Overview of the Federal Reserve and Monetary Policy

Three parts of the Federal Reserve: Three parts of the Federal Reserve: Board of GovernorsBoard of Governors Reserve BanksReserve Banks Federal Open Market Committee (FOMC)Federal Open Market Committee (FOMC)

History of the Fed History of the Fed Before Fed was established, country was in financial crisisBefore Fed was established, country was in financial crisis Panics would cause runs on banksPanics would cause runs on banks Panic of 1907 led Congress to write the Federal Reserve Act of 1913 Panic of 1907 led Congress to write the Federal Reserve Act of 1913 To create first central bank, needed to find delicate balance between national and regional interests To create first central bank, needed to find delicate balance between national and regional interests Need to facilitate exchange between regions to be strong nationally, but needed to meet needs of varying regionsNeed to facilitate exchange between regions to be strong nationally, but needed to meet needs of varying regions Also had to balance between interest of private banks and the public interestAlso had to balance between interest of private banks and the public interest

Congress gave the Fed AUTONOMY Congress gave the Fed AUTONOMY Could operate without political pressureCould operate without political pressure No influence/guidance from federal, state, or local government No influence/guidance from federal, state, or local government

Board of Governors Board of Governors Located in Washington D.C.Located in Washington D.C. Centralized component Centralized component 7 members (Governors)7 members (Governors) Appointed by President, confirmed by Senate Appointed by President, confirmed by Senate Governor’s term is 14 years Governor’s term is 14 years Terms are staggered, one expires every 2 years Terms are staggered, one expires every 2 years Chairman and vice-chairman serve 4 year terms, appointed by President Chairman and vice-chairman serve 4 year terms, appointed by President Reports to Congress twice a yearReports to Congress twice a year Chairman Alan Greenspan appointed in 1987, to fill vacated position. Term ended in January 2006, now filled by Chairman Ben Bernanke Chairman Alan Greenspan appointed in 1987, to fill vacated position. Term ended in January 2006, now filled by Chairman Ben Bernanke

Federal Reserve Banks Decentralized component Decentralized component Provide expertise about regional economies Provide expertise about regional economies 12 districts 12 districts Boston - 1Boston - 1 New York - 2New York - 2 Philadelphia - 3Philadelphia - 3 Cleveland - 4Cleveland - 4 Richmond - 5Richmond - 5 Atlanta - 6Atlanta - 6 Chicago – 7 (Non-voting President – Michael Moskow)Chicago – 7 (Non-voting President – Michael Moskow) St. Louis - 8St. Louis - 8 Minneapolis - 9Minneapolis - 9 Kansas City - 10Kansas City - 10 Dallas - 11Dallas - 11 San Francisco - 12San Francisco - 12

Federal Reserve Banks Serve 3 audiences Serve 3 audiences Bankers, U.S. Treasury, PublicBankers, U.S. Treasury, Public “Bankers’ Bank” – Store commercial banks’ excess $$$ and settle checks and e- payments. Also supervise commercial banks in their regions.“Bankers’ Bank” – Store commercial banks’ excess $$$ and settle checks and e- payments. Also supervise commercial banks in their regions. Process Treasury’s payments, sell its securities, manages investments, etcProcess Treasury’s payments, sell its securities, manages investments, etc Research local economies and disseminate informationResearch local economies and disseminate information Have own board of directors (9 members)Have own board of directors (9 members)

Federal Open Market Committee Voting membership is 7 members of Board of governors, president of NY fed, 4 other Reserve bank presidents, serving a one-year rotating term Voting membership is 7 members of Board of governors, president of NY fed, 4 other Reserve bank presidents, serving a one-year rotating term Chairman of FOMC is chairman of Board of Governors Chairman of FOMC is chairman of Board of Governors Meets 8 times a year in D.C. Meets 8 times a year in D.C. At each meeting, official from NY Fed discusses developments in financial & foreign exchange markets, and NY Fed’s domestic & foreign trading desks At each meeting, official from NY Fed discusses developments in financial & foreign exchange markets, and NY Fed’s domestic & foreign trading desks Staff from Board of Gov’s present their economic & financial forecasts. Staff from Board of Gov’s present their economic & financial forecasts. All Presidents provide views on economic outlook – even if they are not voting members All Presidents provide views on economic outlook – even if they are not voting members

Federal Open Market Committee Give directive to NY Fed’s domestic trading desk for “open market operations” – whether to ease, tighten, or maintain the current policy. Give directive to NY Fed’s domestic trading desk for “open market operations” – whether to ease, tighten, or maintain the current policy. Desk then buys or sells US government securities on open market to achieve the objective Desk then buys or sells US government securities on open market to achieve the objective FOMC establishes a target for federal funds rate – rate banks charge each other for overnight loans FOMC establishes a target for federal funds rate – rate banks charge each other for overnight loans

Federal Open Market Committee Open market purchases of government securities increase the amount of reserve funds that banks have available to lend, which puts downward pressure on the federal funds rate. Open market purchases of government securities increase the amount of reserve funds that banks have available to lend, which puts downward pressure on the federal funds rate. Sales of government securities does just the opposite – they shrink the reserve funds available to lend and tend to raise the funds rate. Sales of government securities does just the opposite – they shrink the reserve funds available to lend and tend to raise the funds rate.

Monetary policy Fed’s goal is to keep inflation and unemployment low Fed’s goal is to keep inflation and unemployment low Use the discount rate, reserve requirements, and open market operations Use the discount rate, reserve requirements, and open market operations Discount rate – Interest rate Reserve banks charge banks for short-term loansDiscount rate – Interest rate Reserve banks charge banks for short-term loans Reserve requirements – Portions of deposits that banks must hold in reserveReserve requirements – Portions of deposits that banks must hold in reserve Open market operations – Buying and selling of government securitiesOpen market operations – Buying and selling of government securities Affect amount of cash on hand, therefore affecting interest rates at banks Affect amount of cash on hand, therefore affecting interest rates at banks