Structure of the Fed

Structure of the Fed

Ø  Board of Governors – The governing body of the Federal Reserve System.

Ø  Federal Open Market Committee (FOMC) –The 12-member policymaking group within the Fed. The committee has the authority to conduct open market operations.

Ø  Open Market Operations – The buying and selling of government securities by the Fed.

Monetary Policy

Changes in the money supply, or in the rate of change of the money supply, to achieve particular macroeconomic goals.

Board of Governors

Ø  Board of Governors coordinates and controls the activities of the Federal Reserve System.

Ø  The board members serve 14-year terms and are appointed by the President with Senate approval.

Ø  To limit political influence on Fed policy, the terms of the governors are staggered—with one new appointment every other year—so a president cannot “pack” the board.

Ø  The President also designates one member as chairman of the board for a 4-year term.

Federal Open Market Committee I

Ø The Federal Open Market Committee (FOMC) is the major policymaking group within the Fed.

Ø Authority to conduct open market operations—the buying and selling of government securities—rests with the FOMC.

Ø The FOMC has 12 members: the 7-member Board of Governors and 5 Federal Reserve District Bank presidents.

Federal Open Market Committee II

Ø The president of the Federal Reserve Bank of New York holds a permanent seat on the FOMC because a large amount of financial activity takes place in New York City and because the New York Fed is responsible for executing open market operations.

Ø The other four positions are rotated among the Federal Reserve District Bank presidents.

Functions of the Fed

Ø Control the money supply

Ø Supply the economy with paper money (Federal Reserve notes)

Ø Provide check clearing services

Ø Hold depository institutions’ reserves

Ø Supervise member banks

Ø Serve as the government’s banker

Ø Serve as the lender of last resort

Ø Serve as a fiscal agent for the Treasury.

The Check Clearing Process

Self-test Questions

Ø The president of which Federal Reserve District Bank holds a permanent seat on the Federal Open Market Committee (FOMC)?

Ø What is the most important responsibility of the Fed?

Ø What does it mean to say the Fed acts as “lender of last resort”?

Tools for Controlling the Money Supply

Ø Open Market Operations

Ø Required Reserve Ratio

Ø Discount Rate

Open Market Operations

Open Market Purchase – The buying of U.S. government securities by the Fed

Open Market Sale – The selling of U.S. government securities by the Fed

Open Market Purchases

Open Market Sales

Required Reserve Ratio

Ø The Fed rule that specifies the amount of reserves a bank must hold to back up deposits.

Ø Maximum change in checkable deposits = (1/r) x ?R (r=required reserve ratio; R = reserves)

Why Banks Borrow Reserves

Ø To increase loan making ability

Ø To meet required reserve requirements

Borrowing Reserves

Federal Funds Market – A market where banks lend reserves to one another, usually for short periods.

Federal Funds Rate – The interest rate in the federal funds market; the interest rate banks charge one another to borrow reserves.

Discount Rate – The interest rate the Fed charges depository institutions that borrow reserves from it.

Discount Rate

Self-test Questions

Ø  How does the money supply change as a result of (a) an increase in the discount rate, (b) an open market purchase, (c) an increase in the required reserve ratio?

Ø  What is the difference between the federal funds rate and the discount rate?

Ø  If bank A borrows $10 million from bank B, what happens to the reserves in bank A? in the banking system?

Ø  If bank A borrows $10 million from the Fed, what happens to the reserves in bank A? in the banking system?

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