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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 linesbetween the private sector and the

governmentamong 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 - cont’d

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 Fed’s 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