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The Federal Reserve

Macro-Economics
Asif Z. Warsi

Outline
History
Organization & Functions
Policies & Concerns

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

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

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

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 countrys
regions and growth
Provide banking facilities for the federal
government

Organization of the Fed


Main components of the Federal
Reserve
Federal Reserve Board of Governors
Federal Reserve Banks
Federal Open Market Committee
(FOMC)

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 anothers term may be
reappointed.

Nominated by President, confirmed by Senate

Federal Reserve Board has a Chairman and ViceChairman


Both nominated by President, confirmed by Senate.
Serve 4-year terms

Todays 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

Federal Reserve Banks


12 regional reserve banks
Each bank with own 9-member board of
directors
One person from each banks 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

Federal Reserve Bank Districts

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 Feds open-market
transactions
Determines holdings of foreign currencies

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

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 reacquires what it issued before reduces money
supply
Bank interest rates can be controlled for short
periods of time in this way

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

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.

Discount Rate History


DISCOUNT RATE
15.00
14.00
13.00
12.00
11.00
10.00

P e rc e n t

9.00
8.00
7.00
6.00
5.00
4.00
3.00
2.00
1.00
0.00
1/1/70

10/17/74

8/2/79

5/17/84

3/2/89
Date

12/16/93

10/1/98

7/17/03

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

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

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)

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