essay about Federal Reserve
BIgJ-11
fed-pres.pdf
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THE FEDERAL RESERVE SYSTEM
• The Fed was created in 1914 after a series of bank failures convinced Congress that the United States needed a central bank to ensure the health of the nation’s banking system.
1. Regulates banks to ensure they follow federal laws intended to promote safe and sound banking practices.
2. Acts as a banker’s bank, making loans to banks and as a lender of last resort.
3. Conducts monetary policy by controlling the money supply.
Three Primary Functions of the Fed
Structure of the Fed
The primary elements in the Federal Reserve System are:
1) The Board of Governors
2) The Regional Federal Reserve Banks
3) The Federal Open Market Committee
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• Fed decisions do not have to be ratified by the president or another member of the executive branch
• The system is however, subject to oversight by the US Congress under its authority to coin money.
1) The Board of Governors
• The Fed is run by a Board of Governors, which has seven members appointed by the president and confirmed by the Senate.
• Among the seven members, the most important is the chairwoman (Janet Yellen). – The chairwoman directs the Fed staff, presides over board meetings,
and testifies about Fed policy in front of Congressional Committees.
Federal Reserve Building Washington, DC
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Chairman: Janet Yellen
The President of the United
States appoints a member of
the Board of Governors as
chairman to serve a four-
year term.
Other Members: Serve staggered 14-year terms so that one comes vacant every two years.
(Stanley Fisher, Daniel Tarullo, Jerome Powell, Lael Brainard)
• Two vacant seats
2) Regional Federal Reserve Banks
Twelve district banks Bring insight on regional economic conditions
1. President
– The directors appoint the district president, which is approved by the Board of Governors.
2. Nine directors
– Three appointed by the Board of Governors.
– Six are elected by the commercial banks in the district.
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Eleventh District
DALLAS
•Houston
•El Paso
•San Antonio
Robert S. Kaplan, President
Federal Reserve Banks
• Assist in the conduct of monetary policy
– set and change the discount rate (must be approved by the Board of Governors)
– make discount window loans to depository institutions
• Supervise and regulate FRS member banks
– conduct examinations and inspections of member banks
– issue warnings when banking activity is unsafe or unsound
– approve bank mergers and acquisitions
• Provide government services
– act as the commercial banks of the U.S. Treasury
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Federal Reserve Banks
• Issue new currency
– collect and replace currency in circulation as necessary
• Clear checks
– act as a central clearing system for U.S. banks
– clear ~25% of all checks written in the U.S.
• Provide wire transfer services
– Fedwire
– Automated Clearinghouse (ACH)
• Perform banking sector and economic research
– used in the formulation of monetary policy
3)The Federal Open Market Committee (FOMC)
– Conducts Open Market Operations (NY)
– Serves as the main policy-making organ of the Federal Reserve System.
– Meets approximately every six weeks in Washington, D.C. to review the economy
The New York Fed
President: William C. Dudley
The New York Fed
implements some of the
Fed’s most important
policy decisions
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The FOMC
• Voting members:
– The chairman and the other six members of the Board of Governors.
– The president of the Federal Reserve Bank of New York.
– The presidents of the other regional Federal Reserve banks (four vote on a yearly rotating basis).
Monetary Policy Goals
Federal Reserve Act December 23, 1913
• Stable prices
• Maximum employment
• Moderate long-term interests
Monetary Policy: Definition
The setting of the money supply by policymakers in the central bank
• Immediate effect: Induce changes in interest rates, and the amount of money and credit in the economy.
• Ultimate Goal: Through these financial variables, monetary policy actions influence the levels of spending, output, employment, and prices
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Money: Definition
Money is the stock of assets that can be readily used to make transactions.
Liquidity: Definition
Liquidity is the ease with which an asset can be converted into the economy’s medium of exchange
Liquidity
M1 M2 M3
More Liquid Less Liquid
Money Supply
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Current Money Supply
Assets included Amount (bil $)
C Currency $ 1,328.9
M1 C + demand deposits, 3,034.9 travelers’ checks, other checkable deposits
M2 M1 ($3,034.9 ) + small time deposits, 12,195.7 savings deposits, money market mutual funds, money market deposit accounts
M3 M2 ($12,195.7)+ large time deposits, 20,349.5 repurchase agreements, institutional money market mutual fund balances ($8,153.8)
*From March 2006
Oct 26. 2015, Federal Reserve Bank (SA)
Where Is All The Currency?
• There is about $1,328.9 billion of U.S. currency outstanding
• That is around $5,422 in currency per adult
• Who is holding all this currency?
– Currency held abroad
– Currency held by illegal entities
Figure 1: Money in the U.S. Economy
Copyright©2003 Southwestern/Thomson Learning
Billions
of Dollars
$3,034.9
$12,195.7
• Demand deposits
• Travelers’ checks
• Other checkable deposits
• Currency
• Everything in M1
• Savings deposits
• Small time deposits
• Money market mutual
funds
• Other minor categories M1
M2
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Monetary Policy: Definition
The setting of the money supply by policymakers in the central bank
Monetary Policy Tools
1. Discount Rates
– Set by directors of the Reserve Banks, subject to review and determination by the Board of Governors
2. Reserve Requirements
– Set by the Board of Governors
3. Open Market Operations
– Federal Open Market Committee
1) Discount Rates
– The discount rate is the interest rate the Fed charges banks for loans.
• Increasing the discount rate decreases the money supply.
• Decreasing the discount rate increases the money supply.
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Monetary Policy
• The discount rate is the rate Federal Reserve Banks charge on loans to depository institutions in their district
• The Federal Reserve rarely uses the discount rate as a policy tool – discount rate changes are strong signals of the Federal Reserves
intentions
– there is no guarantee that banks will borrow, nor that they will lend
2) Reserve Requirements
– The reserve requirement is the amount (%) of a bank’s total reserves that may not be loaned out.
• Increasing the reserve requirement decreases the money supply.
• Decreasing the reserve requirement increases the money supply.
BANKS AND THE MONEY SUPPLY
• Banks can influence the quantity of demand deposits in the economy and the money supply.
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Reserve requirements
• Reserve requirements are the reserve assets depository institutions must keep to “back” transaction deposits
– reserve assets include vault cash and deposits at Federal Reserve Banks
• The multiplier effect
reservesin ratiot requiremen reserve new
1 supply money in
Reserve requirements
• Suppose reserves are $2 billion and the Fed increases reserves by 1% or $20 million when bank reserve requirements are 10%.
• What is the predicted increase in bank deposits?
million $200 million $20 0.10
1
Reserve requirements
• Suppose that instead of changing the $2 billion in reserves the Fed reduces the reserve requirement from 10% to 9%. What is the predicted increase in bank deposits?
million $222 million $20 0.09
1
million $20 billion $2 of 1% reserves excess of levelNew
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3) Open Market Operations
• Open-Market Operations
– Fed buys government bonds from, or sells government bonds to, the public
– When the Fed buys government bonds, the money supply increases.
– The money supply decreases when the Fed sells government bonds.
• The Fed influences money and financial market conditions
that, in turn, affect output, jobs and prices.
Monetary Policy
• Open market operations
– policy directive of the FOMC is forwarded to the Federal Reserve Board Trading Desk at the Federal Reserve Bank of New York
– Trading Desk manager buys or sells U.S. Treasury securities in the over-the-counter (OTC) market, which keeps the fed funds rate near its desired target
Monetary Policy
• Open market operations (cont’d)
– FRBNY acts through the Trading Desk to implement policy directives each business day
– Deals with list of primary dealers
– operations may be permanent or temporary
– may use repurchase agreements for temporary increases or decreases in excess reserves
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Primary dealers Bank of Nova Scotia, New York Agency BMO Capital Markets Corp. BNP Paribas Securities Corp. Barclays Capital Inc. Cantor Fitzgerald & Co. Citigroup Global Markets Inc. Credit Suisse Securities (USA) LLC Daiwa Capital Markets America Inc. Deutsche Bank Securities Inc. Goldman, Sachs & Co. HSBC Securities (USA) Inc. Jefferies LLC J.P. Morgan Securities LLC Merrill Lynch, Pierce, Fenner & Smith Incorporated Mizuho Securities USA Inc. Morgan Stanley & Co. LLC Nomura Securities International, Inc. RBC Capital Markets, LLC RBS Securities Inc. SG Americas Securities, LLC TD Securities (USA) LLC UBS Securities LLC.
Trade off Inflation / Unemployment
MP Goals:
Stable prices
Maximum employment
Moderate long-term interests
Figure 2: Money Market
Equilibrium in Money Market: Liquidity Preference Curve Interest
Rate
Quantity of
Money
Money
Supply
Money
Demand
Equilibrium
Interest Rate
Quantity fixed
by the Fed
r1
r2
Mdsells M d buys
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Transmission Mechanism
1. Open Market Purchases
2. Increase in Money Supply
3. Interest Rates Down
4. More Investment
5. More Production
6. More Jobs
7. Increased Demand…
… High Prices
Trade Off: Inflation vs. Unemployment
1. Open Market Sales
2. Decrease in Money Supply
3. Interest Rates Up
4. Less Investment
5. Less Production
6. Less Jobs
7. Decreased Demand…
...Lower Prices
Transmission mechanism during the crisis:
• Did not work as expected…
• Fed’s approach: Extraordinary measures to extraordinary circumstances.
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The Fed and the Crisis
• August 2006 fed funds rate = 5.25%
• April 2008 fed funds rate = 2.00%
• By year end 2008 target fed funds rate between 0 and 0.25% and the discount rate was lowered to 0.5%
• November 2008 -- The Fed announces it would engage in purchasing up to $600 billion in Treasuries and mortgage-backed securities (quantitative easing)
– This amount was increased to $1.7 trillion in March 2009.
• November 2010 the Fed announced a new series of bond buying of up to $600 billion in what has been termed QE2
The Fed and the Crisis
• 2007
– Term Auction Facility
• 2008
– March: Fed facilitates J.P. Morgan Chase purchase of Bear-Stearns
– Term Securities Lending Facility
– Primary Dealer Credit Facility: Expands discount window borrowing to investment banks
– September: Lehman Brothers collapses, Goldman-Sachs and Morgan Stanley become commercial banks, Merrill-Lynch is bought by Bank of America
The Fed and the Crisis
• 2008 (continued)
– Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Money Market Investor Funding Facility and the Term Asset-Backed Securities Loan Facility (TALF) are created
– Average weekly lending from the Fed grew from about $59 million in 2006 to almost $850 billion per week in late 2008
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Problems in Conducting Monetary Policy
• Significant time lags involved between policy implementation and effect
• Supplying money to lenders does not guarantee they will lend
Problems in Conducting Monetary Policy
• Lowering interest rates or supplying money are attempts to stimulate demand, but they may not work
– Problems in consumer confidence
– High unemployment
– High debt levels
Problems in Conducting Monetary Policy
• Excessive money creation may reduce the value of the dollar and generate inflation – Inflation can cause interest rates to increase, hurting growth
– Loss in confidence of foreign investors could cause higher interest rates, hurting growth
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Monetary Policy: Definition
The setting of the money supply by policymakers in the central bank
• Immediate effect: Induce changes in interest rates, and the amount of money and credit in the economy.
Sometimes…
• Ultimate Goal: Through these financial variables, monetary policy actions influence the levels of spending, output, employment, and prices
Sometimes…
