government bonds in what are called open market operations. When it buys bonds, it adds money to the system, reducing the number of banks that need to borrow and increasing the number of those with money to lend. This pushes the average rate to fall, as there are more lenders and fewer borrowers. When it sells bonds, it pulls money from the system, reducing the number of banks with money to lend. The Federal Reserve can also compete with lenders by loaning money to banks at the discount rate. This decreases the number of banks looking to borrow from other banks, which would push rates down. It rarely does this however. Most banks prefer to borrow from other banks, as there are fewer restrictions. The Federal Reserve also has two ways to influence how much banks keep in reserve. First, it sets an explicit reserve requirement. Every bank must keep that much in reserve. Second, it can pay interest on excess reserves. The higher that rate, the more likely banks are to keep excess reserves instead of loaning them to individuals, companies, or other banks. This would push up the funds rate average, as fewer banks loan. Again, the two Banks of the United States were not central banks the way that the Federal Reserve is. Yes, they could print banknotes, but so .

1. The US had a national bank during the first few decades after its birth before it was abolished.
Today, we have the Federal Reserve.
What are the differences between the Federal Reserve and a National Bank (specifically, with
regard to their intervention policies and powers for acting within the economy)?
Solution
The two Banks of the United States (the First and Second) were nothing like the modern Federal
Reserve system. For example, the First was prohibited from buying government bonds (one of
the main roles of the Federal Reserve system is to buy and sell government bonds). Further,
neither of the national banks had any role in regulating the banking system. They were simply
the only interstate banks allowed. All other banks had to be confined to one state. The national
banks primary impact on the money supply was to require smaller banks to pay them in silver
and gold to redeem checks deposited in the national banks.
By contrast, the Federal Reserve system actively regulates banks, requiring them to maintain a
percentage of their deposits as reserves. It actively sets two rates: the rate at which it loans
money to banks to cover reserve shortages (called the discount rate) and the rate it pays on
excess reserves. The latter power is relatively new. Previously the Federal Reserve did not pay
interest on excess reserves. The Federal Reserve also sets a target for the funds rate, which is the
average rate at which banks loan money to each other. The funds rate target is what most people
mean when they refer to the Federal Reserve setting interest rates.
The Federal Reserve has two main ways to affect the funds rate. First, it publishes a target rate
for the average. Second, it buys and sells government bonds in what are called open market
operations. When it buys bonds, it adds money to the system, reducing the number of banks that
need to borrow and increasing the number of those with money to lend. This pushes the average
rate to fall, as there are more lenders and fewer borrowers. When it sells bonds, it pulls money
from the system, reducing the number of banks with money to lend.
The Federal Reserve can also compete with lenders by loaning money to banks at the discount
rate. This decreases the number of banks looking to borrow from other banks, which would push
rates down. It rarely does this however. Most banks prefer to borrow from other banks, as there
are fewer restrictions.
The Federal Reserve also has two ways to influence how much banks keep in reserve. First, it
sets an explicit reserve requirement. Every bank must keep that much in reserve. Second, it can
pay interest on excess reserves. The higher that rate, the more likely banks are to keep excess
reserves instead of loaning them to individuals, companies, or other banks. This would push up

2. the funds rate average, as fewer banks loan.
Again, the two Banks of the United States were not central banks the way that the Federal
Reserve is. Yes, they could print banknotes, but so could other banks of the time. They had no
special banking privileges. They were simply the only interstate banks allowed during their
charter.