President Woodrow Wilson signed the Federal Reserve Act, creating a new central banking system for the United States. The law aimed to provide an “elastic” currency (money supply that could expand and contract) and a safer banking system after repeated financial panics. It set up a Washington-based board and a network of regional Reserve Banks.
Benjamin Strong Jr. was elected (then “governor,” now roughly equivalent to president) of the Federal Reserve Bank of New York. Because New York was the country’s main financial center, Strong quickly became influential in shaping System-wide policy and coordination. His leadership helped define how the early Fed responded to war finance and postwar instability.
All twelve Federal Reserve Banks opened on the same day, making the new System operational. Early policy tools centered on lending to banks through the “discount window” (Reserve Bank loans to member banks). The opening mattered because it created a national framework to manage liquidity when credit conditions tightened.
After the United States entered World War I, the Treasury launched major bond drives to fund the war. The Federal Reserve supported these efforts by helping sell Liberty Bonds and by lending to member banks, including at preferential rates tied to war-related borrowing. This period tightened the Fed–Treasury relationship and shaped early monetary policy around wartime needs.
Congress created the War Finance Corporation to channel credit to industries and financial institutions considered important for the war effort. It reflected the scale of wartime mobilization and the government’s broader use of financial tools beyond the Federal Reserve alone. The institution also continued some activities into the early postwar period.
Fighting on the Western Front ended with the Armistice of November 11, 1918. The end of the war triggered a difficult economic transition as wartime demand and government controls eased, while prices and credit conditions shifted rapidly. Federal Reserve policy increasingly faced the challenge of moving from war finance to peacetime stabilization.
The U.S. economy entered a sharp downturn (often called the 1920–1921 depression), marked by significant deflation and unemployment. Federal Reserve discount rates rose to high levels in this period, reflecting efforts to curb postwar inflation and maintain monetary stability under the gold-standard environment. The episode became an early lesson in how interest-rate tightening could deepen a contraction even while helping prevent a banking panic.
The Phelan Act authorized Federal Reserve Banks to use “progressive” discount rates—higher rates for heavier or repeated borrowing—to discourage excessive reliance on Reserve Bank credit. This mattered because the Fed’s main tool at the time was discount lending, and policymakers wanted a way to limit persistent borrowing by banks. It was part of the broader shift from wartime credit support to postwar restraint.
The Federal Reserve began coordinating purchases and sales of government securities more systematically through an Open Market Investment Committee. These “open market operations” (buying and selling securities) became a powerful way to influence bank reserves and overall credit conditions, beyond the discount window. This step mattered because it pushed the System toward more centralized, national monetary policy.
The McFadden Act rechartered the Federal Reserve Banks “in perpetuity,” removing uncertainty about whether their original charters would expire in 1934. The law also changed rules affecting bank branching and competition between member and nonmember banks. For the Fed, it reinforced institutional permanence during the mid-1920s period of relative economic stability.
Concerned about rapid stock price gains and speculative borrowing, the Fed tightened policy in 1928. Research from the Federal Reserve Bank of San Francisco describes discount-rate increases from about 3.5% to 5% during the year, along with actions to drain reserves. This period highlighted the interwar debate over whether and how monetary policy should respond to asset-market booms.
Benjamin Strong Jr. died while still leading the New York Fed, removing a central figure in interwar monetary and international financial coordination. His death mattered because the Federal Reserve System was still developing its governance and policy methods, and Strong had often helped align Reserve Bank actions. The leadership transition came just as debates intensified about speculation, credit restraint, and the Fed’s role in a changing economy.
Federal Reserve policy through World War I and the interwar period (1914-1928)