1 Lecture 23: Federal reserve system Mishkin Ch 12 – part A page

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

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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

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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