The Federal Reserve and
Monetary Policy
Structure of the Federal Reserve
1. Board of Governors
– Located in Washington, DC
– 7 members appointed by the president &
approved by the Senate
– 14 year terms
– Chair must be reappointed every 4 years (and
most often is)
Copy and answer:
Why are members of the Board of Directors
appointed for such long terms?
(HINT: Think about Supreme Court Justices!)
Structure of the Federal Reserve
2. Twelve Federal Reserve Banks
– Each serves a different region (Federal Reserve
district)
– Serve the supervisory role for that district
– Each has its own board of directors chosen from
bankers and businesspeople in that region
– NY Federal Reserve Bank carries out the Fed’s
open-market operations
Copy and answer:
Decisions about monetary policy are made by the
Federal Open Market Committee, which consists of:
• the Board of Governors
• the New York Fed president
• Four other regional bank presidents (rotating)
Why don’t other members of the government serve
on this committee?
(HINT: Consider the reasons for the “pseudogovernmental nature of the Fed!)
Functions of the Federal Reserve
1. Provide Financial Services
– “Banker’s bank” that holds reserves, clears
checks, provides cash, and transfers funds for
commercial banks
– Also acts as banker and fiscal agent for the U.S.
government and other large institutions; in fact,
the U.S. Treasury’s checking account is with the
Fed!
Functions of the Federal Reserve
2. Supervise & Regulate the Banking System
– The regional Federal Reserve banks examine and
regulate commercial banks in their district,
ensuring their compliance with laws – including
those regarding reserve requirements
– The Board of Governors provides overall
supervision of the system
Functions of the Federal Reserve
3. Maintain Stability of the Financial System
– The Fed is charged with maintaining a safe and
stable monetary and financial system
– As part of this function, the Fed provides liquidity
to financial institutions through loans (discount
window) that ensure soundness
Functions of the Federal Reserve
4. Conduct Monetary Policy
– Utilizes reserve requirements, discount rate, and
open-market operations to control the monetary
base (and therefore, the money supply and
interest rates)
– The most popular tool of monetary policy is openmarket operations
Tools of Monetary Policy
1. Reserve Requirements
– Banks that fail to maintain reserve requirements
on average for a two-week period face penalties
– Banks borrow from other banks with excess
reserves at the federal funds rate, which is
determined by supply and demand in the fed
funds market
– Fed hasn’t made significant change to the
reserve requirement since 1992
Copy and answer:
How would changes to the reserve requirement
tighten or loosen the money supply?
Tools of Monetary Policy
2. Discount Rate
– Banks can borrow from the Fed via the discount
window
– The discount rate is the rate the Fed charges, and
it is normally set 1% above the fed funds rate to
discourage use of Fed funds (and encourage
interbank lows)
Copy and answer:
How would changes to the discount rate (i.e.,
reducing the gap between the fed funds rate and
discount rate to just .25% as the Fed did in 2008)
tighten or loosen the money supply?
Tools of Monetary Policy
3. Open-Market Operations
–
The Fed has assets and liabilities
Assets
Liabilities
Government debt
Monetary base
(Treasury bills – short term
govt bonds of less than 1 yr.)
(Currency in circulation +
bank reserves)
– Fed buys or sells Treasury bills, usually through
commercial banks
– Credits the commercial banks’ Fed reserve account with
the value of T-bills it purchased (in purchases) or debits
the banks’ account (in sales)
Copy and answer:
How would open-market operations tighten or
loosen the money supply?
Fed Policy Actions
• All Fed policy actions impact the monetary
base, but have impacts on the money supply
and interest rates
• All Fed policy actions are aimed at obtaining a
target interest rate
• For open-market transactions, money credited
to banks’ reserve accounts is simply “created”
– increasing the monetary base
Copy and answer:
Why is it important to factor in the money
multiplier when we consider the impact of Fed
policy actions? Does it apply to the use of all
three tools?