1. Dr. David P. EchevarriaAll Rights Reserved1 CHAPTER 4 THE FEDERAL RESERVE SYSTEM GOALS OF MONETARY POLICY POLICY ROLES AND POLICY TOOLS

2. Dr. David P. EchevarriaAll Rights Reserved2 INTERESTING FACTS  Federal Reserve Act passed in 1913  Largely in response to Panic of 1907  John Pierpont Morgan was major supporter  Income earned from interest received from investments in government securities  Member banks must buy stock in the district bank. Stock pays a maximum dividend of 6%

3. Dr. David P. EchevarriaAll Rights Reserved3 THE FEDERAL RESERVE SYSTEM  Structure of the Federal Reserve  Board of Governors (7 members). Appointed for 14 year terms (2 yr. rotations).  Chairman (appointed by U.S. President - 4 years)  12 District banks; NY is largest. 25 branches. Boston (A), NYC (B), Philadelphia (C), Cleveland (D), Richmond (E), Atlanta (F), Chicago (G), St Louis (H), Minneapolis (I), KC (J), Dallas (K), San Francisco (L) (See Exhibit 4.1, page 75)

4. Dr. David P. EchevarriaAll Rights Reserved4 THE FEDERAL RESERVE SYSTEM  Member banks; All commercial banks chartered by OCC are members. Many state charted banks are also members.  Federal Open Market Committee  The policy making body  Voting members: Board of Governors and 5 presidents from the 12 banks (12). President of NY Fed is always a member.

5. Dr. David P. EchevarriaAll Rights Reserved5 GOALS OF MONETARY POLICY  Stable prices  Inflation measures: Consumer Price Index (CPI)  Inflation drives values of financial assets down, real assets up.  Full employment  Supply of credit and capital (currency)  Funding economic growth  Assure financial market stability  Liquidity supplier of last resort (Bear Stearns, others)

6. Dr. David P. EchevarriaAll Rights Reserved6 GOALS OF MONETARY POLICY D.Supervisory powers over member banks  Auditing and Compliance  Chartering and Capital Requirements  Reserve Requirements (1980: DIDMCA) Type of liability Percent of Liabilities Net transaction accounts (7-days)Effective date $0 to $10.3 million201/1/2009 More than $10.3 million to $44.4 million331/1/2009 More than $44.4 million101/1/2009 Nonpersonal time deposits012/27/1990 Eurocurrency liabilities012/27/1990

7. Dr. David P. EchevarriaAll Rights Reserved7 MONETARY POLICY; CONTROLLING SUPPLY OF MONEY  Reserve requirements for deposit liabilities  Open market operations  Buying government securities by the Fed  Selling government securities by the Fed  Discount rate: cost of borrowing from the Fed  Margin Requirements for Security Markets  Impact on Firms of Monetary and Fiscal Policy  M.P. affects the cost of [new] capital. Affects expansion plans.  Fiscal Policy; create Government demand for capital goods.

8. Dr. David P. EchevarriaAll Rights Reserved8 CHANGES IN MONETARY BASE: IMPACT ON CREDIT  Cash deposits create new excess reserves.  Excess reserves loaned out and new deposits created.  New deposits permit creation of new loans.  The process continues until the last deposit (less Required Reserves.) too small to lend.  What happens when Cash is withdrawn? Reserves depleted, leading to...  Multiple contraction in sources of reserves  Banks resort to borrowing in the federal funds market or  Borrowing from the Federal Reserve (discount window)

9. Dr. David P. EchevarriaAll Rights Reserved9 GLOBAL RESPONSIBILITIES OF THE "FED"  As nation's central bank, responsible for coordinating policy with other CBs  Foreign Bank Supervision Enhancement Act (1991);  Fed oversight of foreign banks operating in US  Approve entry of foreign banks to operate in US  Basel Accords (See Chapter 18)  Capital Adequacy and Risk Management

10. Dr. David P. EchevarriaAll Rights Reserved10 HOMEWORK QUESTIONS  What are the principal objectives of the Federal Reserve System?  How is the Federal Reserve organized?  What is the function of the board of Governors?  What is the function of the Federal Open Market Committee (FOMC)?  What are the goals of Monetary Policy? Fiscal Policy?  How do changes in Monetary Policy affect business?  How does they Fed increase (decrease) the monetary base?