Chapter 4 Functions of the Fed © 2001 South-Western College Publishing Company.
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Transcript of Chapter 4 Functions of the Fed © 2001 South-Western College Publishing Company.
Chapter 4
Functions of the Fed
© 2001 South-Western College Publishing Company
2
Organization of the Federal Reserve
Historical perspectiveFirst bank of the United States 1791 - 1811
• Chartered for a limited period of time, 20 years
• Oversee the bank system Second bank of the United States 1816-1836
3
1913 Federal Reserve ActGoal to solve problems of bank panicsSet up the structure of the Fed
• 12 district banks, initially decentralized
• Reserve requirements for member banks
Organization of the Federal Reserve
4
Organization of the Federal Reserve
Structure of the Federal ReserveFederal Reserve district banksMember banks, private commercial banksBoard of GovernorsFederal Open Market Committee or FOMCAdvisory committees
5
Organization of the Federal Reserve
District Banks12 districtsLarge concentration of major banks in the
New York area makes that district importantMember banks buy stock Fed district bank
6
Organization of the Federal Reserve
District BanksNine directors of each district bank Clear check, replace old currency, make
discount loans
7
Organization of the Federal Reserve
Member BanksMust meet requirements of the Federal
Reserve Board of Governors to be a member bank
Nationally chartered banks must be members35% of banks controlling 70% of all deposits
are members
8
Organization of the Federal Reserve
Board of GovernorsSeven individuals appointed by the
U.S.president and confirmed by the SenateU.S. president appoints one of the seven
chair whose 4-year term is renewableOffices in Washington D.C.Serve nonrenewable 14-year termsStaggered terms
9
Organization of the Federal Reserve
Board of Governors has two main roles First role is to regulate commercial banks
Supervise and regulate member banks and bank holding companies
Oversight of 12 Fed district banksEstablish consumer finance regulations
10
Organization of the Federal Reserve
Board of Governors second role is to control monetary policyDirect control over two tools of monetary
policy
• Reserve requirements
• Discount rate Indirect control in a third area
• Participate in the FOMC
11
Organization of the Federal Reserve
Federal Open Market Committee (FOMC) meets every six weeksTwelve members
• Seven from the Board of Governors
• President of the New York Fed
• Four other district bank presidents appointed on a rotating basis
• Other presidents participate but don’t vote
12
Organization of the Federal Reserve
Federal Open Market Committee (FOMC)Goals of high employment, price stability and
economic growthMake monetary policy decisions to achieve goalsForward decisions to NY Fed open market desk
Advisory committees also part of overall structure of the Fed
13
Monetary Policy Tools
Tools to decrease or increase the money supplyOpen market operationsThe discount rateReserve requirements
14
How the Fed Controls Money Supply
Banks must maintain reserves as % Of deposits Reserves kept as deposits In fed (plus vault
cash) Fed controls level of member bank reserve
deposits in fed Fed influences bank deposit portion Of money
supply
15
Monetary Policy Tools
Open market operations are the purchase or sale of government securities based on FOMC directives sent to NY Fed Trading Desk
Open market involving the purchase of government securities Purchase securities from government
securities dealers Increases the money supply
16
Monetary Policy Tools
Open market operations and interest ratesMost rates are market determined but Fed
influencesFed purchase of securities results in an injection
of additional funds into the bank systemMore funds available for commercial banks to
loan to customersRates drop
17
Comparison of Policy Tools
Increasing the money supplyOpen market operation purchase of securities
via the Trading Desk in the secondary marketDiscount rate lowered to encourage
borrowing at the discount windowReserve requirements lowered
18
Comparison of Policy Tools
Decreasing the money supplyOpen market operation sale of securities via
the Trading Desk in the secondary marketDiscount rate raised to encourage borrowing
at the discount windowReserve requirements raised
19
Impact of Technical Factors on Funds
Technical factors other than Fed policy can affect the volume of funds or money supplySeasonal factorsFloat or the amount of funds credited to a
bank’s funds not yet collectedFed takes these issues into account in setting
monetary policyReview technical factors daily
20
FED Control of the Money Supply
Fed needs to decide which form of the money supply to manipulate
Forms of money include M1, M2 and M3 Fed emphasis on the money supply
Fed used to target both the interest rate and money supply in the 1970s
Recognized it couldn’t do both and switched to a money supply target
Recent money supply target shooting
21
Monetary Control Act of 1980
Key objective where to deregulate depository institutions and give Fed more control over money supplyPrior to the MCA nonmember banks could hold
reserves in interest-bearing form like Treasury bills
Member banks could only hold vault cash or Fed deposits and did not earn interest
Fed membership decreased
22
Monetary Control Act of 1980
To regain more control over the money supply the MCA required all depository institutions toMeet the same reserve requirementsHold noninterest-bearing reservesPromptly report deposit levels to the Fed
Other provision of the MCA allowed all depository institutions To offer transaction accountsAccess to the discount window
23
Global Monetary Policy
Each country has its own central bank and often industrialized countries have banks with similar goals
Integration in the global economy means the Fed must consider conditions in other countries when looking at the U.S. economy
Central banks try to work together but conflicts of interest can make cooperation difficult at times
24
Global Monetary Policy
A single European monetary policyEuro replaced national currencies of 11 countries
in January 1999National currencies withdrawn and replaced by
Euro by June 1, 2002Countries of the 15 in the European Union
needed to meet economic criteria and chose to join
Created a European Central Bank