1. Chapter 4 Functions of the Fed © 2001 South-Western College Publishing Company

2. 2 Organization of the Federal Reserve nHistorical perspective 4First bank of the United States 1791 - 1811 Chartered for a limited period of time, 20 years Oversee the bank system 4Second bank of the United States 1816-1836

3. 3 n1913 Federal Reserve Act 4Goal to solve problems of bank panics 4Set up the structure of the Fed 12 district banks, initially decentralized Reserve requirements for member banks Organization of the Federal Reserve

4. 4 nStructure of the Federal Reserve 4Federal Reserve district banks 4Member banks, private commercial banks 4Board of Governors 4Federal Open Market Committee or FOMC 4Advisory committees

5. 5 Organization of the Federal Reserve nDistrict Banks 412 districts 4Large concentration of major banks in the New York area makes that district important 4Member banks buy stock Fed district bank

6. 6 Organization of the Federal Reserve nDistrict Banks 4Nine directors of each district bank 4Clear check, replace old currency, make discount loans

7. 7 Organization of the Federal Reserve nMember Banks 4Must meet requirements of the Federal Reserve Board of Governors to be a member bank 4Nationally chartered banks must be members 435% of banks controlling 70% of all deposits are members

8. 8 Organization of the Federal Reserve nBoard of Governors 4Seven individuals appointed by the U.S.president and confirmed by the Senate 4U.S. president appoints one of the seven chair whose 4-year term is renewable 4Offices in Washington D.C. 4Serve nonrenewable 14-year terms 4Staggered terms

9. 9 Organization of the Federal Reserve nBoard of Governors has two main roles nFirst role is to regulate commercial banks 4Supervise and regulate member banks and bank holding companies 4Oversight of 12 Fed district banks 4Establish consumer finance regulations

10. 10 Organization of the Federal Reserve nBoard of Governors second role is to control monetary policy 4Direct control over two tools of monetary policy Reserve requirements Discount rate 4Indirect control in a third area Participate in the FOMC

11. 11 Organization of the Federal Reserve nFederal Open Market Committee (FOMC) meets every six weeks 4Twelve members Seven from the Board of Governors President of the New York Fed Four other district bank presidents appointed on a rotating basis Other presidents participate but don’t vote

12. 12 Organization of the Federal Reserve nFederal Open Market Committee (FOMC) 4Goals of high employment, price stability and economic growth 4Make monetary policy decisions to achieve goals 4Forward decisions to NY Fed open market desk nAdvisory committees also part of overall structure of the Fed

13. 13 Monetary Policy Tools nTools to decrease or increase the money supply 4Open market operations 4The discount rate 4Reserve requirements

14. 14 How the Fed Controls Money Supply nBanks must maintain reserves as % Of deposits nReserves kept as deposits In fed (plus vault cash) nFed controls level of member bank reserve deposits in fed nFed influences bank deposit portion Of money supply

15. 15 Monetary Policy Tools nOpen market operations are the purchase or sale of government securities based on FOMC directives sent to NY Fed Trading Desk nOpen market involving the purchase of government securities 4Purchase securities from government securities dealers 4Increases the money supply

16. 16 Monetary Policy Tools nOpen market operations and interest rates 4Most rates are market determined but Fed influences 4Fed purchase of securities results in an injection of additional funds into the bank system 4More funds available for commercial banks to loan to customers 4Rates drop

17. 17 Comparison of Policy Tools nIncreasing the money supply 4Open market operation purchase of securities via the Trading Desk in the secondary market 4Discount rate lowered to encourage borrowing at the discount window 4Reserve requirements lowered

18. 18 Comparison of Policy Tools nDecreasing the money supply 4Open market operation sale of securities via the Trading Desk in the secondary market 4Discount rate raised to encourage borrowing at the discount window 4Reserve requirements raised

19. 19 Impact of Technical Factors on Funds nTechnical factors other than Fed policy can affect the volume of funds or money supply 4Seasonal factors 4Float or the amount of funds credited to a bank’s funds not yet collected 4Fed takes these issues into account in setting monetary policy 4Review technical factors daily

20. 20 FED Control of the Money Supply nFed needs to decide which form of the money supply to manipulate nForms of money include M1, M2 and M3 nFed emphasis on the money supply 4Fed used to target both the interest rate and money supply in the 1970s 4Recognized it couldn’t do both and switched to a money supply target nRecent money supply target shooting

21. 21 Monetary Control Act of 1980 nKey objective where to deregulate depository institutions and give Fed more control over money supply 4Prior to the MCA nonmember banks could hold reserves in interest-bearing form like Treasury bills 4Member banks could only hold vault cash or Fed deposits and did not earn interest 4Fed membership decreased

22. 22 Monetary Control Act of 1980 nTo regain more control over the money supply the MCA required all depository institutions to 4Meet the same reserve requirements 4Hold noninterest-bearing reserves 4Promptly report deposit levels to the Fed nOther provision of the MCA allowed all depository institutions 4To offer transaction accounts 4Access to the discount window

23. 23 Global Monetary Policy nEach country has its own central bank and often industrialized countries have banks with similar goals nIntegration in the global economy means the Fed must consider conditions in other countries when looking at the U.S. economy nCentral banks try to work together but conflicts of interest can make cooperation difficult at times

24. 24 Global Monetary Policy nA single European monetary policy 4Euro replaced national currencies of 11 countries in January 1999 4National currencies withdrawn and replaced by Euro by June 1, 2002 4Countries of the 15 in the European Union needed to meet economic criteria and chose to join 4Created a European Central Bank