|Federal Reserve System|
|Central Bank of||United States|
|ISO 4217 Code||USD|
|Base borrowing rate||0.5%|
|Base deposit rate||3.5%|
|Income tax · Payroll tax
CGT · Stamp duty · LVT
Sales tax · VAT · Flat tax
Tax, tariff and trade
Tax haven · Property tax
|Tax rate · Proportional tax
Progressive tax · Regressive tax
Tax advantage · Fixed tax
Excess burden of taxation
Central bank • Money supply
Spending • Deficit • Debt
Balance of trade
Tariff • Trade agreement
Financial market participants
Corporate · Personal
Public · Regulation
|Fractional-reserve · Full-reserve
Free banking · Islamic banking
The Federal Reserve System (also known as the Federal Reserve, and informally as the Fed) is the central banking system of the United States. It was conceived by several of the world's leading bankers in 1910 and enacted in 1913, with the passing of the Federal Reserve Act. The passing of the Federal Reserve Act was largely a response to prior financial panics and bank runs, the most severe of which being the Panic of 1907. Over time, the roles and responsibilities of the Federal Reserve System have expanded and its structure has evolved. Events such as the Great Depression were some of the major factors leading to changes in the system. Its duties today, according to official Federal Reserve documentation, fall into four general areas:
The Federal Reserve System is subject to the Administrative Procedure Act, and so is legally obligated to inform the public about its organization, procedures and rules. In addition, the Act requires the Fed to establish uniform standards for the conduct of formal rule-making and adjudication.
According to the board of governors: "It is not 'owned' by anyone and is 'not a private, profit-making institution'. Instead, it is an independent entity within the government, having both public purposes and private aspects." In particular, the US Government does not own shares in the Federal Reserve System nor its component banks, but does take all of its profits after salaries are paid to employees, a dividend is paid to member banks that is 6% of their capital investment, and surplus is put in a capital account. The government also exercises some control by appointing its highest-level employees and setting their salaries.
According to the Fed, there are presently five parts of the Federal Reserve System:
The structure of the central banking system in the U.S. is unique in the world, in that an entity outside the central bank creates the currency. This other entity is the U.S. Department of the Treasury.
In early 1781 the Articles of Confederation & Perpetual Union were ratified so that Congress had the power to issue bills of credit. It passed an ordinance later that year to incorporate a privately subscribed national bank following in the footsteps of the Bank of England. However, it was thwarted in fulfilling its intended role as a nationwide central bank due to objections of "alarming foreign influence and fictitious credit," favoritism to foreigners and unfair competition against less corrupt state banks issuing their own notes, such that Pennsylvania's legislature repealed its charter to operate within the Commonwealth in 1785.
Four years after the U.S. Constitution was ratified, the government adopted another central bank - the First Bank of the United States - but it was ultimately shut down under President Madison due to a failure in passing a recharter. The Second Bank of the United States, the "second" central bank, met a similar fate when its charter expired under President Jackson. Both banks were, again, based upon the Bank of England, but increased Federal power, granted by the constitution gave them more control over currency. Political opposition to central banking was the primary reason for shutting down the banks, and concerns over corruption lingered. Ultimately, the third national bank was established in 1913 and still exists to this day. The time line of central banking in the United States is as follows:
The first U.S. institution with central banking responsibilities was the First Bank of the United States, chartered by Congress and signed into law by President George Washington on February 25, 1791 at the urging of Alexander Hamilton. This was done despite strong opposition from Thomas Jefferson and James Madison, among numerous others. The charter was for twenty years and expired in 1811 under President James Madison.
In 1816, however, Madison revived it in the form of the Second Bank of the United States. Early renewal of the bank's charter became the primary issue in the reelection of President Andrew Jackson. After Jackson, who was opposed to the central bank, was reelected, he pulled the government's funds out of the bank. Nicholas Biddle, President of the Second Bank of the United States, responded by contracting the money supply to pressure Jackson to renew the bank's charter forcing the country into a recession, which the bank blamed on Jackson's policies. Interestingly, Jackson is the only President to completely pay off the national debt. The bank's charter was not renewed in 1836. From 1837 to 1862, in the Free Banking Era there was no formal central bank. From 1862 to 1913, a system of national banks was instituted by the 1863 National Banking Act. A series of bank panics, in 1873, 1893, and 1907, provided strong demand for the creation of a centralized banking system.
The main motivation for the third central banking system came from the Panic of 1907, which renewed demands for banking and currency reform. During the last quarter of the 19th century and the beginning of the 20th century the United States economy went through a series of financial panics. According to proponents of the Federal Reserve System and many economists, the previous national banking system had two main weaknesses: an "inelastic" currency, and a lack of liquidity. The following year Congress enacted the Aldrich-Vreeland Act, which provided for an emergency currency and established the National Monetary Commission to study banking and currency reform. The American public believed that the Federal Reserve System would bring about financial stability, so that a panic like the one in 1907 could never happen again; but just twenty-two years later in 1929, the stock market crashed again, and the United States entered the worst depression in its history, the Great Depression. Some economists including Milton Friedman, Thorstein Veblen, Ben Bernanke, Robert Latham Owen, John Kenneth Galbraith and Murray Rothbard believe that the Federal Reserve System helped to cause the Great Depression.
The chief of the bipartisan National Monetary Commission was financial expert and Senate Republican leader Nelson Aldrich. Aldrich set up two commissions—one to study the American monetary system in depth and the other, headed by Aldrich himself, to study the European central-banking systems and report on them. Aldrich went to Europe opposed to centralized banking, but after viewing Germany's monetary system he came away believing that a centralized bank was better than the government-issued bond system that he had previously supported.
Centralized banking was met with much opposition from politicians. Critics were suspicious of a central bank, and charged that Aldrich was biased due to his close ties to wealthy bankers such as J.P. Morgan and his daughter's husband John D. Rockefeller, Jr. Aldrich fought for a private bank with little government influence, but conceded that the public sector should be represented on the Board of Directors. Most Republicans favored the Aldrich Plan, but it lacked enough support in Congress to pass because rural and western states viewed it as favoring the "eastern establishment." In contrast, progressive Democrats favored a reserve system owned and operated by the government; they believed that public ownership of the US's central bank would end Wall Street's control of the American currency supply. Conservative Democrats fought for a privately owned, yet decentralized, reserve system, which would still be free of Wall Street's control.
The Federal Reserve Act passed Congress in late 1913 on a mostly partisan basis, with most Democrats voting "yea" and most Republicans voting "nay." The final Act most closely resembled the Aldrich plan, but more control was given to the public sector.
In July 1944, 730 delegates from all 44 Allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, United States, to build a new international monetary system, which was in serious threat due to damage incurred during the Great Depression and the mounting debt of the Second World War. Their main objective was the cultivation of trade, which relied on the easy convertibility of currencies. Negotiators at the Bretton Woods conference, fresh from what they perceived as a disastrous experience with floating rates in the 1930s, concluded that major monetary fluctuations could stall the free flow of trade. Planners fundamentally supported a capitalistic approach, but favored tight control on currency values.
The agreement established the rules for commercial and financial relations among the world's major industrial states. The Bretton Woods system was the first example of a fully negotiated monetary order intended to govern monetary relations among independent nation-states. Its chief feature was to require that each country adopt a monetary policy that maintained its exchange rate with gold to within plus or minus one percent of a specified value. To do this, they set up a system of fixed exchange rates using the U.S. dollar (which was on the gold standard itself) as a reserve currency. The planners established the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD) to regulate the newly devised system.
In the face of increasing financial strain, however, the Bretton Woods system collapsed in 1971, after the United States unilaterally terminated convertibility of the dollars to gold. This action caused considerable financial stress in the world economy and created the unique situation whereby the United States dollar became the "reserve currency" in the states that had signed the agreement.
Under the dollar reserve standard, the U.S. dollar was the most favored currency for nations of the world to use as reserves, which continued as a trend for over 30 years. At the beginning of the dollar reserve standard, the 1970s became a period of high inflation. As a result, in July 1979 Paul Volcker was nominated by President Carter as Chairman of the Federal Reserve Board. He tightened the money supply, and by 1986 inflation had fallen sharply. In October 1979 the Federal Reserve announced a policy of "targeting" money aggregates and bank reserves in its struggle with double-digit inflation.
In January 1987, with retail inflation at only 1%, the Federal Reserve announced it was no longer going to use money-supply aggregates, such as M2, as guidelines for controlling inflation, even though this method had been in use from 1979, apparently with great success. Before 1980, interest rates were used as guidelines; inflation was severe. The Fed complained that the aggregates were confusing. Volcker was chairman until August 1987, whereupon Alan Greenspan assumed the mantle, seven months after monetary aggregate policy had changed.
Key laws affecting the Federal Reserve have been:
The primary motivation for creating the Federal Reserve System was to address banking panics. Other purposes are stated in the Federal Reserve Act, such as "to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes." Before the founding of the Federal Reserve, the United States underwent several financial crises. A particularly severe crisis in 1907 led Congress to enact the Federal Reserve Act in 1913. Today the Fed has broader responsibilities than only ensuring the stability of the financial system.
Bank runs occur because banking institutions in the United States are only required to hold a fraction of their depositors' money in reserve. This practice is called fractional-reserve banking. As a result, most banks invest the majority of their depositors' money. On rare occasion, too many of the bank's customers will withdraw their savings and the bank will need help from another institution to continue operating. Bank runs can lead to a multitude of social and economic problems. The Federal Reserve was designed as an attempt to prevent or minimize the occurrence of bank runs, and possibly act as a lender of last resort if a bank run does occur. Many economists, following Milton Friedman, believe that the Federal Reserve inappropriately refused to lend money to small banks during the bank runs of 1929.
One way to prevent bank runs is to have a money supply that can expand when money is needed. The term "elastic currency" in the Federal Reserve Act does not just mean the ability to expand the money supply, but also to contract it. Some economic theories have been developed that support the idea of expanding or shrinking a money supply as economic conditions warrant. Elastic currency is defined by the Federal Reserve as:
Currency that can, by the actions of the central monetary authority, expand or contract in amount warranted by economic conditions.
Monetary policy of the Federal Reserve System is based partially on the theory that it is best overall to expand or contract the money supply as economic conditions change.
Because some banks refused to clear checks from certain others during times of economic uncertainty, a check-clearing system was created in the Federal Reserve system. It is briefly described in The Federal Reserve System—Purposes and Functions as follows:
By creating the Federal Reserve System, Congress intended to eliminate the severe financial crises that had periodically swept the nation, especially the sort of financial panic that occurred in 1907. During that episode, payments were disrupted throughout the country because many banks and clearinghouses refused to clear checks drawn on certain other banks, a practice that contributed to the failure of otherwise solvent banks. To address these problems, Congress gave the Federal Reserve System the authority to establish a nationwide check-clearing system. The System, then, was to provide not only an elastic currency—that is, a currency that would expand or shrink in amount as economic conditions warranted—but also an efficient and equitable check-collection system.
The Federal Reserve has the authority to act as “lender of last resort” by extending credit to depository institutions or to other entities in unusual circumstances involving a national or regional emergency, where failure to obtain credit would have a severe adverse impact on the economy.
Through its discount and credit operations, Reserve Banks provide liquidity to banks to meet short-term needs stemming from seasonal fluctuations in deposits or unexpected withdrawals. Longer term liquidity may also be provided in exceptional circumstances. The rate the Fed charges banks for these loans is the discount rate (officially the primary credit rate).
By making these loans, the Fed serves as a buffer against unexpected day-to-day fluctuations in reserve demand and supply. This contributes to the effective functioning of the banking system, alleviates pressure in the reserves market and reduces the extent of unexpected movements in the interest rates. For example, on September 16, 2008, the Federal Reserve Board authorized an $85 billion loan to stave off the bankruptcy of international insurance giant American International Group (AIG). The Federal Reserve System's role as lender of last resort is criticized for shifting risk and responsibility away from lenders and borrowers and placing them on others in the form of taxes and/or inflation.
In its role as the central bank of the United States, the Fed serves as a banker's bank and as the government's bank. As the banker's bank, it helps to assure the safety and efficiency of the payments system. As the government's bank, or fiscal agent, the Fed processes a variety of financial transactions involving trillions of dollars. Just as an individual might keep an account at a bank, the U.S. Treasury keeps a checking account with the Federal Reserve, through which incoming federal tax deposits and outgoing government payments are handled. As part of this service relationship, the Fed sells and redeems U.S. government securities such as savings bonds and Treasury bills, notes and bonds. It also issues the nation's coin and paper currency. The U.S. Treasury, through its Bureau of the Mint and Bureau of Engraving and Printing, actually produces the nation's cash supply and, in effect, sells the paper currency to the Federal Reserve Banks at manufacturing cost, and the coins at face value. The Federal Reserve Banks then distribute it to other financial institutions in various ways. During the Fiscal Year 2008, the Bureau of Engraving and Printing delivered 7.7 billion notes at an average cost of 6.4 cents per note.
Federal funds are the reserve balances (also called federal reserve accounts) that private banks keep at their local Federal Reserve Bank. These balances are the namesake reserves of the Federal Reserve System. The purpose of keeping funds at a Federal Reserve Bank is to have a mechanism for private banks to lend funds to one another. This market for funds plays an important role in the Federal Reserve System as it is what inspired the name of the system and it is what is used as the basis for monetary policy. Monetary policy works by influencing how much money the private banks charge each other for the lending of these funds.
The system was designed out of a compromise between the competing philosophies of privatization and government regulation. In 2006 Donald L. Kohn, vice chairman of the Board of Governors, summarized the history of this compromise:
Agrarian and progressive interests, led by William Jennings Bryan, favored a central bank under public, rather than banker, control. But the vast majority of the nation's bankers, concerned about government intervention in the banking business, opposed a central bank structure directed by political appointees.
The legislation that Congress ultimately adopted in 1913 reflected a hard-fought battle to balance these two competing views and created the hybrid public-private, centralized-decentralized structure that we have today.
In the current system, private banks are for-profit businesses but government regulation places restrictions on what they can do. The Federal Reserve System is a part of government that regulates the private banks. The balance between privatization and government involvement is also seen in the structure of the system. Private banks elect members of the board of directors at their regional Federal Reserve Bank while the members of the Board of Governors are selected by the President of the United States and confirmed by the Senate. The private banks give input to the government officials about their economic situation and these government officials use this input in Federal Reserve policy decisions. In the end, private banking businesses are able to run a profitable business while the U.S. government, through the Federal Reserve System, oversees and regulates the activities of the private banks.
Federal Banking Agency Audit Act enacted in 1978 as Public Law 95-320 and Section 31 USC 714 of US Code establish that the Federal Reserve may be audited by the Government Accountability Office (GAO). The GAO has authority to audit check-processing, currency storage and shipments, and some regulatory and bank examination functions, however there are restrictions to what the GAO may in fact audit. Audits of the Reserve Board and Federal Reserve banks may not include:
The financial crisis which began in 2007, corporate bailouts, and concerns over the Fed's secrecy have brought renewed concern regarding ability of the Fed to effectively manage the national monetary system. A July 2009 Gallup Poll found only 30% Americans thought the Fed was doing a good or excellent job, a rating even lower than that for the Internal Revenue Service, which drew praise from 40%. The Federal Reserve Transparency Act was introduced by congressman Ron Paul in order to obtain a more detailed audit of the Fed. The Fed has since hired Linda Robertson who headed the Washington lobbying office of Enron Corp. and was adviser to all three of the Clinton administration’s Treasury secretaries.
The Board of Governors in the Federal Reserve System has a number of supervisory and regulatory responsibilities in the U.S. banking system, but not complete responsibility. A general description of the types of regulation and supervision involved in the U.S. banking system is given by the Federal Reserve:
The Board also plays a major role in the supervision and regulation of the U.S. banking system. It has supervisory responsibilities for state-chartered banks that are members of the Federal Reserve System, bank holding companies (companies that control banks), the foreign activities of member banks, the U.S. activities of foreign banks, and Edge Act and agreement corporations (limited-purpose institutions that engage in a foreign banking business). The Board and, under delegated authority, the Federal Reserve Banks, supervise approximately 900 state member banks and 5,000 bank holding companies. Other federal agencies also serve as the primary federal supervisors of commercial banks; the Office of the Comptroller of the Currency supervises national banks, and the Federal Deposit Insurance Corporation supervises state banks that are not members of the Federal Reserve System.
Some regulations issued by the Board apply to the entire banking industry, whereas others apply only to member banks, that is, state banks that have chosen to join the Federal Reserve System and national banks, which by law must be members of the System. The Board also issues regulations to carry out major federal laws governing consumer credit protection, such as the Truth in Lending, Equal Credit Opportunity, and Home Mortgage Disclosure Acts. Many of these consumer protection regulations apply to various lenders outside the banking industry as well as to banks.
Members of the Board of Governors are in continual contact with other policy makers in government. They frequently testify before congressional committees on the economy, monetary policy, banking supervision and regulation, consumer credit protection, financial markets, and other matters.
The Board has regular contact with members of the President’s Council of Economic Advisers and other key economic officials. The Chairman also meets from time to time with the President of the United States and has regular meetings with the Secretary of the Treasury. The Chairman has formal responsibilities in the international arena as well.
The board of directors of each Federal Reserve Bank District also has regulatory and supervisory responsibilities. For example, a member bank (private bank) is not permitted to give out too many loans to people who cannot pay them back. This is because too many defaults on loans will lead to a bank run. If the board of directors has judged that a member bank is performing or behaving poorly, it will report this to the Board of Governors. This policy is described in United States Code:
Each Federal reserve bank shall keep itself informed of the general character and amount of the loans and investments of its member banks with a view to ascertaining whether undue use is being made of bank credit for the speculative carrying of or trading in securities, real estate, or commodities, or for any other purpose inconsistent with the maintenance of sound credit conditions; and, in determining whether to grant or refuse advances, rediscounts, or other credit accommodations, the Federal reserve bank shall give consideration to such information. The chairman of the Federal reserve bank shall report to the Board of Governors of the Federal Reserve System any such undue use of bank credit by any member bank, together with his recommendation. Whenever, in the judgment of the Board of Governors of the Federal Reserve System, any member bank is making such undue use of bank credit, the Board may, in its discretion, after reasonable notice and an opportunity for a hearing, suspend such bank from the use of the credit facilities of the Federal Reserve System and may terminate such suspension or may renew it from time to time.
Whoever knowingly makes any false statement or report, or willfully overvalues any land, property or security, for the purpose of influencing in any way...shall be fined not more than $1,000,000 or imprisoned not more than 30 years, or both.
These aspects of the Federal Reserve System are the parts intended to prevent or minimize speculative asset bubbles, which ultimately lead to severe market corrections. The recent bubbles and corrections in energies, grains, equity and debt products and real estate cast doubt on the efficacy of these controls.
 The Federal Reserve plays an important role in the U.S. payments system. The twelve Federal Reserve Banks provide banking services to depository institutions and to the federal government. For depository institutions, they maintain accounts and provide various payment services, including collecting checks, electronically transferring funds, and distributing and receiving currency and coin. For the federal government, the Reserve Banks act as fiscal agents, paying Treasury checks; processing electronic payments; and issuing, transferring, and redeeming U.S. government securities.
In passing the Depository Institutions Deregulation and Monetary Control Act of 1980, Congress reaffirmed its intention that the Federal Reserve should promote an efficient nationwide payments system. The act subjects all depository institutions, not just member commercial banks, to reserve requirements and grants them equal access to Reserve Bank payment services. It also encourages competition between the Reserve Banks and private-sector providers of payment services by requiring the Reserve Banks to charge fees for certain payments services listed in the act and to recover the costs of providing these services over the long run.
The Federal Reserve plays a vital role in both the nation’s retail and wholesale payments systems, providing a variety of financial services to depository institutions. Retail payments are generally for relatively small-dollar amounts and often involve a depository institution’s retail clients—individuals and smaller businesses. The Reserve Banks’ retail services include distributing currency and coin, collecting checks, and electronically transferring funds through the automated clearinghouse system. By contrast, wholesale payments are generally for large-dollar amounts and often involve a depository institution’s large corporate customers or counterparties, including other financial institutions. The Reserve Banks’ wholesale services include electronically transferring funds through the Fedwire Funds Service and transferring securities issued by the U.S. government, its agencies, and certain other entities through the Fedwire Securities Service. Because of the large amounts of funds that move through the Reserve Banks every day, the System has policies and procedures to limit the risk to the Reserve Banks from a depository institution’s failure to make or settle its payments.
The Federal Reserve Banks began a multi-year restructuring of their check operations in 2003 as part of a long-term strategy to respond to the declining use of checks by consumers and businesses and the greater use of electronics in check processing. The Reserve Banks will have reduced the number of full-service check processing locations from 45 in 2003 to 4 by early 2011.
The Federal Reserve System is an independent government institution that has private aspects. The System is not a private organization and does not operate for the purpose of making a profit. The stocks of the regional federal reserve banks are owned by the banks operating within that region and which are part of the system. The System derives its authority and public purpose from the Federal Reserve Act passed by Congress in 1913. As an independent institution, the Federal Reserve System has the authority to act on its own without prior approval from Congress or the President. The members of its Board of Governors are appointed for long, staggered terms, limiting the influence of day-to-day political considerations. The Federal Reserve System's unique structure also provides internal checks and balances, ensuring that its decisions and operations are not dominated by any one part of the system. It also generates revenue independently without need for Congressional funding. Congressional oversight and statutes, which can alter the Fed's responsibilities and control, allow the government to keep the Federal Reserve System in check. Since the System was designed to be independent while also remaining within the government of the United States, it is often said to be "independent within the government."
The twelve Federal Reserve banks provide the financial means to operate the Federal Reserve System. Each reserve bank is organized much like a private corporation so that it can provide the necessary revenue to cover operational expenses and implement the demands of the board. Member banks are privately owned banks that must buy a certain amount of stock in the Reserve Bank within its region to be a member of the Federal Reserve System. This stock "may not be sold, traded, or pledged as security for a loan" and all member banks receive a 6% annual dividend. No stock in any Federal Reserve Bank has ever been sold to the public, to foreigners, or to any non-bank U.S. firm. These member banks must maintain fractional reserves either as vault currency or on account at its Reserve Bank; member banks earn no interest on either of these. The dividends paid by the Federal Reserve Banks to member banks are considered partial compensation for the lack of interest paid on the required reserves. All profit after expenses is returned to the U.S. Treasury or contributed to the surplus capital of the Federal Reserve Banks (and since shares in ownership of the Federal Reserve Banks are redeemable only at par, the nominal "owners" do not benefit from this surplus capital); the Federal Reserve system contributed over $31.7 billion to the Treasury in 2008.
The seven-member Board of Governors is the main governing body of the Federal Reserve System. It is charged with overseeing the 12 District Reserve Banks and with helping implement national monetary policy. Governors are appointed by the President of the United States and confirmed by the Senate for staggered, 14-year terms. By law, the appointments must yield a "fair representation of the financial, agricultural, industrial, and commercial interests and geographical divisions of the country," and as stipulated in the Banking Act of 1935, the Chairman and Vice Chairman of the Board are two of seven members of the Board of Governors who are appointed by the President from among the sitting Governors. As an independent federal government agency, the Board of Governors does not receive funding from Congress, and the terms of the seven members of the Board span multiple presidential and congressional terms. Once a member of the Board of Governors is appointed by the president, he or she functions mostly independently. The Board is required to make an annual report of operations to the Speaker of the U.S. House of Representatives. It also supervises and regulates the operations of the Federal Reserve Banks, and the US banking system in general.
Membership is by statute limited in term, and a member that has served for a full 14 year term is not eligible for reappointment. There are numerous occasions where an individual was appointed to serve the remainder of another member's uncompleted term, and has been reappointed to serve a full 14-year term. Since "upon the expiration of their terms of office, members of the Board shall continue to serve until their successors are appointed and have qualified," it is possible for a member to serve for significantly longer than a full term of 14 years. The law provides for the removal of a member of the Board by the President "for cause".
The current members of the Board of Governors are
On March 2, 2010, Kohn announced his retirement in June and, on March 12, the Barack Obama's White House identified three as likely nominees. Two economists are "Janet L. Yellen, president of the Federal Reserve Bank of San Francisco, who is the top choice for vice chairman, and Peter A. Diamond, an M.I.T. economist who is an authority on Social Security, pensions and taxation. The lawyer, Sarah Bloom Raskin, is the Maryland commissioner of financial regulation."
A list of every member since 1914 is also available.
The Federal Open Market Committee (FOMC) created under 12 U.S.C. § 263 comprises the seven members of the board of governors and five representatives selected from the regional Federal Reserve Banks. The FOMC is charged under law with overseeing open market operations, the principal tool of national monetary policy. These operations affect the amount of Federal Reserve balances available to depository institutions, thereby influencing overall monetary and credit conditions. The FOMC also directs operations undertaken by the Federal Reserve in foreign exchange markets. The representative from the Second District, New York, is a permanent member, while the rest of the banks rotate at two- and three-year intervals. All the presidents participate in FOMC discussions, contributing to the committee’s assessment of the economy and of policy options, but only the five presidents who are committee members vote on policy decisions. The FOMC, under law, determines its own internal organization and by tradition elects the Chairman of the Board of Governors as its chairman and the president of the Federal Reserve Bank of New York as its vice chairman. Formal meetings typically are held eight times each year in Washington, D.C. Nonvoting Reserve Bank presidents also participate in Committee deliberations and discussion. The FOMC generally meets eight times a year in Telephone consultations and other meetings are held when needed.
There are 12 regional Federal Reserve Banks (not to be confused with the "member banks") with 25 branches, which serve as the operating arms of the system. Each Federal Reserve Bank is subject to oversight by the Board of Governors. Each Federal Reserve Bank has a board of directors, whose members work closely with their Reserve Bank president to provide grassroots economic information and input on management and monetary policy decisions. These boards are drawn from the general public and the banking community and oversee the activities of the organization. They also appoint the presidents of the Reserve Banks, subject to the approval of the Board of Governors. Reserve Bank boards consist of nine members: six serving as representatives of nonbanking enterprises and the public (nonbankers) and three as representatives of banking. Each Federal Reserve branch office has its own board of directors, composed of three to seven members, that provides vital information concerning the regional economy.
The Reserve Banks opened for business on November 16, 1914. Federal Reserve Notes were created as part of the legislation to provide a supply of currency. The notes were to be issued to the Reserve Banks for subsequent transmittal to banking institutions. The various components of the Federal Reserve System have differing legal statuses.
The Federal Reserve Banks have an intermediate legal status, with some features of private corporations and some features of public federal agencies. Each member bank owns nonnegotiable shares of stock in its regional Federal Reserve Bank. However, holding Fed stock is not like owning publicly traded stock. Fed stock cannot be sold or traded, and they do not control the Fed as a result of owning this stock. They do, however, elect six of the nine members of Reserve Banks’ boards of directors. Furthermore, the charter of each Federal Reserve Bank is established by law and cannot be altered by the member banks. In Lewis v. United States, the United States Court of Appeals for the Ninth Circuit stated that:
The Reserve Banks are not federal instrumentalities for purposes of the FTCA [the Federal Tort Claims Act], but are independent, privately owned and locally controlled corporations.
The opinion also stated that:
The Reserve Banks have properly been held to be federal instrumentalities for some purposes.
Another decision is Scott v. Federal Reserve Bank of Kansas City, in which the distinction between the Federal Reserve Banks and the Board of Governors is made.
The nine member board of directors of each district is made up of 3 classes, designated as classes A, B, and C. The directors serve a term of 3 years. The makeup of the boards of directors is outlined in U.S. Code, Title 12, Chapter 3, Subchapter 7:
A list of all of the members of the Reserve Banks' boards of directors is published by the Federal Reserve.
The Federal Reserve Act provides that the president of a Federal Reserve Bank shall be the chief executive officer of the Bank, appointed by the board of directors of the Bank, with the approval of the Board of Governors of the Federal Reserve System, for a term of five years.
The terms of all the presidents of the twelve District Banks run concurrently, ending on the last day of February every five years. The appointment of a president who takes office after a term has begun ends upon the completion of that term. A president of a Reserve Bank may be reappointed after serving a full term or an incomplete term.
Reserve Bank presidents are subject to mandatory retirement upon becoming 65 years of age. However, presidents initially appointed after age 55 can, at the option of the board of directors, be permitted to serve until attaining ten years of service in the office or age 70, whichever comes first.
The Federal Reserve Districts are listed below along with their identifying letter and number. These are used on Federal Reserve Notes to identify the issuing bank for each note. The 25 branches are also listed.
|Federal Reserve Bank||Letter||Number||Branches||Website||President|
|Boston||A||1||http://www.bos.frb.org/||Eric S. Rosengren|
|New York City||B||2||Buffalo (closed as of October 31, 2008), New York ||http://www.newyorkfed.org/||William C. Dudley|
|Philadelphia||C||3||http://www.philadelphiafed.org/||Charles I. Plosser|
|Cleveland||D||4||Cincinnati, Ohio / Pittsburgh, Pennsylvania||http://www.clevelandfed.org/||Sandra Pianalto|
|Richmond||E||5||Baltimore, Maryland / Charlotte, North Carolina||http://www.richmondfed.org/||Jeffrey M. Lacker|
|Atlanta||F||6||Birmingham, Alabama / Jacksonville, Florida / Miami, Florida / Nashville, Tennessee / New Orleans, Louisiana||http://www.frbatlanta.org/||Dennis P. Lockhart|
|Chicago||G||7||Detroit, Michigan / Des Moines, Iowa||http://www.chicagofed.org/||Charles L. Evans|
|St Louis||H||8||Little Rock, Arkansas / Louisville, Kentucky / Memphis, Tennessee||http://www.stlouisfed.org/||James B. Bullard|
|Minneapolis||I||9||Helena, Montana||http://www.minneapolisfed.org/||Narayana R. Kocherlakota|
|Kansas City||J||10||Denver, Colorado / Oklahoma City, Oklahoma / Omaha, Nebraska||http://www.kansascityfed.org/||Thomas M. Hoenig|
|Dallas||K||11||El Paso, Texas / Houston, Texas / San Antonio, Texas||http://www.dallasfed.org/||Richard W. Fisher|
|San Francisco||L||12||Los Angeles, California / Portland, Oregon / Salt Lake City, Utah / Seattle, Washington||http://www.frbsf.org/||Janet L. Yellen|
A primary dealer is a bank or securities broker-dealer that may trade directly with the Federal Reserve System of the United States. They are required to make bids or offers when the Fed conducts open market operations, provide information to the Fed's open market trading desk, and to participate actively in U.S. Treasury securities auctions. They consult with both the U.S. Treasury and the Fed about funding the budget deficit and implementing monetary policy. Many former employees of primary dealers work at the Treasury, because of their expertise in the government debt markets, though the Fed avoids a similar revolving door policy.
Between them, these dealers purchase the vast majority of the U.S. Treasury securities (T-bills, T-notes, and T-bonds) sold at auction, and resell them to the public. Their activities extend well beyond the Treasury market, for example, according to the Wall Street Journal Europe (2/9/06 p. 20), all of the top ten dealers in the foreign exchange market are also primary dealers, and between them account for almost 73% of forex trading volume. Arguably, this group's members are the most influential and powerful non-governmental institutions in world financial markets.
The primary dealers form a worldwide network that distributes new U.S. government debt. For example, Daiwa Securities and Mizuho Securities distribute the debt to Japanese buyers. BNP Paribas, Barclays, Deutsche Bank, and RBS Greenwich Capital (a division of the Royal Bank of Scotland) distribute the debt to European buyers. Goldman Sachs, and Citigroup account for many American buyers. Nevertheless, most of these firms compete internationally and in all major financial centers.
Five notable changes to the list have occurred in 2008. Countrywide Securities Corporation was removed on July 15 due to its acquisition by Bank of America. Lehman Brothers Inc. was removed on September 22 due to bankruptcy. Bear Stearns & Co. Inc. was removed from the list on October 1 due to its acquisition by J.P. Morgan Chase. On February 11, 2009, Merrill Lynch Government Securities Inc. was removed from the list due to its acquisition by Bank of America.
Each member bank is a private bank (e.g., a privately owned corporation) that holds stock in one of the twelve regional Federal Reserve banks. All of the commercial banks in the United States can be divided into three types according to which governmental body charters them and whether or not they are members of the Federal Reserve System:
|national banks||Those chartered by the federal government (through the Office of the Comptroller of the Currency in the Department of the Treasury); by law, they are members of the Federal Reserve System|
|state member banks||Those chartered by the states who are members of the Federal Reserve System.|
|state nonmember banks||Those chartered by the states who are not members of the Federal Reserve System.|
All nationally chartered banks hold stock in one of the Federal Reserve banks. State-chartered banks may choose to be members (and hold stock in a regional Federal Reserve bank), upon meeting certain standards.
Holding stock in a Federal Reserve bank is not, however, like owning publicly traded stock. The stock cannot be sold or traded. Member banks receive a fixed, 6 percent dividend annually on their stock, and they do not directly control the applicable Federal Reserve bank as a result of owning this stock. They do, however, elect six of the nine members of Reserve banks’ boards of directors. Federal statute provides (in part):
Every national bank in any State shall, upon commencing business or within ninety days after admission into the Union of the State in which it is located, become a member bank of the Federal Reserve System by subscribing and paying for stock in the Federal Reserve bank of its district in accordance with the provisions of this chapter and shall thereupon be an insured bank under the Federal Deposit Insurance Act [. . . .]—
Other banks may elect to become member banks. According to the Federal Reserve Bank of Boston:
Any state-chartered bank (mutual or stock-formed) may become a member of the Federal Reserve System. The twelve regional Reserve Banks supervise state member banks as part of the Federal Reserve System’s mandate to assure strength and stability in the nation’s domestic markets and banking system. Reserve Bank supervision is carried out in partnership with the state regulators, assuring a consistent and unified regulatory environment. Regional and community banking organizations constitute the largest number of banking organizations supervised by the Federal Reserve System.—
For example, as of October 2006 the member banks in New Hampshire included Community Guaranty Savings Bank; The Lancaster National Bank; The Pemigewasset National Bank of Plymouth; and other banks. In California, member banks (as of September 2006) included Bank of America California, National Association; The Bank of New York Trust Company, National Association; Barclays Global Investors, National Association; and many other banks.
The majority of US banks are not members of the Federal Reserve System.
A list of all member banks can be found at the website of the Federal Deposit Insurance Corporation (FDIC). Most commercial banks in the United States are not members of the Federal Reserve System, but the total value of all the banking assets of member banks is substantially larger than the total value of the banking assets of nonmembers.
The Federal Reserve System uses advisory committees in carrying out its varied responsibilities. Three of these committees advise the Board of Governors directly:
Of these advisory committees, perhaps the most important are the committees (one for each Reserve Bank) that advise the Banks on matters of agriculture, small business, and labor. Biannually, the Board solicits the views of each of these committees by mail.
The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals. What happens to money and credit affects interest rates (the cost of credit) and the performance of the U.S. economy. The Federal Reserve Act of 1913 gave the Federal Reserve responsibility for setting monetary policy.
The Federal Reserve implements monetary policy by influencing the interbank lending of excess reserves. The rate that banks charge each other for these loans is determined by the markets but the Federal Reserve influences this rate through the three tools of monetary policy described in the "Tools" section below. This is a short-term interest rate the FOMC focuses on directly. This rate ultimately affects the longer-term interest rates throughout the economy. A summary of the basis and implementation of monetary policy is stated by the Federal Reserve:
The Federal Reserve implements U.S. monetary policy by affecting conditions in the market for balances that depository institutions hold at the Federal Reserve Banks...By conducting open market operations, imposing reserve requirements, permitting depository institutions to hold contractual clearing balances, and extending credit through its discount window facility, the Federal Reserve exercises considerable control over the demand for and supply of Federal Reserve balances and the federal funds rate. Through its control of the federal funds rate, the Federal Reserve is able to foster financial and monetary conditions consistent with its monetary policy objectives.
This influences the economy through its effect on the quantity of reserves that banks use to make loans. Policy actions that add reserves to the banking system encourage lending at lower interest rates thus stimulating growth in money, credit, and the economy. Policy actions that absorb reserves work in the opposite direction. The Fed's task is to supply enough reserves to support an adequate amount of money and credit, avoiding the excesses that result in inflation and the shortages that stifle economic growth.
There are three main tools of monetary policy that the Federal Reserve uses to influence the amount of reserves in private banks:
|open market operations||purchases and sales of U.S. Treasury and federal agency securities—the Federal Reserve's principal tool for implementing monetary policy. The Federal Reserve's objective for open market operations has varied over the years. During the 1980s, the focus gradually shifted toward attaining a specified level of the federal funds rate (the rate that banks charge each other for overnight loans of federal funds, which are the reserves held by banks at the Fed), a process that was largely complete by the end of the decade.|
|discount rate||the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility—the discount window.|
|reserve requirements||the amount of funds that a depository institution must hold in reserve against specified deposit liabilities.|
Open market operations put money in and take money out of the banking system. This is done through the sale and purchase of U.S. government treasury securities. When the U.S. government sells securities, it gets money from the banks and the banks get a piece of paper (I.O.U.) that says the U.S. government owes the bank money. This drains money from the banks. When the U.S. government buys securities, it gives money to the banks and the banks give the I.O.U. back to the U.S. government. This puts money back into the banks. The Federal Reserve education website describes open market operations as follows:
Open market operations involve the buying and selling of U.S. government securities (federal agency and mortgage-backed). The term 'open market' means that the Fed doesn’t decide on its own which securities dealers it will do business with on a particular day. Rather, the choice emerges from an 'open market' in which the various securities dealers that the Fed does business with—the primary dealers—compete on the basis of price. Open market operations are flexible and thus, the most frequently used tool of monetary policy.
Open market operations are the primary tool used to regulate the supply of bank reserves. This tool consists of Federal Reserve purchases and sales of financial instruments, usually securities issued by the U.S. Treasury, Federal agencies and government-sponsored enterprises. Open market operations are carried out by the Domestic Trading Desk of the Federal Reserve Bank of New York under direction from the FOMC. The transactions are undertaken with primary dealers.
The Fed’s goal in trading the securities is to affect the federal funds rate, the rate at which banks borrow reserves from each other. When the Fed wants to increase reserves, it buys securities and pays for them by making a deposit to the account maintained at the Fed by the primary dealer’s bank. When the Fed wants to reduce reserves, it sells securities and collects from those accounts. Most days, the Fed does not want to increase or decrease reserves permanently so it usually engages in transactions reversed within a day or two. That means that a reserve injection today could be withdrawn tomorrow morning, only to be renewed at some level several hours later. These short-term transactions are called repurchase agreements (repos) – the dealer sells the Fed a security and agrees to buy it back at a later date.
A simpler description is described in The Federal Reserve in Plain English:
How do open market operations actually work? Currently, the FOMC establishes a target for the federal funds rate (the rate banks charge each other for overnight loans). Open market purchases of government securities increase the amount of reserve funds that banks have available to lend, which puts downward pressure on the federal funds rate. Sales of government securities do just the opposite—they shrink the reserve funds available to lend and tend to raise the funds rate.
By targeting the federal funds rate, the FOMC seeks to provide the monetary stimulus required to foster a healthy economy. After each FOMC meeting, the funds rate target is announced to the public.
To smooth temporary or cyclical changes in the monetary supply, the desk engages in repurchase agreements (repos) with its primary dealers. Repos are essentially secured, short-term lending by the Fed. On the day of the transaction, the Fed deposits money in a primary dealer’s reserve account, and receives the promised securities as collateral. When the transaction matures, the process unwinds: the Fed returns the collateral and charges the primary dealer’s reserve account for the principal and accrued interest. The term of the repo (the time between settlement and maturity) can vary from 1 day (called an overnight repo) to 65 days.
The Federal Reserve System implements monetary policy largely by targeting the federal funds rate. This is the rate that banks charge each other for overnight loans of federal funds, which are the reserves held by banks at the Fed. This rate is actually determined by the market and is not explicitly mandated by the Fed. The Fed therefore tries to align the effective federal funds rate with the targeted rate by adding or subtracting from the money supply through open market operations. The late economist Milton Friedman consistently criticized this reverse method of controlling inflation by seeking an ideal interest rate and enforcing it through affecting the money supply since nowhere in the widely accepted money supply equation are interest rates found.
The Federal Reserve System also directly sets the "discount rate", which is the interest rate for "discount window lending", overnight loans that member banks borrow directly from the Fed. This rate is generally set at a rate close to 100 basis points above the target federal funds rate. The idea is to encourage banks to seek alternative funding before using the "discount rate" option. The equivalent operation by the European Central Bank is referred to as the "marginal lending facility."
Both of these rates influence the prime rate, which is usually about 3 percent higher than the federal funds rate.
Lower interest rates stimulate economic activity by lowering the cost of borrowing, making it easier for consumers and businesses to buy and build, but at the cost of promoting the expansion of the money supply and thus greater inflation. Higher interest rates may slow the economy by increasing the cost of borrowing. (See monetary policy for a fuller explanation.)
The Federal Reserve System usually adjusts the federal funds rate by 0.25% or 0.50% at a time.
The Federal Reserve System might also attempt to use open market operations to change long-term interest rates, but its "buying power" on the market is significantly smaller than that of private institutions. The Fed can also attempt to "jawbone" the markets into moving towards the Fed's desired rates, but this is not always effective.
Another instrument of monetary policy adjustment employed by the Federal Reserve System is the fractional reserve requirement, also known as the required reserve ratio. The required reserve ratio sets the balance that the Federal Reserve System requires a depository institution to hold in the Federal Reserve Banks,, which depository institutions trade in the federal funds market discussed above. The required reserve ratio is set by the Board of Governors of the Federal Reserve System. The reserve requirements have changed over a time and some of the history of these changes is published by the Federal Reserve.
|Type of liability||Requirement|
|Percentage of liabilities||Effective date|
|Net transaction accounts|
|$0 to $10.3 million||0||01/01/09|
|More than $10.3 million to $44.4 million||3||01/01/09|
|More than $44.4 million||10||01/01/09|
|Nonpersonal time deposits||0||12/27/90|
NOTE: As a response to the financial crisis of 2008, the Federal Reserve now makes interest payments on depository institutions' required and excess reserve balances. The payment of interest on excess reserves gives the central bank greater opportunity to address credit market conditions while maintaining the federal funds rate close to the target rate set by the FOMC.
In order to address problems related to the subprime mortgage crisis and United States housing bubble, several new tools have been created. The first new tool, called the Term Auction Facility, was added on December 12, 2007. It was first announced as a temporary tool but there have been suggestions that this new tool may remain in place for a prolonged period of time. Creation of the second new tool, called the Term Securities Lending Facility, was announced on March 11, 2008. The main difference between these two facilities is that the Term Auction Facility is used to inject cash into the banking system whereas the Term Securities Lending Facility is used to inject treasury securities into the banking system. Creation of the third tool, called the Primary Dealer Credit Facility (PDCF), was announced on March 16, 2008. The PDCF was a fundamental change in Federal Reserve policy because now the Fed is able to lend directly to primary dealers, which was previously against Fed policy. The differences between these 3 new facilities is described by the Federal Reserve:
The Term Auction Facility program offers term funding to depository institutions via a bi-weekly auction, for fixed amounts of credit. The Term Securities Lending Facility will be an auction for a fixed amount of lending of Treasury general collateral in exchange for OMO-eligible and AAA/Aaa rated private-label residential mortgage-backed securities. The Primary Dealer Credit Facility now allows eligible primary dealers to borrow at the existing Discount Rate for up to 120 days.
Some of the measures taken by the Federal Reserve to address this mortgage crisis haven't been used since The Great Depression. The Federal Reserve gives a brief summary of what these new facilities are all about:
As the economy has slowed in the last nine months and credit markets have become unstable, the Federal Reserve has taken a number of steps to help address the situation. These steps have included the use of traditional monetary policy tools at the macroeconomic level as well as measures at the level of specific markets to provide additional liquidity.
The Federal Reserve's response has continued to evolve since pressure on credit markets began to surface last summer, but all these measures derive from the Fed's traditional open market operations and discount window tools by extending the term of transactions, the type of collateral, or eligible borrowers.
The Term Auction Facility is a program in which the Federal Reserve auctions term funds to depository institutions. The creation of this facility was announced by the Federal Reserve on December 12, 2007 and was done in conjunction with the Bank of Canada, the Bank of England, the European Central Bank, and the Swiss National Bank to address elevated pressures in short-term funding markets. The reason it was created is because banks were not lending funds to one another and banks in need of funds were refusing to go to the discount window. Banks were not lending money to each other because there was a fear that the loans would not be paid back. Banks refused to go to the discount window because it is usually associated with the stigma of bank failure. Under the Term Auction Facility, the identity of the banks in need of funds is protected in order to avoid the stigma of bank failure. Foreign exchange swap lines with the European Central Bank and Swiss National Bank were opened so the banks in Europe could have access to U.S. dollars. Federal Reserve Chairman Ben Bernanke briefly described this facility to the U.S. House of Representatives on January 17, 2008:
the Federal Reserve recently unveiled a term auction facility, or TAF, through which prespecified amounts of discount window credit can be auctioned to eligible borrowers. The goal of the TAF is to reduce the incentive for banks to hoard cash and increase their willingness to provide credit to households and firms...TAF auctions will continue as long as necessary to address elevated pressures in short-term funding markets, and we will continue to work closely and cooperatively with other central banks to address market strains that could hamper the achievement of our broader economic objectives.
It is also described in the Term Auction Facility FAQ
The TAF is a credit facility that allows a depository institution to place a bid for an advance from its local Federal Reserve Bank at an interest rate that is determined as the result of an auction. By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could help ensure that liquidity provisions can be disseminated efficiently even when the unsecured interbank markets are under stress.
In short, the TAF will auction term funds of approximately one-month maturity. All depository institutions that are judged to be in sound financial condition by their local Reserve Bank and that are eligible to borrow at the discount window are also eligible to participate in TAF auctions. All TAF credit must be fully collateralized. Depositories may pledge the broad range of collateral that is accepted for other Federal Reserve lending programs to secure TAF credit. The same collateral values and margins applicable for other Federal Reserve lending programs will also apply for the TAF.
The Term Securities Lending Facility is a 28-day facility that will offer Treasury general collateral to the Federal Reserve Bank of New York’s primary dealers in exchange for other program-eligible collateral. It is intended to promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally. Like the Term Auction Facility, the TSLF was done in conjunction with the Bank of Canada, the Bank of England, the European Central Bank, and the Swiss National Bank. The resource allows dealers to switch debt that is less liquid for U.S. government securities that are easily tradable. It is anticipated by Federal Reserve officials that the primary dealers, which include Goldman Sachs Group. Inc., Bear Stearns Cos. and Merrill Lynch & Co., will lend the Treasuries on to other firms in return for cash. That will help the dealers finance their balance sheets. The currency swap lines with the European Central Bank and Swiss National Bank were increased.
The Primary Dealer Credit Facility (PDCF) is an overnight loan facility that will provide funding to primary dealers in exchange for a specified range of eligible collateral and is intended to foster the functioning of financial markets more generally. This new facility marks a fundamental change in Federal Reserve policy because now primary dealers can borrow directly from the Fed when this previously was not permitted.
As of October 2008, the Federal Reserve banks will pay interest on reserve balances (required & excess) held by depository institutions. The rate is set at the lowest federal funds rate during the reserve maintenance period of an institution, less 75bp. As of October 23, 2008, the Fed has lowered the spread to a mere 35 bp.
The Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (ABCPMMMFLF) is also called the AMLF. Borrower Eligibility:
All U.S. depository institutions, bank holding companies (parent companies or U.S. broker-dealer affiliates), or U.S. branches and agencies of foreign banks are eligible to borrow under this facility pursuant to the discretion of the FRBB.
Collateral eligible for pledge under the Facility must meet the following criteria:
The Commercial Paper Funding Facility is also called the CPFF. On October 7, 2008 the Federal Reserve further expanded the collateral it will loan against, to include commercial paper. The action made the Fed a crucial source of credit for non-financial businesses in addition to commercial banks and investment firms. Fed officials said they'll buy as much of the debt as necessary to get the market functioning again. They refused to say how much that might be, but they noted that around $1.3 trillion worth of commercial paper would qualify. There was $1.61 trillion in outstanding commercial paper, seasonally adjusted, on the market as of October 1, 2008, according to the most recent data from the Fed. That was down from $1.70 trillion in the previous week. Since the summer of 2007, the market has shrunk from more than $2.2 trillion.
The Money Market Investor Funding Facility is also called the MMIFF. The Federal Reserve introduced a facility on October 21, 2008, whereby money market mutual funds can set up a structured investment vehicle of short-term assets underwritten by the Federal Reserve Bank of New York. The program will run until April 30, 2009, unless extended by the FRB.
Another policy that can be used is a little used tool of the Federal Reserve (US central bank) that is known as the quantitative policy. With that the Federal Reserve actually buys back corporate bonds and mortgage backed securities held by banks or other financial institutions. This in effect puts money back into the financial institutions and allows them to make loans and conduct normal business. The Federal Reserve Board used this policy in the early nineties when the US economy experienced the Savings and Loan crisis.
Quantitative easing is another way to influence monetary policy, only recently begun to be used in the United States. Other countries, such as Japan, have provided a template for some Fed actions. Essentially, quantitative easing provides a method for the central bank to provide funds at lower than zero interest rates, in order to increase the monetary supply and combat deflationary forces. This is accomplished by the Fed purchasing U.S. government debt with newly printed U.S. currency. In essence, the Fed is monetizing the debt. In the current (late 2007 to today) macro-economic environment, the slowing velocity of money has induced U.S. central bankers to pursue a variety of new, and to some radical, policies to produce economic stimulus.
A few of the uncertainties involved in monetary policy decision making are described by the federal reserve:
A lot of data is recorded and published by the Federal Reserve. A few websites where data is published are at the Board of Governors Economic Data and Research page, the Board of Governors statistical releases and historical data page, and at the St. Louis Fed's FRED (Federal Reserve Economic Data) page. The Federal Open Market Committee (FOMC) examines many economic indicators prior to determining monetary policy.
The net worth of households and nonprofit organizations in the United States is published by the Federal Reserve in a report titled, Flow of Funds. At the end of fiscal year 2008, this value was $51.5 trillion.
The most common measures are named M0 (narrowest), M1, M2, and M3. In the United States they are defined by the Federal Reserve as follows:
|M0||The total of all physical currency, plus accounts at the central bank that can be exchanged for physical currency.|
|M1||M0 + those portions of M0 held as reserves or vault cash + the amount in demand accounts ("checking" or "current" accounts).|
|M2||M1 + most savings accounts, money market accounts, and small denomination time deposits (certificates of deposit of under $100,000).|
|M3||M2 + all other CDs, deposits of eurodollars and repurchase agreements.|
The Federal Reserve ceased publishing M3 statistics in March 2006, explaining that it cost a lot to collect the data but did not provide significantly useful information. The other three money supply measures continue to be provided in detail.
The consumer price index is used as one measure of the value of money. It is defined as:
A measure of the average price level of a fixed basket of goods and services purchased by consumers as determined by the Bureau of Labor Statistics. Monthly changes in the CPI represent the rate of inflation. Core CPI excludes volatile components, i.e., food and energy prices.
The data consists of the US city average of consumer prices and can be found at The US Department of Labor—Bureau of Labor Statistics
The CPI taken alone is not a complete measure of the value of money. For example, the monetary value of stocks, real estate, and other goods and services categorized as investment vehicles are not reflected in the CPI. It is difficult to obtain a full picture of value across the full range of the cost of living, so the CPI is typically used as a substitute. The CPI therefore has powerful political ramifications, and Administrations of both parties have been tempted to change the basis for its calculation, progressively underestimating the true rate of decline in purchasing power. A controversial method used in calculating CPI is "hedonic adjustments". The basic concept applies a discount for the assumed increased utility of products (i.e. faster CPU processing speeds of computers). However, consumers rarely make decisions based upon the price per computer processing cycle. An argument can be made that such hedonic adjustments significantly contribute to understating true inflation experienced by consumers buying everyday goods and services.
One of the Fed's main roles is to maintain price stability. This means that the change in the consumer price index over time should be as small as possible. The ability to maintain a low inflation rate is a long-term measure of the Fed's success. Although the Fed usually tries to keep the year-on-year change in CPI between 2 and 3 percent, there has been debate among policy makers as to whether or not the Federal Reserve should have a specific inflation targeting policy.
There are two types of inflation that are closely tied to each other. Monetary inflation is an increase in the money supply. Price inflation is a sustained increase in the general level of prices, which is equivalent to a decline in the value or purchasing power of money. If the supply of money and credit increases too rapidly over many months (monetary inflation), the result will usually be price inflation. Price inflation does not always increase in direct proportion to monetary inflation; it is also affected by the velocity of money and other factors. With price inflation, a dollar buys less and less over time.
The effects of monetary and price inflation include:
The unemployment rate statistics are collected by the Bureau of Labor Statistics. Since one of the stated goals of monetary policy is maximum employment, the unemployment rate is a sign of the success of the Federal Reserve System.
Like the CPI, the unemployment rate is used as a barometer of the nation's economic health, and thus as a measure of the success of an administration's economic policies. Since 1980, both parties have made progressive changes in the basis for calculating unemployment, so that the numbers now quoted cannot be compared directly to the corresponding rates from earlier administrations, or to the rest of the world.
The Federal Reserve is self-funded. The vast majority (90%+) of Fed revenues come from open market operations, specifically the interest on the portfolio of Treasury securities as well as “capital gains/losses” that may arise from the buying/selling of the securities and their derivatives as part of Open Market Operations. The balance of revenues come from sales of financial services (check and electronic payment processing) and discount window loans. The Board of Governors (Federal Reserve Board) creates a budget report once per year for Congress. There are two reports with budget information. The one that lists the complete balance statements with income and expenses as well as the net profit or loss is the large report simply titled, Annual Report. It also includes data about employment throughout the system. The other report, which explains in more detail the expenses of the different aspects of the whole system, is called Annual Report: Budget Review. These are comprehensive reports with many details and can be found at the Board of Governors' website under the section Reports to Congress
One of the keys to understanding the Federal Reserve is the Federal Reserve balance sheet (or balance statement). In accordance with Section 11 of the Federal Reserve Act, the Board of Governors of the Federal Reserve System publishes once each week the "Consolidated Statement of Condition of All Federal Reserve Banks" showing the condition of each Federal Reserve bank and a consolidated statement for all Federal Reserve banks. The Board of Governors requires that excess earnings of the Reserve Banks be transferred to the Treasury as interest on Federal Reserve notes.
Below is the balance sheet as of April 22, 2009 (in millions of dollars):
Analyzing the Federal Reserve's balance sheet reveals a number of facts:
In addition, the balance sheet also indicates which assets are held as collateral against Federal Reserve Notes.
|Federal Reserve Notes and collateral|
|Federal Reserve notes outstanding||1,048,136|
|Less: Notes held by F.R. Banks||185,176|
|Federal Reserve notes to be collateralized||862,960|
|Collateral held against Federal Reserve notes||862,960|
|Gold certificate account||11,037|
|Special drawing rights certificate account||2,200|
|U.S. Treasury, agency debt, and mortgage-backed securities pledged||849,723|
|Other assets pledged||0|
The Federal Reserve System has faced criticism throughout its existence.
Transparency has been a primary concern of Federal Reserve critics. Deals with foreign central banks are not published in congressional reports, for instance, and many assets and liabilities of the Federal Reserve Banks are not published anywhere. Some accuse the Fed, along with other western central banks, of suppressing the gold price by covertly lending their massive gold holdings into the markets, without ever asking the indebted banks to pay them back (This supposedly props up confidence in the U.S. dollar). This has in turn led to accusations against U.S. Army and Marine officials for not keeping a close eye on the gold at Fort Knox.
Other criticism involves economic data compiled by the Fed. Some allege that values reported are misleading, exaggerated or altogether falsified to fulfill some type of political gain. The Fed sponsors much of the monetary economics research in the US, and Lawrence H. White objects that this makes it less likely for researchers to publish findings challenging the status quo.
Some allege that the Fed is unaccountable, while others allege that the Fed is not independent enough, following orders from the President of the United States, other powerful politicians, or well-established think tanks etc.
Adherents to the Austrian School of economic theory blame the current economic crisis on the Federal Reserve's policy, particularly the policy of the Fed under the leadership of Alan Greenspan, of credit expansion through historically low interest rates starting in 2001, which they claim enabled the United States housing bubble.
The Fed's discount window, for instance, through which it lends direct to banks, has barely been approached, despite the soaring spreads in the interbank market. The quarter-point cuts in its federal funds rate and discount rate on December 11 were followed by a steep sell-off in the stockmarket...The hope is that by extending the maturity of central-bank money, broadening the range of collateral against which banks can borrow and shifting from direct lending to an auction, the central bankers will bring down spreads in the one- and three-month money markets. There will be no net addition of liquidity. What the central bankers add at longer-term maturities, they will take out in the overnight market.
But there are risks. The first is that, for all the fanfare, the central banks' plan will make little difference. After all, it does nothing to remove the fundamental reason why investors are worried about lending to banks. This is the uncertainty about potential losses from subprime mortgages and the products based on them, and—given that uncertainty—the banks' own desire to hoard capital against the chance that they will have to strengthen their balance sheets.
The Federal Reserve System is the central banking system of the United States. Created in 1913, its unique organizational structure combines public regulation and oversight with private banking expertise.
Several plans and regulatory measures were discussed during the development of the Federal Reserve System. The following quotations do not necessarily refer to the final Federal Reserve Act passed by Congress.
From Lewis v. United States 680 F. 2d 1239 9th Circuit (1982), involving a man who was hit by a Federal Reserve Bank vehicle and attempted to sue the federal government.