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

Chapter 4

Functions of the Fed

© 2001 South-Western College Publishing Company

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Organization of the Federal Reserve

Historical perspectiveFirst bank of the United States 1791 - 1811

• Chartered for a limited period of time, 20 years

• Oversee the bank system Second bank of the United States 1816-1836

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1913 Federal Reserve ActGoal to solve problems of bank panicsSet up the structure of the Fed

• 12 district banks, initially decentralized

• Reserve requirements for member banks


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Structure of the Federal ReserveFederal Reserve district banksMember banks, private commercial banksBoard of GovernorsFederal Open Market Committee or FOMCAdvisory committees

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District Banks12 districtsLarge concentration of major banks in the

New York area makes that district importantMember banks buy stock Fed district bank

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District BanksNine directors of each district bank Clear check, replace old currency, make

discount loans

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Member BanksMust meet requirements of the Federal

Reserve Board of Governors to be a member bank

Nationally chartered banks must be members35% of banks controlling 70% of all deposits

are members

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Board of GovernorsSeven individuals appointed by the

U.S.president and confirmed by the SenateU.S. president appoints one of the seven

chair whose 4-year term is renewableOffices in Washington D.C.Serve nonrenewable 14-year termsStaggered terms

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Board of Governors has two main roles First role is to regulate commercial banks

Supervise and regulate member banks and bank holding companies

Oversight of 12 Fed district banksEstablish consumer finance regulations

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Board of Governors second role is to control monetary policyDirect control over two tools of monetary

policy

• Reserve requirements

• Discount rate Indirect control in a third area

• Participate in the FOMC

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Federal Open Market Committee (FOMC) meets every six weeksTwelve 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

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Federal Open Market Committee (FOMC)Goals of high employment, price stability and

economic growthMake monetary policy decisions to achieve goalsForward decisions to NY Fed open market desk

Advisory committees also part of overall structure of the Fed

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Monetary Policy Tools

Tools to decrease or increase the money supplyOpen market operationsThe discount rateReserve requirements

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How the Fed Controls Money Supply

Banks must maintain reserves as % Of deposits Reserves kept as deposits In fed (plus vault

cash) Fed controls level of member bank reserve

deposits in fed Fed influences bank deposit portion Of money

supply

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Open market operations are the purchase or sale of government securities based on FOMC directives sent to NY Fed Trading Desk

Open market involving the purchase of government securities Purchase securities from government

securities dealers Increases the money supply

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Open market operations and interest ratesMost rates are market determined but Fed

influencesFed purchase of securities results in an injection

of additional funds into the bank systemMore funds available for commercial banks to

loan to customersRates drop

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Comparison of Policy Tools

Increasing the money supplyOpen market operation purchase of securities

via the Trading Desk in the secondary marketDiscount rate lowered to encourage

borrowing at the discount windowReserve requirements lowered

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Comparison of Policy Tools

Decreasing the money supplyOpen market operation sale of securities via

the Trading Desk in the secondary marketDiscount rate raised to encourage borrowing

at the discount windowReserve requirements raised

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Impact of Technical Factors on Funds

Technical factors other than Fed policy can affect the volume of funds or money supplySeasonal factorsFloat or the amount of funds credited to a

bank’s funds not yet collectedFed takes these issues into account in setting

monetary policyReview technical factors daily

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FED Control of the Money Supply

Fed needs to decide which form of the money supply to manipulate

Forms of money include M1, M2 and M3 Fed emphasis on the money supply

Fed used to target both the interest rate and money supply in the 1970s

Recognized it couldn’t do both and switched to a money supply target

Recent money supply target shooting

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Monetary Control Act of 1980

Key objective where to deregulate depository institutions and give Fed more control over money supplyPrior to the MCA nonmember banks could hold

reserves in interest-bearing form like Treasury bills

Member banks could only hold vault cash or Fed deposits and did not earn interest

Fed membership decreased

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Monetary Control Act of 1980

To regain more control over the money supply the MCA required all depository institutions toMeet the same reserve requirementsHold noninterest-bearing reservesPromptly report deposit levels to the Fed

Other provision of the MCA allowed all depository institutions To offer transaction accountsAccess to the discount window

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Global Monetary Policy

Each country has its own central bank and often industrialized countries have banks with similar goals

Integration in the global economy means the Fed must consider conditions in other countries when looking at the U.S. economy

Central banks try to work together but conflicts of interest can make cooperation difficult at times

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Global Monetary Policy

A single European monetary policyEuro replaced national currencies of 11 countries

in January 1999National currencies withdrawn and replaced by

Euro by June 1, 2002Countries of the 15 in the European Union

needed to meet economic criteria and chose to join

Created a European Central Bank

Documents

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