7 Organization of the Federal Reserve System Federal Reserve System created by action of the U.S. Congress in 1913Prior to 1913, U.S. had no Central Banking SystemOccasional Financial Panics (1880’s, 1890’s, and finally, 1907) – Public demanded that government take steps to prevent such panicsThe Federal Reserve System to become the “lender of last resort” should commercial banks begin to fail
8 Organization of the Federal Reserve System Each of the Twelve Federal Reserve District Banks are owned by the member commercial District Banks in their District.Fed is a quasi public-private enterprise, not controlled by the President or Congress.
9 The Board of GovernorsSeven Members appointed by the President & Confirmed by the SenateAppointed for a single fourteen year termA Board positions is scheduled for replacement every two yearsOftentimes, however, board members do not remain for the full term, giving a sitting president opportunity to choose several board members during his term of office
10 Independence of the Board of Governors The only control a sitting president has over the Board of Governors is the opportunity to fill positions as terms expireOnce a Board member has received Senate confirmation, he is not subject to the control of either the President or the CongressThis gives the Board both independence and tremendous power
11 Federal Open Market Committee (FOMC) The Federal Open Market Committee (FOMC) sets goals regarding the money supply and interest rates and directs the operations of the Open Market Desk in New York.The Open Market Desk is an office in the New York Federal Reserve Bank from which government securities are bought and sold by the Fed.
12 Functions of the Federal Reserve Conduct Monetary PolicyFirst and Foremost, maintain price stabilitySecondly, to promote full employment and economic growthServe as a lender of last resort to commercial banks within the DistrictIssue CurrencyProvide Banking Services to the U.S. GovernmentSupervise and regulate our financial institutions (Banks)
13 Monetary Policy Tools Open Market Operations. Adjustments in the discount rate.Adjustments in the reserve requirement ratio.
14 Open Market Operations Open market operations is the purchase and sale by the Fed of government securities in the open market; a tool used to expand or contract the amount of reserves in the system and thus the money supply.Open market operations is by far the most significant tool of the Fed for controlling the supply of money.
15 Open Market Operations An open market purchase of securities by the Fed results in an increase in reserves and an increase in the supply of money.
16 Open Market Operations An open market sale of securities by the Fed results in a decrease in reserves and a decrease in the supply of money.
17 Tools of Monetary Policy Open Market Transactions If the Fed wishes to stimulate the economy it will purchase U.S. Government Securities in the bond market (U.S. Treasury Notes) – Raises bond prices; reduces interest ratesCash flows from the Fed to sellers of bonds; sellers deposit cash in their banks, thereby increasing the nations deposits and the excess reserves of the banking industryIf the Fed wishes to restrain the economy it will buy U.S. Government Securities in the bond market (U.S. Treasury Notes) – Lowers bond prices; increases interest ratesCash flows from the banks to buyers of bonds and ultimately to the Fed, thereby reducing the deposit accounts and restricting the ability of commercial banks to loan money
18 Open Market Operations Fed Use of the Repurchase Agreements.The effect of the Open Market Operations on Interest Rate.Open Market Operations in Response to the Crash.Open Market Operations in Response to the Weak U.S. Economy.Open Market Operations in Response to the September 11 Attacks.
19 The Discount RateThe discount rate is the interest rate that banks pay to the Fed to borrow from it.Bank borrowing from the Fed leads to an increase in the money supply.The higher the discount rate, the higher the cost of borrowing, and the less borrowing banks will want to do.
20 The Required Reserve Ratio The required reserve ratio establishes a link between the reserves of the commercial banks and the deposits (money) that commercial banks are allowed to create.If the Fed wants to increase the money supply, the Fed can decrease the required reserve ratio, which allows the bank to create more deposits by making loans.
21 Tools of Monetary Policy Changing the Reserve Requirements The Fed’s Ultimate Weapon, but rarely usedGenerally, the Fed has not changed reserve requirements but once a decade or soThe limits for checking deposits are between 8-14%Use of this tool would be perceived as a reaction to extraordinary eventsFed will be very cautious and publicize its intentions well in advanceLast time required reserves changed – 1980 – resulted in a credit crunch that plunged the economy into the worst recession since the Great Depression
22 Tools of Monetary Policy Summary To Restrain the EconomyRaise the Fed Funds and Discount RatesSell U.S. Government Securities on the Open MarketDeclining Securities Values and Increasing Bond Yield RatesRaise the Reserve RequirementsTo Stimulate the EconomyLower the Fed Funds and Discount RatesBuy U.S. Government Securities on the Open MarketIncreasing Securities Values and Decreasing Bond Yield RatesLower the Reserve Requirements
23 The Fed’s Effectiveness in Fighting Inflation & Recession The Fed has a much harder time igniting the economic engineAlthough it is true, the Fed can lower interest rates, increase the banks’ deposits, but . . .It cannot force a broke man (business) to borrowGood risks in prosperous times become poor risks in recessionary timesFed ability to stimulate is often compared to the problem of trying to push a string – no matter how much effort you give it, it just doesn’t move much
25 Global Monetary Policy A Single Eurozone Monetary Policy.Impact of the Euro on Monetary Policy.Variations in the Value of the Euro.Global Central Bank Coordination.
26 Conclusions Fiscal Policy and Monetary Policy should mesh Fed is given primary praise or criticism for management of the economy, butThe Fed is still only one set of variables in an ocean of variablesThe direction of the economy itself must be consideredNew innovations, globalization, and demographics create fundamental forces that weigh heavily on the economy and its future