Study Guide FIN3244 Test 2 Chapter 19 Organization of Central Banks Creation of the System o Federal Reserve Act of 1913 created a central bank for the U S Federal Reserve System The act created four groups within the system each with separate duties The responsibilities given to each were meant to give the central bank control over the amount of currency outstanding and the volume of discount loans to member banks Federal Reserve banks o U S was divided into 12 Federal Reserve districts each with a Federal Reserve bank in one city to conduct discount lending o Most districts contain a mixture of urban and rural areas to prevent any one interest group or one state from obtaining preferential treatment o Private commercial banks in each district that are members of the FRS own the district banks o Board of directors appointed to the reserve banks which represent banks businesses and the general public o Duties of the reserve banks include perform supervisory and regulatory functions such as examining state member banks and evaluating merger applications o FR district banks engage in monetary policy both directly and o All national banks were required to become member banks of the FRS state banks may elect to become members but only one in 7 currently are o The Fed keeps reserve requirements which compel banks to keep part of their deposits as idle funds effectively imposing a tax on bank intermediation This was thought to give Federally indirectly Member banks controlled banks a disadvantage so now all banks must maintain reserve deposits o Today around 3000 banks are FRS members Board of Governors o Board has seven members which are appointed by the president of the U S and confirmed by the Senate o Governors serve a nonrenewable term of 14 years staggered terms so that one expires every other year No geographical overrepresentation o Many board members are professional economists Chairmen of the Board in history have come from many different backgrounds o Chairman serves a four year term and may be reappointed or serve out the balance of a 14 year member s term o Duties of board Administer monetary policy to influence nation s money supply through open market operations reserve requirements and discount lending Effectively sets the discount rate through its review and determination procedure o The board holds seven of the 12 seats on the FOMC influences the setting of guidelines for open market operations Also informally influences national and international economic policy decisions o Board sets margin requirements proportion of the purchase price of securities that an investor must pay in cash rather than buying on credit o Finally reviews budgets and sets salaries of presidents and officers of Federal Reserve Banks Federal Open Market Committee FOMC o Made up of 12 members gives directions to the Fed s open market operations o Members include chairman of Board of Governors other Fed governors president of the Federal Reserve Bank of new York and presidents of four of the other 11 Federal Reserve Banks o FOMC is the centerpiece of Fed policymaking o FOMC members receive a national economic forecast for the next two years in the green book beige and blue books are available to public with projections for monetary aggregates Power and Authority Within the Fed o The Banking Act of 1935 centralized the Fed s participation in the money supply process Gave Board of Governors a majority of seats on the FOMC and thereby great influence in implementing monetary policy o Many Fed watchers believe that the informal power structure within the Fed may be more concentrated and influential than the formal power structure o Member banks own shares of stock in the Federal Reserve banks and receive at most a 6 annual dividend Member banks have virtually no control over how their stakes in the system are used o Member banks elect three bankers Class A directors and three leaders in industry commerce and agriculture Class B directors Fed s Board of Governors appoints three public interest directors Class C directors Member banks have little actual influence within the system although they are the nominal owners of the Federal Reserve banks Handling External Pressure o The Federal Reserve was created to operate independently of external pressures o Its financial independence allows it to combat external pressure the Fed is exempt from the annual appropriations process during which Congress scrutinizes budgetary requests authorizes funds and then appropriates the funds o The Fed is not completely insulated from external pressure the president can exercise control over the Board of Governors members The president can also appoint a new Chairman of the Board every four years o The Fed is still a creation of Congress Congress can amend the Fed s charter and powers or even abolish it members of Congress remind members of the Fed of this so they do not abuse their power The Public Interest View o Public interest view holds that the Fed acts in the interest of its primary constituency the general public and that it seeks to achieve economic goals that are in the public interest Examples price and employment stability and economic growth The principal agent View o Public organizations face the agency problem just as private corporations do o Agency problem refers to when managers agents have little stake in their business and their incentives to maximize the value of shareholders principals claims may be weak o Principle agent view predicts that the Fed acts to increase its power influence and prestige as an organization subject to constrains placed on it by principals such as the president and Congress o The Fed is one of the most successful bureaucratic organizations in mobilizing constituents in its own defense and fights to maintain its autonomy over Congress o Political business cycle Fed tries to lower interest rates to stimulate credit demand and economic activity before an election to make the Fed look good after election the Fed would reverse this Fed Independence o The political issue of Fed independence arises typically because of the public s negative reaction to Fed policy Example legislation in 1982 by Congress to decrease the Fed s autonomy stemmed from public reaction to high interest rates Arguments for independence o Main argument for Fed independence is that monetary policy is too important and technical to be determined by politicians Monetary policy affects inflation interest rates
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