ECO CH13 and CH15

Act that Created the FED

Federal Reserve Act of 1913

Goal of Federal Reserve Act of 1913

Maintaining the same sort of decentralized powers and systems of checks and balances emphasized in the US constitution

Goals of the Federal Reserve in practice

1. Divisions of power between the Board of Governors in D.C. and the Federal Reserve Banks in 12 other cities

2. Divisions of power between the Federal Government, the banking industry, non-bank business interests, and the public

12

How many federal reserve districts?

A Federal Reserve district includes

Main Federal Reserve Bank and a number of Federal Reserve Bank branches

Legally separate

Each Federal Reserve Bank is _ corporation that is owned by the commercial banks in its districts

Member Banks

Commercial banks that own the Federal Reserve Banks. They hold stock which pays a 6% annual dividend

9

Each Federal Reserve Bank has _ directors

Classification of Federal Reserve Bank Directors

3 Class A - Bankers, elected by member banks

3 Class B - leaders in business, elected by member banks

3 Class C - Members of non-bank public, appointed by the Board of Governors

Member Banks

Who elects class A & B directors?

Class A & B directors

select the President of each Federal Reserve Bank

Monetary policy functions of Federal Reserve Banks

1. The directors at each banks recommend a setting for the discount rate, which is then approved by the board of governors

2. Make discount loans to depositing institutions in their district

3. At any given time, five Federal Reserve Bank presidents have a vote on the Federal Open Market Committee. The president of the NY Fed always has a vote, the other presidents rotate each year

4. Directors at each bank select one banker from their district to serve on the Federal Advisory council, which provides information to the Board of Governors about banking conditions

Other functions of Federal Reserve Banks

Help regulate banks Clear checks Remove damaged currency from circulation Act as liaisons between the government and businesses

National Banks

Commercial banks chartered by the Federal Government through the Office of the Comptroller of the Currency (OCC). Required to be member banks

State Banks

Commercial banks chartered by their state governments. Optional to be member banks

Required

National banks are to be member banks

Optional, but can join

State banks are _ to be member banks

7

The Board of Governors consists of ____ governors

14

Each governor is appointed by the US President and confirmed by the US senate to a nonrenewable ___ year term

4

Chair of the board is ___ year term and is renewable

Voting Members

All 7 governors are of the Federal Open Market committee (FMOC)

Bank Regulations

The board of governors sets the _

Discount Rate

The Board of Governors selects from among the 12 recommendation to set the _

Margin Requirements

The limit on how much investors can borrow to purchase securities

The Board of Governors sets

Margin requirements, Discount Rate, Bank Regulations, Reserve Requirements

8

The Federal Open Market Committee (FOMC) meets ____ per year

FOMC consists of

All seven members of the Board of Governors, The President of the NW Fed & four other reserve banks presidents

Facts about the FOMC

The chair of the Board of Governors also presides as chair of the FOMC & The governis as a group have 7/12 votes on the FOMC

Primary role of FOMC

Make decisions regarding the conduct of the open market operations

What does the FOMC control

The monetary base

FOMC

Most powerful influence on the money supply

Monetary Policy

The management of money and the interest rate

The FEDs tools for monetary policy

Open market operations, discount loans, and changing the reserve requirement

Open Market Purchases

Fed buys US Government securities to increase the monetary base

Open Market Sale

Fed sells US Government securities to decrease the monetary base

US T-Bills

Since the market for _ is so active, the Fed can make large purchases and sales without disrupting the market

Open Market Operations

Have long lasting effects on the monetary base, but sometime the FED may want to change the monetary base only temporarily

Ways to temporarily affect the monetary base

Repurchase Agreements (Repos) & Reverse Repurchase Agreements (Reverse Repo)

Repurchase Agreements

Fed buys US government securities with an agreement from the seller to buy them back at a specified price, on a specified date, usually within two weeks. They are like a temporary open market sale.

Reverse Repurchase Agreements

The Fed sells US government securities with an agreement from the buyer to sell them back at a specified price, on a specified date, usually within two weeks. Like a temporary open market sale

Advantages of Open Market Operations

They are under the direct and complete control of the Fed, they can be large or small, they can be implemented quickly

Discount Window

When a bank is said to receive a loan from the FED

Discount Rate

The FED can influence the volume of discount loans through the

Higher

A _ discount rate makes discount borrowing less attractive to banks and decreases the volume of discount loans

Lower

A discount rate makes discount window borrowing more attractive to banks and increase the volume of discount bonds

Discount borrowing is most important during

Financial panics when people rush to withdraw their money. Banking system is in great need of reserves. The FED will supply these.

Lender of last resort

During financial panics, the FED can act as the _

Advantages of discount loans

Lender of last resort

Disadvantages of discount loans

1. Changes in the discount rate must be proposed by the Federal Reserve Banks and then approved by the Board of Governors, which takes time

2. The Fed can influence the volume of discount loans by setting the discount rate, but it cannot control the volume since it can’t be sure how many banks will borrow it at any given rate

Money Multiplier

By changing the , changes in reserve requirements can affect money supply

Disadvantages of changes in reserve requirements

1. Large changes in the reserve requirements are required to be approved by congress

2. If a bank holds only a small amount of excess reserves, and the required reserve ratio is increased, the bank must quickly acquire reserves by borrowing, selling securities, or reducing its loans

Liquidity Management

Changes to reserve requirements can make things difficult for banks by making more difficult

Federal Funds Rate

The rate on interbank loans of reserves

Federal Funds Rate

Interest rate that the FED targets

2008

When did the FED start giving interest on excess reserves

Opportunity Cost for Holding Excess Reserves

= Federal Funds Rate - Interest Paid on excess reserves

When If > Ior

Banks will lend excess reserves in the federal funds market

When If = Ior

Bank become willing to hold excess reserves

Discount Loans and Open Market Operations

Two ways that the Fed can supply additional reserves to banks

Rs

= Rn + Rb

Discount Loans

= reserves borrowed from the FED = Rb

Open Market Operations

= Non-borrowed reserves = Rn

Supply of Reserves, in practice, the Fed

1. Set a target for the federal funds rate

2. Determine the amount of nonborrowed reserves to supply so that the equilibrium federal funds rate equals its target

3. Set the discount rate Id above the federal funds target

4. Stand ready to lend at the discount rate

If < Id

Banks will not borrow from the discount window and the supply of reserves is fixed at Rn

If rises to Id

Banks become willing to borrow from the discount window, and the supply curve is horizontal

Market Equilibrium conditions of Supply and Demand of reserves

1. The equilibrium federal funds rate If* equals the target Tft

2. The discount rate is above the equilibrium fed funds rate

3. The supply of reserves is fixed at Rn*

4. Discount window borrowing is zero

5. The interest on reserves Ior is below the equilibrium federal funds rate

How does the FED wants to increase the federal funds target?

Engages in an open market sale to reduce the amount of non-borrowed reserves in the system

Tighter Monetary Policy

A higher setting for the target federal funds rate is associated with a smaller money supply, that is, _

Discount Lending is 0

The Fed sets the discount rate above its federal funds rate target

FED Balance Sheet - Assets

US Government Securities & Discount Loans

FED Balance Sheet - Liabilities

Currency & Reserves & Overnight Reverse Repos (ONRR)

Three Goals of Monetary Policy

1. High Employement and Economic Growth

2. Low inflation and Stable Price

3. Stable financial markets and interest rates

Bills that instruct the FEDs monetary policy goals

The Employment Act of 1948 and the Full Employment and Balanced Growth Act of 1978

Federal Reserve Strategy

Tool of MP are used to set targets of MP are set to achieve goals of MP

Targets of Monetary Policy

Money Supply Target and Interest Rate Target