Download Federal Reserve Banks

Chapter Four
Modified
The Federal Reserve
System, Monetary Policy,
and Interest Rates
McGraw-Hill /Irwin
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Major Duties and Responsibilities
of the Federal Reserve System
• The Federal Reserve is an independent central
bank charged with:
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Conducting monetary policy
Supervising and regulating depository institutions
Maintaining the stability of the financial system
Providing payment and other financial services to
the U.S. government, the public, FIs and foreign
official institutions
McGraw-Hill /Irwin
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Structure of the Federal Reserve
System
• 12 FR Banks plus 10 branches located in
major U.S. cities
• A 7-member Board of Governors in
Washington, DC
• The Federal Open Market Committee
(FOMC)
McGraw-Hill /Irwin
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Structure of the Federal Reserve System
McGraw-Hill /Irwin
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Locations of FR Banks and Branches
• Banks located in Atlanta, Boston, Chicago,
Cleveland, Dallas, Kansas City, Minneapolis, New
York, Philadelphia, Richmond, San Francisco and
St. Louis
• Branches located in Baltimore, Birmingham,
Buffalo, Charlotte, Cincinnati, Denver, Detroit, El
Paso, Helena, Houston, Jacksonville, Little Rock,
Los Angeles, Louisville, Memphis, Miami,
Nashville, Oklahoma City, Omaha, Pittsburgh,
Portland Salt Lake City, San Antonio, Seattle
McGraw-Hill /Irwin
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Functions Performed by the Federal
Reserve Banks
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Assistance in the Conduct of Monetary Policy
Supervision and Regulation
Government Services
New Currency Issue
Check Clearing
Wire Transfer Services
Research Services
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Federal Reserve Banks
• Supervision and Regulation
– Each Federal Reserve Bank has supervisory and
regulatory authority over the activities of state
chartered member banks and bank holding
companies in their districts
– Activities include examinations, warnings,
approval of expanded activities (M&A) etc.
McGraw-Hill /Irwin
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Federal Reserve Banks
• Government Services
– The Federal Reserve serves as the commercial
bank for the U.S. Treasury
– Services include payment of unemployment
benefits, income taxes withheld, U.S. savings
bonds, issuance of Treasury securities,
payments, etc.
McGraw-Hill /Irwin
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Federal Reserve Banks
• New Currency Issue
– Federal Reserve Banks are responsible for the
collection and replacement of currency (paper
and coin) from circulation
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Federal Reserve Banks
• Check Clearing
– The Federal Reserve operates a central checkclearing system for U.S. banks, routing
interbank checks to the appropriate parties.
McGraw-Hill /Irwin
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Federal Reserve Banks
• Wire Transfer Services (2 systems)
– Fedwire- allows depository institutions to
transfer funds on their own behalf or for
customers.
– Automated Clearinghouse- for processing
credit and debit transfer of funds.
McGraw-Hill /Irwin
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Federal Reserve Banks
• Research Services
– Each Federal Reserve Bank has a staff of
professional economists who gather, analyze,
and interpret economic data and developments
in the banking sector in their district and
economy wide.
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Board of Governors
• Headquartered in Washington, DC
• Each of 7 members appointed by the president of the
United States and confirmed by the Senate
• Board members serve nonrenewable 14-year terms
• President designates two members to chairman and vicechairman for four year terms
• Primary responsibilities are the formulation and conduct
of monetary policy and the supervision and regulation of
banks
• Chairman advises President on economic policy and
serves as spokesperson for the FR system
McGraw-Hill /Irwin
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Federal Open Market Committee
(FOMC)
• The major monetary policy-making body of the FR
System
• Main responsibilities are to formulate policies to
promote full employment, economic growth, price
stability, and a sustainable pattern of international
trade
• Open market operations--the purchase and sale of
U.S. government and federal agency securities
• Sets ranges for growth of monetary aggregates and
directs the FR in foreign exchange markets
McGraw-Hill /Irwin
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Objective of Monetary Policy
• To influence the amount of reserve in the
banking system…
• which affects interest rates and availability of
credit and…
• ultimately affects the levels of employment,
output, prices and inflation
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Monetary Policy Tools
• Open Market Operations
– primary determinate of changes in excess reserves in
the banking system impacting the size of the money
supply and/or interest rates
• The Discount Rate
– the rate of interest FR Banks charge on emergency
loans to depository institutions
• Reserve Requirements
– determine the minimum amount of reserve assets that
depository institutions must maintain by law to back
transaction deposits held as liabilities
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Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Open Market Operations
• The Fed constantly buys and sells U.S. government
securities in the financial markets, which in turn
influences the level of reserves in the banking
system. These decisions also affect the volume and
the price of credit (interest rates). The term "open
market" means that the Fed doesn't independently
decide which securities dealers it will do business
with on a particular day. Rather, the choice emerges
from an open market where the various primary
securities dealers compete. Open market operations
are the most frequently employed tool of monetary
policy.
– Source: Investopedia - http://www.investopedia.com/university/thefed/fed3.asp
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Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
The Discount Rate
• Rate of interest charged by Fed Reserve Banks on
“lender of last resort” loans to depository institutions.
Changing the rate signals to the market that the Federal
Reserve would like to see higher or lower rates in the
economy.
– Adjustment credit- discount window loan offered for shortterm liquidity problems from a temporary deposit outflow.
– Seasonal credit- offered to banks for seasonal liquidity
squeezes.
– Extended credit- offered to more severely liquidity
constrained banks at a rate above seasonal credit.
McGraw-Hill /Irwin
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Reserve Requirements
Currently 10% of transaction deposits are required to be
held as vault cash or bank deposits at Federal Reserve
Banks.
By lowering (raising) reserve requirements the Fed
increases (decreases) the money supply with a
multiplier effect.
The multiplier effect:
• = 1/new reserve requirement X the amount of excess reserves
McGraw-Hill /Irwin
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Impact of Monetary Policy
on Various Economic Variables
Expansionary
Activities
Contractionary
Activities
Impact on
Reserve Requirements
Credit availability
Money supply
Interest rates
Security prices
McGraw-Hill /Irwin
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.