Lecture 23: Federal reserve system

1. Lecture 23: Federal reserve system Mishkin Ch 12 – part A page 311-320

2. 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).

3. 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

4. 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

5. 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

7. 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

9. 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

10. 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

11. 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.

12. 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)

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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