Lecture 23: Federal reserve system

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Lecture 23 Federal reserve system

• Mishkin Ch 12 part A
• page 311-320

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Introduction

• Central bank government authorities in charge of
  monetary policy.
• Policies affect interest rates, the amount of
  credit, and the money supply.
• Important player in financial system
• The central bank in the U.S. is the Federal
  Reserve System (the Fed).

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Origins of the Federal Reserve System

• First U.S. experiments with a central bank
  terminated in 1811 and in 1836
• Resistance to establishment of a central bank
• fear of centralized power
• distrust of moneyed interests on Wall Street
  including large banks.
• No lender of last resort ? bank panics
• Federal Reserve Act of 1913, established the Fed,
  which is
• An elaborate system of checks and balances
• Decentralized

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Feature of the Federal Reserve System

• Diffuse power
• along regional lines
• between the private sector and the government
• among bankers, business people and the public

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Structure of the Federal Reserve System

• Federal Reserve Banks owned by member banks.
• Board of Governors of the Federal Reserve System
• Federal Open Market Committee (FOMC)
• Federal Advisory Council

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Federal Reserve Banks

• Each of 12 Federal district has one main Federal
  Reserve bank, with New York bank being the
  largest.
• Federal Reserve bank quasi-public
  (private/public) institution owned by private
  commercial banks in the district that are members
  of the Fed.
• Member banks elect six directors (3 bankers 3
  businessmen) for each district three more are
  appointed by the Board of Governors. 9 directors
  appoint the president of the bank subject to
  approval by Board of Governors

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Functions of the Federal Reserve Banks

• Clear checks
• Issue new currency
• Withdraw damaged currency from circulation
• Administer and make discount loans to banks in
  their districts
• Evaluate proposed mergers and applications for
  banks to expand their activities

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Functions of the Federal Reserve Banks - contd

• Act as liaisons between the business community
  and the Federal Reserve System
• Examine bank holding companies and
  state-chartered member banks
• Collect data on local business conditions
• Economic research

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Federal Reserve Banks and Monetary Policy

• Directors establish the discount rate
• Decide which banks can obtain discount loans
• Consults with the Board of Governors and provides
  information to help conduct monetary policy
• Five of the 12 bank presidents have a vote in the
  Federal Open Market Committee (FOMC) which
  directs open market operations.

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Member banks

• Member banks all national banks are required to
  be members of the Federal Reserve System, state
  banks may choose to be members.
• Decline of membership ? lessen Feds control
• Depository Institutions Deregulation and Monetary
  Control Act of 1980
• Member and nonmember banks all subject to reserve
  requirements
• all depository institutions can access to Federal
  Reserve facilities (e.g. discount window)

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Board of Governors of the Federal Reserve System

• Washington, D.C.
• Seven members, appointed by the president and
  confirmed by the Senate
• 14-year non-renewable term
• Required to come from different districts

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Main duties of the Board of Governors

• They are the voting majority on conduct of open
  market operations.
• Set reserve requirements, control the discount
  rate
• Approves bank mergers and applications for new
  activities, specifies the permissible activities
  of bank holding companies

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Chairman of the Board of Governors

• Chairman is chosen from the governors and serves
  four-year term
• Advises the president on economic policy
• Testifies in Congress
• Speaks for the Federal Reserve System to the
  media
• May represent the U.S. in negotiations with
  foreign governments on economic matters

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Federal Open Market Committee (FOMC)

• Referred to as Fed by the press, because open
  market operations is the most important policy
  tool, affect interest rate and money supply.
• Meets eight times a year, every six weeks
• Chairman of the Board of Governors is also chair
  of FOMC, and he runs the show.
• Issues directives to the trading desk at the
  Federal Reserve Bank of New York

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FOMC meeting

• Report on the market
• Green Book forecast
• Blue book current monetary policy and domestic
  policy directive
• Discussion and voting
• Presentation on relevant Congressional actions
• Public announcement about the outcome of the
  meeting

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Chairman runs the show

• Spokesperson for the Fed and negotiates with
  Congress and the President
• Sets the agenda for FOMC meetings
• Speaks and votes first about monetary policy
• Supervises professional economists and advisers