The Federal Reserve and Monetary Policy

1. The Federal Reserve and Monetary Policy

2. Structure of the Federal Reserve • Board of Governors • Located in Washington, DC • 7 members appointed by the president & approved by the Senate • 14 year terms • Chair must be reappointed every 4 years (and most often is)

3. Copy and answer: Why are members of the Board of Directors appointed for such long terms? (HINT: Think about Supreme Court Justices!)

4. Structure of the Federal Reserve • Twelve Federal Reserve Banks • Each serves a different region (Federal Reserve district) • Serve the supervisory role for that district • Each has its own board of directors chosen from bankers and businesspeople in that region • NY Federal Reserve Bank carries out the Fed’s open-market operations

5. Copy and answer: Decisions about monetary policy are made by the Federal Open Market Committee, which consists of: • the Board of Governors • the New York Fed president • Four other regional bank presidents (rotating) Why don’t other members of the government serve on this committee? (HINT: Consider the reasons for the “pseudo-governmental nature of the Fed!)

6. Functions of the Federal Reserve • Provide Financial Services • “Banker’s bank” that holds reserves, clears checks, provides cash, and transfers funds for commercial banks • Also acts as banker and fiscal agent for the U.S. government and other large institutions; in fact, the U.S. Treasury’s checking account is with the Fed!

7. Functions of the Federal Reserve • Supervise & Regulate the Banking System • The regional Federal Reserve banks examine and regulate commercial banks in their district, ensuring their compliance with laws – including those regarding reserve requirements • The Board of Governors provides overall supervision of the system

8. Functions of the Federal Reserve • Maintain Stability of the Financial System • The Fed is charged with maintaining a safe and stable monetary and financial system • As part of this function, the Fed provides liquidity to financial institutions through loans (discount window) that ensure soundness

9. Functions of the Federal Reserve • Conduct Monetary Policy • Utilizes reserve requirements, discount rate, and open-market operations to control the monetary base (and therefore, the money supply and interest rates) • The most popular tool of monetary policy is open-market operations

10. Tools of Monetary Policy • Reserve Requirements • Banks that fail to maintain reserve requirements on average for a two-week period face penalties • Banks borrow from other banks with excess reserves at the federal funds rate, which is determined by supply and demand in the fed funds market • Fed hasn’t made significant change to the reserve requirement since 1992

11. Copy and answer: How would changes to the reserve requirement tighten or loosen the money supply?

12. Tools of Monetary Policy • Discount Rate • Banks can borrow from the Fed via the discount window • The discount rate is the rate the Fed charges, and it is normally set 1% above the fed funds rate to discourage use of Fed funds (and encourage interbank lows)

13. Copy and answer: How would changes to the discount rate (i.e., reducing the gap between the fed funds rate and discount rate to just .25% as the Fed did in 2008) tighten or loosen the money supply?

14. Tools of Monetary Policy • Open-Market Operations • The Fed has assets and liabilities Assets Liabilities Government debt Monetary base (Treasury bills – short term (Currency in circulation + govt bonds of less than 1 yr.) bank reserves) • Fed buys or sells Treasury bills, usually through commercial banks • Credits the commercial banks’ Fed reserve account with the value of T-bills it purchased (in purchases) or debits the banks’ account (in sales)

15. Copy and answer: How would open-market operations tighten or loosen the money supply?

16. Fed Policy Actions • All Fed policy actions impact the monetary base, but have impacts on the money supply and interest rates • All Fed policy actions are aimed at obtaining a target interest rate • For open-market transactions, money credited to banks’ reserve accounts is simply “created” – increasing the monetary base

17. Copy and answer: Why is it important to factor in the money multiplier when we consider the impact of Fed policy actions? Does it apply to the use of all three tools?