1. Federal Reserve System (I) (ch7) -- Fin331 1 Federal Reserve System (I) Overview of Federal Reserve System (central banking) Structure of Federal Reserve How Independent is the Fed?

2. Federal Reserve System (I) (ch7) -- Fin331 2 Overview of Fed Tradeoff between benefits and costs of having a regulated banking system –particularly, preventing bank run Started in 1913, 12 regional Federal Reserve banks (the system consists of 12 districts) quasi-public

3. Federal Reserve System (I) (ch7) -- Fin331 3

4. 4 Structure of Federal Reserve Board of Governors 12 Federal Reserve Banks FOMC Federal Advisory Council 3600 Member Commercial Banks

5. Federal Reserve System (I) (ch7) -- Fin331 5 Formal Structure of the Fed

6. Federal Reserve System (I) (ch7) -- Fin331 6 Terminology Reserve requirement -- all banks are required to hold an account at the Fed discount lending -- the Fed provides reserves to the banking system by making discount loans to banks open market operation -- the central bank’s purchase or sale of bonds in the open market

7. Federal Reserve System (I) (ch7) -- Fin331 7 Board of Governors Governors are appointed by the US president Governors serve one nonrenewable 14-year term Chairman’s term is 4-year Actively involved in conduct of monetary policy Set reserve requirement and control discount rate by “review and determination” process … Has substantial regulatory functions: approves bank mergers and the activities of foreign banks in the US

8. Federal Reserve System (I) (ch7) -- Fin331 8 Federal Reserve Banks Clear checks Issue new currency Withdraw damaged currency from circulation Evaluate proposed mergers and applications for banks to expand their activities Administer and make discount loans to banks in their district Act as liaisons Examine bank holding companies and state-chartered member banks Conduct research related to monetary policy

9. Federal Reserve System (I) (ch7) -- Fin331 9 Federal Reserve Districts

10. Federal Reserve System (I) (ch7) -- Fin331 10 Member banks All national banks (commercial banks charted by the Office of Comptroller of the Currency) are required Currently, 1/3 commercial banks are members Before 1980, only member banks were required to keep reserve After 1980, all depository institutions became subject to the same requirement

11. Federal Reserve System (I) (ch7) -- Fin331 11 FOMC Meets eight times a year Makes decisions regarding the conduct of open market operations -- purchase or sale of bonds in the open market to determine changes in reserves and interest rate

12. Federal Reserve System (I) (ch7) -- Fin331 12 Central Bank Independence Factors making Fed independent 1. Members of Board have long terms 2. Fed is financially independent: This is most important Factors making Fed dependent 1.Congress can amend Fed legislation 2.President appoints Chairmen and Board members and can influence legislation Overall: Fed is quite independent

13. Federal Reserve System (I) (ch7) -- Fin331 13 Explaining Central Bank Behavior Theory of Bureaucratic Behavior 1. Is an example of principal-agent problem 2. Bureaucracy often acts in own interest Implications for Central Bank Behavior: 1. Act to preserve independence 2. Try to avoid controversy: often plays games 3. Seek additional power over banks

14. Federal Reserve System (I) (ch7) -- Fin331 14 Central Bank Independence and Macro Performance in 17 Countries