The Federal Reserve

1. The Federal Reserve Richard Slevinsky 4/7/03

2. Outline • History • Organization & Functions • Policies & Concerns

3. U.S. Bank History • First Bank of United States • Est. after birth of U.S. (1791) • Second Bank of U.S. (Est. 1816) • Charters of both not renewed by President Jackson (1836) • De-centralized banking from 1836-1863 • 1,400 bank institutions, up to 1,600 note types • Inefficient, subject to counterfeiting

4. Move Toward Centralization • Civil War: National Currency Act (1863) • Reserves maintained / notes redeemed at principal locations (main cites) • Allowed for chartering of national banks • Panic of 1907 • 2nd and 3rd largest banks in country closed • Depositors withdrew funds (run on banks) • JP Morgan et al., backed remaining banks to restore depositor faith

5. Reform • Bankers realized reform needed. Washington not easily convinced • Aldrich-Vreeland Act • Est. commission to study banking systems and adapt changes if applicable. • Aldrich Plan • Contained several ideas of Federal Reserve • Lack of central authority • Uniform discount rate

6. Federal Reserve Established • Created by Federal Reserve Act, 1913 • Purposes: • To provide the country with an elastic currency • Centralize bank reserves • Provide multi-regional check / currency clearing system, to reflect country’s regions and growth • Provide banking facilities for the federal government

7. Organization of the “Fed” • Main components of the Federal Reserve • Federal Reserve Board of Governors • Federal Reserve Banks • Federal Open Market Committee (FOMC)

8. Board of Governors • Seven member Federal Reserve Board • 14-year terms • One new term begins every two years (on 2/1, even-numbered years) • Member who serves a full-term cannot be appointed again • A member finishing out another’s term may be reappointed. • Nominated by President, confirmed by Senate • Federal Reserve Board has a Chairman and Vice-Chairman • Both nominated by President, confirmed by Senate. • Serve 4-year terms

9. Today’s Members • Chairman: Alan Greenspan • Vice-Chairman: Robert W. Ferguson, Jr. • Other members: • Edward M. Gramlich • Susan Schmidt Bies • Mark W. Olson • Ben S. Bernacke • Donald L. Kohn

10. Federal Reserve Banks • 12 regional reserve banks • Each bank with own 9-member board of directors • One person from each bank’s board selected for the Federal Advisory Board, meeting in Washington 4 times a year. • Responsibilities • Distribution of currency (paper and coin) • Supervise Banks • Dept. of Treasury functions

11. Federal Reserve Bank Districts

12. FOMC • Composed of the 7-member Board of Governors and 5 Reserve Bank presidents • Reserve Bank of NY is always a member • Other FRB presidents serve one-year terms • Implements national monetary policy • Determines the Fed’s open-market transactions • Determines holdings of foreign currencies

13. Policies • The Federal Reserve has three main tools to execute its monetary policy • Open market operations – the purchase and sale of government securities • Reserve requirements – the required cash reserve a financial institution must keep at the Fed • The discount rate – rate at which the Fed lends funds to banks

14. Open Market Operations • The Fed controls bank reserves by buying/selling U.S. Treasury and federal securities • Controls money supply • Effects banks’ lending capacity, and rates • Buying from a bank increases that banks’ lending capacity  increases money supply • By selling securities, the Fed effectively re-acquires what it issued before  reduces money supply • Bank interest rates can be controlled for short periods of time in this way

15. Reserve requirements • Seldom used by Fed to control bank reserves • Small change in requirements translates to massive changes in the dollar reserve requirement • Banks are obligated to deposit in the Fed a specified percentage of its liabilities

16. Discount Rate • Interest rate charged to banks on loans they receive from Federal Reserve Bank • Lending facility called discount window • 3 types of loans • Primary: loaned to stable institutions • Secondary: liquidity needs, financial difficulties • Seasonal: Repeating intra-year fluctuations, loaned to agricultural banks, seasonal resort lenders.

17. Discount Rate History

18. Other Fed roles • Fight inflation • Discipline monetary growth and credit growth • Through interest rates • Monitor Gross National Product (GNP) and • Unemployment • Debt • Check Congressional spending/income • Trade deficits • Strength of dollar • Fed is more flexible than Congress

19. Other Fed roles • Check GNP growth • If falling below 1% • Ease reserve constraints • Lower interest rates • Counter rising unemployment • If rising above 5% • Strengthen reserve constraints • Raise interest rates • Monitor inflation • Ideal: around 3% • Fed policies remain the same

20. Fed & Foreign Currency • Aim – intervene in foreign currency markets when conditions not ideal • Intervention through NY foreign exchange markets. • If dollar falling – Fed purchases dollar (sells other currencies) • If dollar rising – Sale of dollar (for other currencies)

21. Swap Network • Reciprocal short-term credit management between Fed and other foreign central banks • Fed can borrow currencies from foreign country for intervention operations • Works both ways