Overview of the Federal Reserve and Monetary Policy

1. Overview of the Federal Reserve and Monetary Policy

2. Three parts of the Federal Reserve: • Board of Governors • Reserve Banks • Federal Open Market Committee (FOMC)

3. History of the Fed • Before Fed was established, country was in financial crisis • Panics would cause runs on banks • 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 • Need 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 interest

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

5. Board of Governors • Located in Washington D.C. • Centralized component • 7 members (Governors) • Appointed by President, confirmed by Senate • Governor’s term is 14 years • Terms are staggered, one expires every 2 years • Chairman and vice-chairman serve 4 year terms, appointed by President • Reports 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

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

7. Federal Reserve Banks • Serve 3 audiences • Bankers, U.S. Treasury, Public • “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, etc • Research local economies and disseminate information • Have own board of directors (9 members)

8. 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 • Chairman of FOMC is chairman of Board of Governors • 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 • 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

9. 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. • 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

10. 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. • Sales of government securities does just the opposite – they shrink the reserve funds available to lend and tend to raise the funds rate.

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