In 1690, the Massachusetts Bay colony issued the first paper money in the colonies that would later become the United States. Until that time, money consisted of gold and silver coins from England, Spain and other countries. For many years, the Spanish Dollar coin served as the "unofficial" national currency of the American colonies. As trading started between the settlements and coins became scarce, many colonies printed their own colonial notes.
Picture a fledgling army of colonists led by General George Washington. To finance this army, the Continental Congress authorized the limited printing of paper notes in 1775. Known as "Continentals" the currency had no backing in gold or silver. Instead, Continentals were backed by the anticipation of future tax revenues--redeemable only when the colonies won their independence.
After the American Revolution, the new nation began the difficult task of building a national government. Alexander Hamilton, the first Secretary of the Treasury, conceived the idea of a central bank. After the Constitution was adopted in 1789, Congress established The First Bank of the United States, giving it power to operate from 1791 until 1811 and authorizing it to issue paper bank notes. The First Bank of the United States also served as the U.S. Treasury's fiscal agent, thus performing the first central bank functions in the United States.
The Second Bank of the United States functioned from 1816 to 1836. Both the First and Second central banks were unpopular with those wanting easy credit, primarily the western agrarian interests, and in 1832 President Andrew Jackson vetoed the re-charter of the Second Bank.
The Free Banking Era followed the demise of the First and Second Banks of the United States, marking a quarter century in which American banking was a hodgepodge of state-chartered banks without federal regulation. By 1860, an estimated 8,000 different state banks were circulating worthless currency called "wildcat" or "broken" bank notes, so called because many of these banks were located in remote regions and frequently failed.
The Free Banking Era ended in 1863 with the passage of the National Bank Act. The Act established a national banking system and a uniform national currency to be issued by new "national" banks. The banks were required to purchase U.S. government securities as backing for their National Bank notes. In 1865, a 10 percent tax levied against State Bank notes essentially taxed those notes out of existence.
Although the National Bank Act of 1863 established a national currency and banking system, the country was still plagued by bank failures, panics, business bankruptcies, and economic contractions as it entered the 20th century. A particularly severe bank panic in 1907 fueled the reform movement to create the Federal Reserve System.
President Woodrow Wilson signed the Federal Reserve Act on December 23, 1913. The Act established the Federal Reserve System to oversee the nation's money supply and provide an "elastic" currency that could expand and contract in response to the economy's changing demand for money and credit. Congress also empowered Federal Reserve Banks to issue Federal Reserve notes.
The creation of the Federal Reserve helped to stabilize the nation's money and banking system, but bank panics were not entirely eliminated. During the Great Depression of the 1930s, bank failures were common again. Congress passed the Banking Act of 1935 which altered the Federal Reserve's structure by creating the Federal Open Market Committee to oversee the conduct of monetary policy, adding stability to the banking system.
The Great Inflation of the 1970s was the next major U.S. economic disruption. This problem was addressed in a 1977 amendment to the Federal Reserve Act, which provided the first explicit recognition of price stability as a national policy goal. The amended Act states that the Fed, "…shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." Congress proceeded to redefine maximum employment in 1978 through the passage of the Full Employment and Balanced Growth Act, and informally known as the Humphrey-Hawkins Act, acknowledging the existence of frictional unemployment as a necessary accompaniment to the proper functioning of the economy in the long run.
On July 21, 2010, President Barack Obama signed into law the most extensive and comprehensive regulatory reform legislation since the early 1930s. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was created in response to a severe financial crisis that led to the Great Recession of 2007-09. The Dodd-Frank Act has a number of implications for the Federal Reserve's structure and functions, including increased transparency, changes to governance, expansion of supervisory responsibilities, and transfer of much of its consumer protection authority.