The Federal Reserve Richard Slevinsky 4/7/03

Outline History Organization & Functions Policies & Concerns

U.S. Bank History First Bank of United States Est. after birth of U.S. (1791) Second Bank of U.S. (Est. 1816) Charters of both not renewed by President Jackson (1836) De-centralized banking from ,400 bank institutions, up to 1,600 note types Inefficient, subject to counterfeiting

Move Toward Centralization Civil War: National Currency Act (1863) Reserves maintained / notes redeemed at principal locations (main cites) Allowed for chartering of national banks Panic of nd and 3 rd largest banks in country closed Depositors withdrew funds (run on banks) JP Morgan et al., backed remaining banks to restore depositor faith

Reform Bankers realized reform needed. Washington not easily convinced Aldrich-Vreeland Act Est. commission to study banking systems and adapt changes if applicable. Aldrich Plan Contained several ideas of Federal Reserve Lack of central authority Uniform discount rate

Federal Reserve Established Created by Federal Reserve Act, 1913 Purposes: To provide the country with an elastic currency Centralize bank reserves Provide multi-regional check / currency clearing system, to reflect country’s regions and growth Provide banking facilities for the federal government

Organization of the “Fed” Main components of the Federal Reserve Federal Reserve Board of Governors Federal Reserve Banks Federal Open Market Committee (FOMC)

Board of Governors Seven member Federal Reserve Board 14-year terms One new term begins every two years (on 2/1, even-numbered years) Member who serves a full-term cannot be appointed again A member finishing out another’s term may be reappointed. Nominated by President, confirmed by Senate Federal Reserve Board has a Chairman and Vice- Chairman Both nominated by President, confirmed by Senate. Serve 4-year terms

Today’s Members Chairman: Alan Greenspan Vice-Chairman: Robert W. Ferguson, Jr. Other members: Edward M. Gramlich Susan Schmidt Bies Mark W. Olson Ben S. Bernacke Donald L. Kohn

Federal Reserve Banks 12 regional reserve banks Each bank with own 9-member board of directors One person from each bank’s board selected for the Federal Advisory Board, meeting in Washington 4 times a year. Responsibilities Distribution of currency (paper and coin) Supervise Banks Dept. of Treasury functions

Federal Reserve Bank Districts

FOMC Composed of the 7-member Board of Governors and 5 Reserve Bank presidents Reserve Bank of NY is always a member Other FRB presidents serve one-year terms Implements national monetary policy Determines the Fed’s open-market transactions Determines holdings of foreign currencies

Policies The Federal Reserve has three main tools to execute its monetary policy Open market operations – the purchase and sale of government securities Reserve requirements – the required cash reserve a financial institution must keep at the Fed The discount rate – rate at which the Fed lends funds to banks

Open Market Operations The Fed controls bank reserves by buying/selling U.S. Treasury and federal securities Controls money supply Effects banks’ lending capacity, and rates Buying from a bank increases that banks’ lending capacity  increases money supply By selling securities, the Fed effectively re- acquires what it issued before  reduces money supply Bank interest rates can be controlled for short periods of time in this way

Reserve requirements Seldom used by Fed to control bank reserves Small change in requirements translates to massive changes in the dollar reserve requirement Banks are obligated to deposit in the Fed a specified percentage of its liabilities

Discount Rate Interest rate charged to banks on loans they receive from Federal Reserve Bank Lending facility called discount window 3 types of loans Primary: loaned to stable institutions Secondary: liquidity needs, financial difficulties Seasonal: Repeating intra-year fluctuations, loaned to agricultural banks, seasonal resort lenders.

Discount Rate History

Other Fed roles Fight inflation Discipline monetary growth and credit growth Through interest rates Monitor Gross National Product (GNP) and Unemployment Debt Check Congressional spending/income Trade deficits Strength of dollar Fed is more flexible than Congress

Other Fed roles Check GNP growth If falling below 1% Ease reserve constraints Lower interest rates Counter rising unemployment If rising above 5% Strengthen reserve constraints Raise interest rates Monitor inflation Ideal: around 3% Fed policies remain the same

Fed & Foreign Currency Aim – intervene in foreign currency markets when conditions not ideal Intervention through NY foreign exchange markets. If dollar falling – Fed purchases dollar (sells other currencies) If dollar rising – Sale of dollar (for other currencies)

Swap Network Reciprocal short-term credit management between Fed and other foreign central banks Fed can borrow currencies from foreign country for intervention operations Works both ways