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The Federal Reserve System
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Tools of Monetary Policy

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“the Fed”
• originally a lender of last resort to prevent bank panics
• today, also conducts monetary policy

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Board of Governors
• 7 members, 14 yr. nonrenewable terms
• 1 member is Chair
-- Alan Greenspan (1987)

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Regional Banks
• 12 districts
• FRBNY is most important
• perform bank services

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FOMC
• 12 members
-- Board
-- FRBNY President
-- 4 other district presidents
(rotate)
• meet every 6 weeks to vote on monetary policy (FF rate target)
• FRBNY implements FOMC votes

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How?
• Fed is self-financing
• Fed governors serve long-terms
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Why?
• economic vs. political goals
• long-term vs. short-term goals

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Fed is NOT completely independent
• Fed powers can be limited by
Congress

• reserve requirement
• % deposits banks must hold as cash or Fed deposits
• changing this will affect MS but
• this is expensive to change, and is too powerful

• discount loans
• loans from the Fed to banks
• Fed can change interest rate or availability of loans but
• most banks do not use them
• not very effective in controlling MS

• open market operations
• main monetary policy tool
• Fed buys/sells Treasuries through private dealers
• in 1998 made $35 billion in profit
• FOMC votes on federal funds rate target
• FRBNY sells/buys to meet the target

• banks reserves increase,
FF rate decreases
• immediately
• other short-term rates fall, MS increases
• weeks - months
• economic expansion
• 1 year

FF rate target, 2000-2003
As FF rate falls, other ST rates also fall

• temporary changes in bank reserves
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Repo
• Fed buys Treasuries with seller repurchasing them later
• temporary increase in reserves

• reverse repo
• Fed sell Treasuries and agrees to repurchase
• temporary decrease in reserves

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Goals
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Recent history

• price stability/low inflation
• goal: below 3%
• 2003: 1.87% (CPI)
• low unemployment
• goal: natural rate (4%?)
• 12/03: 5.7%

• economic growth
• % increase in real GDP
• goal: 3%
• 4 th Q 2003: 4% annual rate
• financial market stability
• calm investors
• intervene if markets “too high” or
“too low”

• low inflation vs. economic growth
• or
• low inflation vs. financial market stability
• but in 1990s, enjoyed strong growth, low inflation

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Fed targets FF rate
• FOMC votes on FF rate target
• current target: 1%
(since 6/2003)

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Fed slow to recognize recession and cut FF rate
• ‘90-’92 falls from 8% to 3%
• mild recession, but mild/slow recovery

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FOMC announces FF rate target after meeting
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FF rate target raise 8 times (3-6%)
• prevent inflation
• surprise to financial markets
• “soft landing”
• currency intervention to increase
Yen/$

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Russian debt default
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Asian currency crisis
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Fed cuts FF rate
• bailout of LTCM to prevent financial panic

• increases in FF rate for another “soft landing”
• reversed in 2000 after economy slows
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3/91 - 3/01
• longest U.S. expansion

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FF rate target cut from 6.5% to 1%
2000-03
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Recession 2001 (March-Nov.)
• slow recovery, esp. job market
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FOMC has indicated that they will keep FF rate low for now
• not worried about inflation