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The Structure of the Federal Reserve

The Structure of the Federal Reserve. Chapters 15. Overview. Origins of the U.S. Federal Reserve System Formal Structure Evolved Structure Independence of the Fed International Central Banking Motivation of Central Bankers. Central Banks. Affect Interest rate (federal funds rate)

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The Structure of the Federal Reserve

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  1. The Structure ofthe Federal Reserve Chapters 15

  2. Overview • Origins of the U.S. Federal Reserve System • Formal Structure • Evolved Structure • Independence of the Fed • International Central Banking • Motivation of Central Bankers

  3. Central Banks • Affect • Interest rate (federal funds rate) • Money Supply • Amount of Credit • Influence • Financial Markets • Economic Output • Inflation • International Trade

  4. Origins • Historic fear in U.S. of centralized power • Rural, frontier, farmer interests • Feared loss of control to places far and away • Big city, moneyed, businessmen interests • Feared too much government involvement • Private or public central bank? • Resulted in formal check and balance system

  5. Origins • No lender of last resort • Bank panics common every 20 years • Bank panic of 1907 • Stock market fell 50% • Wave of bank runs across the country after large speculative loans bust (on failed hostile buyout) • J.P. Morgan (private) stepped in to avert crisis: extra credit lines, bought out plummeting stocks, redirected money • By 1913, Fed. Reserve Act finally had enough support

  6. Formal Structure of the Fed • 12 regional federal reserve banks • 4000 member commercial banks • Board of Govenors • Federal Open Market Committee (FOMC) • FOMC Meeting Schedule

  7. Regional Fed Banks • 12 regional banks • NY Fed bank has 25% of Fed assets (SF and Chicago have another 25%) • Owned by member banks in area • Buy stock in their region’s bank • Elect 6 of 9 directors • 3 bankers • 3 from business, labor, agriculture • Max limit of 6% on Fed stock • Other 3 appointed by Fed Res. Board • Directors Elect President

  8. Regional Fed Banks • Major Administrative Functions • Issue/Replace Currency • Clear checks • Regulate holding companies (McFadden) • Oversee state banks in FR system • Approve mergers and acquisitions • Help formulate monetary policy • “Establish” discount rate • Decide who gets discount loans • Sit on national Fed. Advisory Council to “advise” • 5 of 12 votes on FOMC

  9. “The New York Special” • Region has the largest banks • Does all open market operations • Houses foreign exchange desk • Member of the Bank of International Settlements • President of this regional bank is ALWAYS on the FOMC

  10. Member Banks • 4000 national and state members • National banks must join, state banks option • Between one-third and one-half have belonged since 1947 • Banks that don’t join can hold reserves as securities • Reserve ratio expensive • Fed lost control of MS because of this • DIDMCA: all depository institutions must keep reserves with Fed (get access to discount window and check clearing services) • Fed/Non-fed distinction diminished

  11. Board of Governors • Head of Fed Reserve System Nationally • 7 members • 14 year terms, non-renewable • Chairman appointed by president • Administrative Duties • Approve salaries, budgets of regional banks • Regulate holding companies, foreign banks • Approve mergers and state banks (jointly w/Reg. banks)

  12. Board of Governors • Monetary Policy • 7 of 12 FOMC seats • Set reserve requirements • APPROVE discount rates set by regional banks • Advise politicians • President • Congress • Foreign Gov’t

  13. Federal Open Market Committee • 12 members • 7 board of governor members • 5 regional president members rotating • Meets every six weeks • Decisions about how many bonds to buy/sell and thereby change money supply • Also generally discuss discount rate, reserve ration

  14. Typical FOMC Meeting • Green book: where economy is headed • Blue book • Projections for monetary supply • Discuss three alt. recommendations for MS • Open market • Discount Rate • Reserve Ratio • Beige Book • Regional banks, report on regional state of economy

  15. Meeting Implications • Chairman (Ben Bernanke) presents his views on economy • Vote taken on EXACT directions to open market desk at NY regional bank • Announce changes in federal funds rate, discount rates • New since 1994 • Tuesday, March 18th: drop in federal funds rate of 0.75%!

  16. Informal Structure of the Fed • 1913 act SUPPOSED to create highly decentralized federal reserve system • 12 separate central banks not responsible for health of economy • No control of monetary supply (except discount loans • No control of interest rate (except discount rate)

  17. Informal Structure • Depression reforms • Control of money supply (1933) • Control of reserve ratio (1935) • Board of governors has 7 of 12 votes on FOMC • BOG also strongly influences regional appointees • Member banks have very little power, pretty much branches of central bank in Wash. • Chairman doesn’t formally have control, but… • Sets agenda for FOMC meetings • Representative to president, Congress • Controls staff who set green/blue books • Most powerful office in America??

  18. Independence of the Fed • Remarkably independent • 14 year, nonrenewable terms • Don’t have to go to Congress for budget approval • Income from loans, securities • Cannot be audited by Federal Government • But… • Congress can change power in long run • President appoints members, relationship with chairman • Alan Greenspan though…

  19. Should the Fed be Independent? • For independence • Political bias (willing to risk long term inflation) • Political “business cycle” • President can’t finance federal deficit with purchases of bonds • Empirical evidence: independent central banks have less inflation • Politicians like independence! • Don’t have to make hard decisions • Not always economic experts • Candidacy doesn’t depend as much on monetary policy ups and downs

  20. Against Independence • Undemocratic, elitist, technocrats • Not accountable to anyone • Moral hazard, principle-agent • President and Congress are held accountable, so they should have ultimate authority • Coordination of monetary and fiscal policy harder • Fed makes mistakes too, and less checks and balances leave less of safety net

  21. Foreign Central Banks • European Central Bank (EU, 1999) • Independent • Similar to U.S., each country has regional bank • Japan (Nippon Ginko, 1882) • Legally dependent • Answers to ministry of finance • Traditionally allowed independence • Canada (1934) • joint-control, almost independent • Bank of England (1694) • Very dependent (to UK gov, not EU) • Can only recommend policy • 1997: can set interest rates, but must be approved

  22. Motivations of Central Bankers • Public Interest View • Bank has society’s best interests in mind, or at least the financial industry’s best interests • Civil Servant Perspective • Theory of Bureaucratic Behavior • Maximize the agency’s own welfare • Power corrupts, self-survival • Implications • Push for autonomy • Avoid controversial decisions (current events?)

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