Federal Reserve System
Why do a report on the Federal Reserve System?
This is a question I went over in
my head while making a decision on the type
of report to do, and what I wanted
to learn more about and why. Over the past
few years I have realized the impact
that the Federal Government has on our
economy, yet I never knew enough about
the subject to understand why. While
taking this Economics course it has brought
so many things to my attention,
especially since I see inflation, gas prices,
and interest rates on the rise.
It has given me a better understanding of the
affect of the Government on the
economy, the stock market, the interest rates,
etc. Since the Federal
Government has such a control over our Economy, I decided
to tackle the
subject of the Federal Reserve System and try to get a better
understanding
of the history, the structure, and the monetary policy of the
power that it
holds.
The
Federal Reserve System is the
central banking authority of the United States. It
acts as a fiscal agent for
the United States government and is custodian of the
reserve accounts
commercial banks, makes loans to commercial banks, and is
authorized to issue
Federal Reserve notes that constitute the entire supply of
paper currency of
the country. Created by the Federal Reserve Act of 1913, the
12 Federal
Reserve banks, the Federal Open Market Committee, and the
Federal
Advisory Council, and since 1976, a Consumer Advisory Council
which includes
several thousand member banks. The board of Governors of the
Federal Reserve
System determines the reserve requirements of the member
banks within statutory
limits, reviews and determines the discount rates
established pursuant to the
Federal Reserve Act to serve the public
interest; it is governed by a board of
nine directors, six of whom are
elected by the member banks and three of whom
are appointed by the Board of
Governors of the Federal Reserve System. The
Federal Reserve banks are
located in Boston, New York, Philadelphia, Chicago,
San Francisco,
Cleveland, Ohio; Richmond, Virginia; Atlanta, Georgia; Saint
Louis, Mo.;
Minneapolis, Minnesota; Kansas City, Mo.; and Dallas Texas. The
Federal
Open Market Committee, consisting of the seven members of the Board
of
Governors and five members elected by the Federal Reserve banks, is
responsible
for the determination of Federal Reserve Bank policy in the
purchase and sale of
securities on the open market. The Federal Advisory
Council, whose role is
purely advisory, consists of 12 members if the meet
membership qualifications.
The Federal Reserve System exercises its
regulatory powers in several ways, the
most important of which may be
classified as instruments of direct or indirect
control. One form of direct
control can be exercised by adjusting the legal
reserve ratio (the proportion
of its deposits that a member bank must hold in
its reserve account), and as
a result, increasing or decreasing the amount of
new loans that the
commercial banks can make. Because loans give rise to new
deposits, the
possible money supply is, in this way, expanded or reduced. This
policy tool
has not been used too much in recent years. The money supply may
also be
influenced through manipulation of the discount rate, which is the rate
if
interest charged by the Federal Reserve banks on short-term secured loans
to
member banks. Since these loans are typically sought to maintain reserves
at
their required level, an increase in the cost of such loans has an
effect
similar to that of increasing the reserve requirement. The classic
method of
indirect control is through open-market operations, first widely
used in the
1920s and now used daily to make some adjustment to the
market. Federal Reserve
bank sales or purchases of securities on the open
market tend to reduce or
increase the size of commercial bank reserves. (When
the Federal Reserve sells
securities, the purchasers pay for them with checks
drawn on their deposits,
thereby reducing the reserves of the banks on which
the checks are drawn. The
three instruments of control explained above have
been conceded to be more
effective in preventing inflation in times of high
economic activity than in
bring about revival from a period of depression.
Another control occasionally
used by the Federal Reserve Board is that of
changing the margin requirements
involved in the purchase of securities. The
Federal Reserve System was founded
by Congress in 1913 to provide the nation
with a safer, more flexible and more
stable monetary and financial system.
Over the years its role in banking and the
economy has expanded. Today the
Federal Reserve’s Duties fall into four
general areas: · Conducting the
nation’s monetary policy by influencing the
money and credit conditions in
the economy in pursuit of full employment and
stable prices. · Supervising
and regulating banking institutions to ensure the
safety and soundness of the
nation’s banking and financial system to protect
the credit rights of
consumers. · Maintaining the stability of the financial
system and containing
systemic risk that may arise in financial markets. ·
Providing certain
financial services to the United States government, the
public, financial
institutions, and to foreign official institutions, including
playing a major
role in operating the nation’s payments
system.
Before Congress created the Federal
Reserve System, periodic financial panics
had plagued the nation. These
panics had contributed to many bank failures,
business bankruptcies, and
general economic downturns. A severe crisis in 1907
prompted Congress to
establish the National Monetary Commission, which put forth
proposals to
create an institution that would counter financial disruptions of
these
kinds. After much debate, Congress passed the Reserve Act, which was
signed
into law by President Woodrow Wilson, on December 23, 1913. The Act
stated
that its purpose was to provide for the establishment of Federal
reserve
banks, to furnish an elastic currency, to afford means of discounting
commercial
paper, to establish a more effective supervision of banking in the
United
States, and for other reasons. Soon after the creation of the
Federal Reserve,
it became clear that the act had broader implications for
national economic and
financial policy. As time has passed, further
legislation has clarified and
supplemented the original purposes. Key laws
affecting the Federal Reserve have
been the Banking Act of 1935, the
Employment Act of 1946, the 1970 amendments to
the Bank Holding Company Act;
the International Banking Act of 1978, the Full
Employment and Balanced
Growth Act of 1978, the Depository Institutions
Deregulation and Monetary
Control Act of 1980, the Financial Institutions
Reform, Recovery, and
Enforcement Act of 1989, and the Federal Deposit Insurance
Corporation
Act of 1991. Congress defines the primary objectives of national
economic
policy in two of these acts: the Employment Act of 1946 and the
Full
Employment and Balanced Growth Act of 1946. These objectives include
economic
growth in line with the economy’s potential to expand; a high level
of
employment; stable prices and moderate long-term interest rates. The
Federal
Reserve System is considered to be an independent central bank.
It is so,
however, only in the sense that its decisions do not have to be
ratified by the
President or anyone else in the executive branch of
government. The entire
System is subject to oversight by the United
States Congress because the
Constitution gives to Congress, the power to
coin money and its value-a power
that, in the 1913 act, Congress itself
delegated to the Federal Reserve. The
Federal Reserve must work within
the framework of the overall objectives of
economic and financial policy
established by the government, and thus the
description of the System as
"independent within the government" is
more
accurate.
The
Federal Reserve
System has a structure designed by Congress to give it a broad
perspective on
the economy and on economic activity in all parts of the nation.
It is a
federal system, composed basically of a central, governmental
agency-the
Board of Governors-in Washington D.C., and twelve regional
Federal Reserve
Banks, located in major cities throughout the nation.
These components share
responsibility for supervising and regulating certain
financial institutions and
activities; for providing banking services to
depository institutions and to the
federal government; and for ensuring that
consumers receive adequate information
and fair treatment in the business
with the banking system. A major component of
the System is the Federal Open
Market Committee (FOMC), which is made up of the
Board of Governors, the
president of the Federal Reserve Bank of New York, and
presidents of four
other Federal Reserve Banks, who serve on a rotating basis,
The FOMC
oversees open market operations, which is the main tool used by
the
Federal Reserve to influence money market conditions and the growth
of money and
credit. Two other groups play roles in the way the Federal
Reserve System works;
depository institutions, through which the tools of
monetary policy operate, and
advisory committees, which make recommendations
to the Board of Governors and to
the Reserve Bans regarding the System’s
responsibilities. The Board of
Governors The Board of Governors of the
Federal Reserve System was established
as a federal government agency. It is
made up of seven members appointed by the
President of the United States
and confirmed by the United States Senate. The
full term of a Board member is
fourteen years; the appointments are staggered so
that one term expires on
January 31 of each even-numbered year. After serving a
full term, A board
member may not be reappointed, If a member leaves the Board
before his or her
term expires, however, the person appointed and confirmed to
serve the
remainder of the term may later be reappointed to a full term.
The
Chairman and Vice Chairman of the board are also appointed by the
President and
confirmed by the Senate. The nominees to these posts must
already be members of
the Board or must be simultaneously appointed to the
Board. The terms for these
positions are four years. A Washington staff of
about 1,700 supports the Board
of Governors. The Board’s responsibilities
require thorough analysis of
domestic and international financial and
economic developments. The Board
carries out those responsibilities in
conjunction with other components of the
Federal Reserve System. It also
supervises and regulates the operations of the
Federal Reserve Banks and
their Branches and the activities of various banking
organizations, exercises
broad responsibility in the nation’s payments system,
and administers most of
the nation’s laws regarding consumer credit
protection. The Federal Reserve
System conducts monetary policy using three
major tools: · Open market
operations-the buying and selling of U.S. government
(mainly Treasury)
securities in the open market to influence the level of
reserves in the
depository system. · Reserve requirements-requirements
regarding the amount
of funds that commercial banks and other depository
institutions must hold in
reserve against deposits. · The discount rate-the
interest rate charged
commercial banks and other depository institutions when
they borrow reserves
from a regional Federal Reserve. Policy regarding open
market operations is
established by the FOMC. However, the Board of Governors
has sole authority
over changes in reserve requirements, and it must also
approve any change in
the discount rate initiated by a Federal Reserve Bank. The
Federal
Reserve also plays a major role in the supervision and regulation of
the
U.S. banking system. Banking supervision-the examination of
institutions for
safety and soundness and for compliance with law-is shared
with the Office of
the Comptroller of the Currency, which supervises national
banks and the Federal
Deposit Insurance Corporation, which supervises
state banks that are not members
of the Federal Reserve System. The Board’s
supervisory responsibilities extend
to the roughly 1,000 state bands that are
members of the Federal Reserve System,
all bank holding companies, the
foreign activities of member banks, the U.S.
activities of foreign banks, and
Edge Act and agreement corporations (the
institutions that engage in a
foreign banking business). Monetary Policy and
Effects of on the Economy
Using tools of monetary policy, the Federal Reserve
can affect the volume of
money and credit and their price-interest rates. In
this way it influences
employment, output, and the general level of prices. The
Federal Reserve
Act lays out the goals of monetary policy; the Federal Reserve
System and
The Federal Open Market Committee should seek "to promote
effectively the
goals of maximum employment, stable prices, and moderate
long-term interest
rates." Monetary policy works through the market for
reserves and involves
the federal funds rate. A change in the reserves market
will trigger a chain
of events that affect other short-term interest rates,
foreign exchange
rates, long-term interest rates, the amount of money and credit
in the
economy, and levels of employment, output and prices. For example, if
the
Federal Reserve reduces the supply of reserves, the resulting
increase in the
federal funds rate tends to spread quickly to other
short-term market interest
rates, such as those on Treasury Bills and
commercial paper. A change in
short-term rates will also translate into
changes in long-term rates on such
financial instruments as mortgages,
corporate bonds, treasury bonds, especially
if the change in short-term rates
is expected to persist. A rise in short-term
rates that is expected to
continue will lead to a rise in long-term rates.
Higher ling-term
interest rates will reduce the demand for items that are most
sensitive to
interest cost, such as housing, business investment, and durable
consumer
goods. Higher mortgage rates depress the demand for housing, Higher
corporate
bond rates increase the cost of borrowing for businesses and thus,
restrain
the demand for additions to plants and equipment; and tighter supplies
of
bank credit may constrain the demand for investment goods by those
firms
particularly dependent on bank loans. Higher interest rates also reduce
consumer
demand for such items as cars, and they also will effect the value
of household
assets-such as stocks, bonds, and land. The implications of
changes in interest
rates extend beyond domestic money and credit markets. If
the interest rates in
the U.S. move higher in relation to those abroad,
holding assets denominated in
U.S. dollars become more appealing, and the
demand for dollars in foreign
exchange markets increases. A result is upward
pressure on the exchange value of
the dollar. With flexible exchange rates
the dollars strengthens, the cost of
imported goods to Americans declines,
and the price of U.S. produced goods to
people abroad rises. As a
consequence, demands for U.S. goods are reduced as
Americans are induced
to substitute goods from abroad for those produced in the
United States
and people abroad are induced to buy fewer American goods. Such
changes in
the demand for goods and services get translated into changes in
total
production and prices. Closing Thoughts There are so many different views
on
the impact that the Federal Reserve has on the National and Global
Economy.
Many feel that the Fed generally lowers rates to stimulate
consumption and
lowering rates would prevent the U.S. from becoming part of a
global slump. A
rise in rates is typically matched by the prime rate set by
banks and by
short-term interest on Treasuries. Eventually, those higher
rates brake the
economy—and cool inflationary tendencies. There are these
that actually feel
that those who control this country’s money inherently
control this country.
They feel that ½ to 1% of the population rules the
other 99 to 99.5% of the
population. They say that rulership is achieved
through direct control of this
nation’s private economy, In addition, the
elite of U.S. society controls the
national communications media as well as
the executive branch of the federal
government by virtue of the Federal
Reserve. I feel that the latter is on the
radical side of thinking, and that
overall the Federal Reserve has the best
interest of the nation and
international economy in all their decisions
regarding the increases in
interest rates, etc. Since the onset of the Federal
Reserve we have not
gone into a depression, and over a course of time there will
be times when
our economy will peak and boom and the Fed will feel that it is
time to slow
the economy by raising the rates, as in the course of the last
six
months.
Bibliography
A Monetary History of the United
States, 1867-1960 By Milton Friedman and
Anna Jacobson Schwartz,
Princeton, 1963 last printing 1993 Managerial Economics,
Thomas
Hailstones and John Rothwell, Prentice Hall, 1985 Encyclopedia
Britannica
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