 A quick question. Can you tell me what the Federal Reserve System is? The Federal Reserve System, no. The Federal Reserve System? That's something to do with the government. Come on, you can do better than that. They're trying to control the amount of money that's out in the economy. Well, the Federal Reserve System, I think, makes sure that the banks stay operating. Actually, they're both right. The Federal Reserve System, the Fed, does lots of different things. Things that affect our daily lives. For one thing, there's the Fed's role in the banking system. Suppose it's payday. You go to the bank to deposit your check. But the bank's closed out of business. It's happened before, and it could happen again. Making sure it doesn't is one of the Fed's main jobs. To start off, the most important thing anyone wants from a bank is confidence. For example, let's say, I'm the bank, and these high school students trust me with their money. Good morning. How are you? Okay, how are you? I'd like to deposit $30. $30 cash into your account? Thank you. Alright, take care. Some hand over their cash. Others deposit a check. And they're confident their money will be there when they need it. They're also confident the bank will be around when they want to take out a loan. Good morning. How can I help you? I would like to take out a $2,500 loan. $2,500 you need a loan from the bank, and can I inquire what do you need the loan for? I need to buy a used car. Don't forget, banks are in business to earn a profit. So, I'll charge interest. You can see that cash doesn't play a very big part in modern banking. For instance, when you deposit a check, there's no cash involved. Your bank simply increases your account electronically. And if your bank gives you a loan, you don't receive a pile of $20 bills. The bank again adds money to your account. You can then write checks on that account. Still, cash is important for many of the things we buy. And one of the Fed's many jobs is to ensure the smooth flow of cash throughout our economy. The Federal Reserve is sometimes called the Bankers Bank. Because much like you and I might have an account at the bank on Main Street, our bank has an account at the Federal Reserve Bank in its area. When our bank has more cash than it needs, it ships it to the Fed. And increases its account balance. When our bank needs cash, it withdraws from its account with the Fed. There are 12 Federal Reserve Banks around the country, plus 25 branches located in other cities, all coordinated by the Board of Governors in Washington. Every day, the Federal Reserve Banks receive truckloads of cash from local commercial banks. This truck is arriving at a Federal Reserve Bank. Inside are containers filled with nothing but cash. Once the truck is unloaded, the robots take over. They're programmed to move the containers of cash through the hallways and into the vault. From there, more robots move the cash to another area where it's counted and sorted. The coins are weighed by the bag full, and the currency is counted by computerized machines at the rate of 80,000 bills every hour. The sorting machines reject bills that may be counterfeit to make sure the suspicious bills are inspected by an expert. The color, the feel, you'll know it's a counterfeit right off the bank. Bills that are counterfeit are sent to the Secret Service for further investigation. And as for currency that's worn out, it's shredded. Yes, every day nearly $400 million worth of cold cash is shredded into tiny pieces. Then compressed into bricks. These bricks started life as $100 bills. Now, they're trash. But most bills make it through the sorting process. They're wrapped in bundles ready to be sent back out to banks that need currency. These operations go on every day at Federal Reserve banks around the country. In some ways, the Fed is like many other high-tech factories. It's just that the Fed's business is money. Usually things run smoothly, but every once in a while, Federal Reserve banks are pressed into emergency action. For an example, let's go back in time. Back to 1992. It's August 1992. The B-52s release a new album called Good Stuff. In Minneapolis, the Mall of America opens for business. With 300 stores, it's the largest shopping mall in the country. Meanwhile, a major hurricane is moving directly toward South Florida. We expect that the storm is going to be in our neighborhood here by early in the day Monday. On Monday, August 24, the storm hits with full force, carrying winds that reach 160 miles an hour. Local airports are shut down. Most of the area is without power. In its wake, devastation that is nearly total. All your life's savings, right? Yeah, all my life's savings. Put everything, every money in the house. Everything. Tuesday, August 25, almost everyone needs food and emergency supplies, but most stores are shut down. We're selling generators, chain saws, gas and oil. The only people selling things come from out of town. They won't accept checks or credit cards. So there's a huge demand for cash, and local banks are running short. That triggers emergency action by the Miami branch of the Federal Reserve. The Miami branch is part of the Federal Reserve Bank of Atlanta, which serves the southeast. Branch Manager Jay Curry was at the bank soon after Andrew struck. We started calling all the financial institutions and talking with them, letting them know that we were in business and wanted to ensure them that we heard they may have a cash shortage is that we had cash available and we would do whatever possible to get that cash to them as based on their need. Local banks have an account with the Fed. They deposit their extra cash and the Fed credits their account. In normal times, the local banks ask for cash as it's needed. In this case, it's needed immediately and in great quantity. Bob Jensen is Vice President of the First National Bank of Homestead. People literally had to walk out of the lobby with somewhere between $3,000 and $5,000 in cash, and many people needed far more than that and got more than that. If you didn't have cash, you didn't have nothing. Absolutely nothing. Butch Sullivan owns a service station in Homestead. The town was hit especially hard. There was no water, no phone service, no electricity. Just to buy ice, residents had to drive out of town and wait in long lines. Butch Sullivan needed an emergency generator. You had to pay $2,000 or $2,500 cash. No credit cards, no checks, cash. They wouldn't accept anything. Back at the Fed, Susie Fernandez and Ana Vieira were in charge of shipping cash to local banks. Tuesday, August 25th was the busiest day on record. $99 million was paid out that day. It was a very, very heavy day. Every day, hectic. Everything was done manually. No computers. The $99 million was sent out to local banks throughout South Florida, including the First National Bank of Homestead. We got deliveries every day, every morning, early. We got large amounts of cash and lots of large bills. The Fed essentially gave us whatever we wanted, whatever we needed. Thursday, August 27th, South Florida is just beginning the long process of rebuilding. Throughout the crisis, many people did everything they could to help their neighbors, including workers at the Fed. The Federal Reserve is like the main bank to all these banks. It's like, you go to your mom for help and that's what they were doing. They were going for help and the banks were in need of cash because the people were in need of cash. So we were there for all the banks and we were there for all the people. Storing cash and providing it to banks is just one of the Fed's jobs. The vast majority of payments are made by a check and the Fed is heavily involved in the complex system of check clearing. When you write a check to a person or business, whether they're across town or across the country, the check makes its way all the way back to your bank where the money is deducted from your account. Along the way, many checks are read and sorted by at least one Federal Reserve bank, often more than one. Each day, the Federal Reserve system sorts something like 75 million checks. But again, the most important element in our banking system isn't cash or checks. It's confidence. You're confident that when you go to get cash from the bank, the bank will be there and you're confident that cash will be accepted when you want to buy something. That wasn't always the case. In the 1800s, many banks issued their own notes, redeemable in gold or silver. But currency good in one state might not be accepted in another. And if a bank got into financial trouble, its notes might be worthless. Then there were financial disasters, like the panic of 1907, when people stormed their banks demanding their deposits in gold or silver. Finally, in 1913, Congress established the Federal Reserve system to safeguard the banking system. The Fed was to be the lender of last resort, meaning it could lend money to a bank that ran short of funds. But banks can and do fail even today. Here's how. You're two months behind and your payment's on your bank loan. Yeah. What is the problem? Well, the job I was supposed to get, well, it fell through and I wasn't able to get it. So I don't see how I can pay the loan back right now. We need the money back in order to function as a bank. So how can we rectify this problem? Unless I can find another job or I don't know, I don't see what I can do. If enough people and businesses don't repay their loans, the bank will fail. Go bankrupt. When a bank failed in the old days, people could lose some of their life savings. So if a rumor spread that a bank was in financial trouble, it often started something called a run. Depositors would literally run to the bank, all of them demanding their money at the same time. You might have seen the movie It's a Wonderful Life. In one scene, there's a pretty accurate depiction of what a run looked like. Don't look now, but there's something funny going on over there at the bank, George. I've never really seen one, but that's got all the earmarks of being a run. Hey, you got any money in the bank? Bank runs were actually fairly common during the Great Depression of the 1930s. These days, small depositors don't have to worry as much. Even if their bank fails, the deposits are insured by the federal government. Still, a bank failure can create major problems for an entire community. So the Fed tries to ensure the overall safety of the banking system. That means examining banks to make sure they're financially healthy. Now in the movies, a visit from the bank examiner is about as welcome as going to the dentist for a root canal. Good morning, sir. Carter, bank examiner. Mr. Carter, Merry Christmas. Merry Christmas. I'm excited around here. My brother just got the Congressional Medal of Honor, the present just decorated. Yeah, well, I guess they do those things. I trust you had a good year. Good year? Ah, well, between you and me, Mr. Carter, we're broke. Yeah, very funny. In the real world, things don't quite work that way. Bank examinations are conducted by a number of government agencies, including the Federal Reserve, and not all examiners are as sour as old Mr. Carter. The team has arrived. A team of five bank examiners from the Fed. Their home base is the Federal Reserve Bank of St. Louis, which is responsible for examining state-chartered member banks in its district. On this day, they're in Jacksonville, Illinois, right in the middle of farm country. All right, a beautiful day here in Jacksonville in our great state of Illinois. We have 58 degrees. The relative humidity stands at 80 percent. The wind's out of the southwest at five. That's the latest forecast for service of 1180 radio WLDS. 19 minutes past eight. It's eight-nineteen, and the team is checking the books. The company made pretty good profits for this year. $100,000 for that income. Unlike the movies, this visit is scheduled in advance, and it's done in a spirit of cooperation. Barkley Bailey is the team leader. We review our jobs somewhat as a doctor or physician. We would give the banks an annual checkup to determine that they are in good health. In this case, the patient is Elliott State Bank. It's been in business in the same location for more than 125 years. Like all banks, Elliott takes in money from its depositors, then lends the money out to other people and businesses. The bank has lent money to the local radio station, to a small college in Jacksonville, and to farmer Donnie Headen. I needed a combine, and it was going to take $20,000, and at that particular time, it wasn't liquid, so I went to the bank, to Elliott Bank, and they loaned me the money. Of course, all the loans have to be paid back, because if enough loans aren't paid back, Elliott State Bank could go out of business. So the examiners try to make sure the loans are as safe as possible. In the end, Elliott State Bank will be graded on its overall safety and soundness. If a bank is unsound, it will be constantly monitored, perhaps even shut down. But that's the last option. We're not in the business to close banks, but to ensure that banks stay healthy, and that they continue to offer the valuable service to its community. Aside from the banking system, the Federal Reserve has another responsibility that's probably even more important. It's in charge of something called monetary policy. Basically, it means trying to keep prices stable to avoid inflation. Say you buy a CD today for $14, but what if next year the price of the CD jumped to $20, or $50? Not because of a change in supply or demand, but because all prices were going up. That's inflation. There are a lot of different causes of inflation, but one of the most important is too much money. Here's what I mean. Pardon my reach. We gave this high school class some money to spend, $2.50 each, and something to bid on. Three dozen fresh bagels. That's getting $20. $25. $25. Back there for $25. Guy in the blue. Another one. Their goal? To buy as many bagels as possible. $25. $30. $30. He says she's hungry. $35. You got it. All right. What about this one? $10. $10. She says $25. $35. $30. $30. $30. He's got it. $50. $50. $50 bagel. $50. Then we started over, but this time each student had $5. Twice as much as before. Okay. What about this one? He says $80. $80. $90. A dollar. The lady in front in the blue says a dollar. Yes, the lady with the boopy-do. All right. One more. One dollar. $10. A dollar. How much? $30. $30. $40. $50. This must be a golden bagel. $20. And prices were twice as high. And as we kept increasing the money supply, the price of a bagel went out of sight. $5. $5. Whoa, look at her. She's got $5 here. Can you catch it? Yes. Our example is simple, but it shows what can happen in real life. If there's more money around, prices go up. It's the old cliche. Too much money chasing the same amount of goods. There were the same number of bagels, but more money. So prices were higher. Because many people and companies are hurt badly by inflation, governments aim for stable prices. Think of all the transactions going on every day. All the people buying and selling things. That's the overall economy. You might picture it as kind of a vehicle going down the road. All those millions of transactions require money. If there's not enough money, the whole system, the economy, may jerk along too slowly. But with the right amount of money, things run smoothly. And prices remain fairly stable. Okay, so how does the amount of money change? That's where the Federal Reserve System comes in. As the country's central bank, the Fed manages monetary policy. Meaning it actually changes the size of the nation's money supply to meet a goal that sounds simple, a growing economy with stable prices. But it's not always easy to achieve. The best way to explain it is to look at how inflation works in the real world. Let's go back in time, way back to 1979. It's March, 1979. Magic Johnson and Larry Bird meet in the finals of the NCAA Basketball Tournament. The latest fad? Pet Rocks, which do absolutely nothing. Meanwhile, gas prices are climbing. So is the price of food and just about everything else. Everyone's talking about inflation. Even the comedians on Saturday Night Live. Inflation is our friend. For example, consider this. In the year 2000, if current trends continue, the average blue color annual wage in this country will be $568,000. But inflation is no joke. In one way or another, almost everyone is affected. I really hate it, because you pay so much for so little. This is NBC Nightly News. To most Americans, inflation is public enemy number one. Good evening. Prices in the United States during the first three months of 1979 went up at an annual rate of 13%. So while Magic Johnson was winning a national championship, Paul Volcker was worried about inflation. You cannot build economic growth. You cannot build prosperity. You cannot build full employment on a currency that is inflating, a currency that people don't have some confidence in. In 1979, Volcker was appointed chairman of the Federal Reserve Board of Governors. The Fed tries to avoid inflation because it causes many problems. Businesses don't know where prices are headed and can't plan for the future. Individuals tend to spend their money faster before it loses even more value. And they tend to save less. If you're going to build more factories, if you're going to buy some machines, you have to have some savings. But there's no incentive to save. If you see your savings growing up in smoke, so to speak, because prices are rising. What's the use of saving $10 this year if it's going to cost you $15 next year for what you didn't buy this year? One fear was that inflation could spiral into hyperinflation, as it had in Argentina when the government kept printing more and more currency. At one point, Argentina's inflation got so out of control that consumers rioted against rising prices. So in 1979, the Fed was forced to take strong action. Inflation can only persist with big growth in the money supply that feeds and supports the inflationary process. So what the Federal Reserve does fundamentally is control the money supply and we finally reached a point where we said, look, we're just not going to permit an increase in money supply to support this inflation. That sounds easy. Just issue less money. But there's more to it. First off, money isn't just this green stuff. Paper currency and coins make up less than a third of all the money in circulation. Money also includes all the deposits we hold in checking accounts. These are simply electronic entries that exist on a bank's computer, but they're money just the same. Basically, anything you can spend, whether by writing a check or taking out your wallet, is defined as money. The Fed can adjust the money supply by injecting money into the system electronically or by withdrawing money from the economy. Think of it, the Federal Reserve has the ability to create money and make it disappear. What's most important is what happens as a result. Anytime the supply of money is altered, the effects are felt throughout the economy. If the money supply is growing rapidly, interest rates tend to go down, at least in the short run. It's a simple matter of supply and demand. When banks have more money available to lend, they don't charge as much interest. In turn, lower interest rates encourage consumers to borrow money. And when people have more money, they're usually willing to spend more for products. Prices tend to go up. That means inflation and all the problems that come with it. Now look at the other side of it. When there's too little money around, the scarcity of money means people will have to pay more to borrow it. Interest rates tend to go up. Because borrowing is more expensive, consumers are less likely to take out loans. In general, people have fewer dollars to buy things with and businesses can't raise their prices. Over time, inflation tends to slow down or stop altogether. That's the power of monetary policy. So when inflation gets out of hand, the Fed tries to slow the growth of the money supply. But as you saw, that can mean higher interest rates, at least in the short term. Which brings us back to our story. It's December, 1980. There's the launching of a new cable channel. It's called Music Television, MTV. At the same time, the spaceship Voyager sends back pictures of the planet Saturn. Meanwhile, the U.S. economy is still in trouble. The prime lending rate went to 21.5% today. Before this week, it had never in American history been above 20. The Fed has restricted the growth of the money supply, and interest rates are rising rapidly. One effect, fewer people can afford to borrow money to buy a new car. The price of the car is bad enough, but the interest rate is ridiculous. High interest rates also mean fewer people can buy new homes. As a result, the housing industry is in the pits. The Fed governors receive hundreds of 2x4s in the mail, a symbol of protest from the construction industry. Meanwhile, there's a demonstration outside the Federal Reserve Building in Washington. The Fed, and especially Chairman Paul Volcker, are under attack. There was a cement company that used to put ads, full-page ads in the Wall Street Journal, and sculling crossbones under my name or under my picture or whatever. And it kind of rankled a bit, but I do think there was a feeling in the country then that there was something of an emergency that had to be dealt with. It had to be dealt with by forceful action and a kind of common-sense reaction that there'd be a little pain in the process. And that's what got you through. It's October, 1982. The Space Shuttle Columbia takes off for an important mission. It will release a satellite into permanent orbit. Back on Earth, the latest rage is called breakdancing. Meanwhile, inflation and high interest rates have taken their toll on the economy. Companies are borrowing less and investing in fewer new plants. And existing plants are being shut down. Nancy Teeters was sworn in as a governor of the Federal Reserve Board just as inflation was picking up steam. Once you begin to decrease the rate of real growth, you begin to cross the rate of unemployment to rise. And you know that. And that's why it's a difficult decision to make. I mean, it's the sort of thing that wakes you up when you worry about it at 3 o'clock in the morning, because real people are getting hurt. Rising unemployment has one side effect. Because people have less money to spend, businesses can't raise prices as quickly. One eventual result? Lower inflation. The inflation numbers for 1983 came out, and they were the lowest that they have been since 1971-72. 3.8 percent. That's down for more than 12 percent in 1980. July 1984. The new fashion torn sweatshirts inspired by the movie Flash Dance. Meanwhile, Americans are going back to work, and the unemployment rate is falling fast. In May, the rate stood at 7.5 percent. Today, the June rate was announced, and it's a big drop to 7.1 percent. At the same time, inflation seems under control. Prices, which were going up at more than 13 percent a year, are rising at 4 percent. The fight against inflation has apparently been won. Once we got the inflation rate down, we had the longest expansion in peacetime and recorded American history. So, instead of kind of stumbling from one recession to another, I think it is true in a broad sense that we laid the basis for a long period of expansion. Of course, the Fed doesn't have absolute control over the nation's economy, just the monetary policy side of the equation. The President and Congress manage fiscal policy, decisions about taxing and governmental spending and major effects on economic performance. Still, the Fed has a huge influence on matters like inflation and interest rates, things that affect all our lives. The Fed's methods have changed over time to take advantage of the latest computers and electronics, but its mission remains the same, to aim for stable prices, full employment, and a growing economy. I'm Bobby Rivers. Thanks for watching.