FIN3244 Chapter 19 Organization of Central Banks 03 15 2012 I History Behind the Federal Reserve System First two creations attempts at the creation of a central bank were failures The need for a lender of last resort forced private lending institutions into the picture but economic disparity led to the questioning of its stability Gov t intervention became necessary Federal Reserve Act of 1913 created a central bank of the US called the federal reserve system o Provided checks and balances o Power distribution to Bankers to account for business interests States and regions The gov t and private sector 4 Groups in the Federal Reserve System o Federal reserve banks member banks the board of governors and the federal open market committee FOMC o II Federal Reserve Banks district banks The Fed Act of 1913 divided the US into 12 districts each with its own Federal Reserve Bank to conduct discount lending o These districts purposely contain a mix of urban rural manufacturing service business sectors to prevent one district from getting too much power Congress made members of the boards of each federal reserve bank represent the interests of business banks and the general public to prevent exploitation of power Duties of the 12 Federal Reserve Banks MMCSP o Manage check clearing in the payments system o Manage currency in circulation o Conduct discount lending o Supervise and regulate member banks o Provide information services to businesses The district banks engage in monetary policy directly through discount lending and indirectly through membership in the Fed s committees ex the FOMC o Basically they establish the discount rate and set the amount that each member bank can borrow III Member Banks Fed Reserve Act of 1913 required all nat l banks to become member banks State banks can choose Non member banks usually did not elect to join because the Fed required members to keep a part of their total funds in a reserve which was costly because that money couldn t earn interest o The Fed then argued that member banks were at a disadvantage because their funds couldn t earn interest and the lack of member banks limited the Feds power to influence monetary policy o This led to the requirement that all banks must match the reserve requirement of the Fed IV Board of Governors FOMC The 7 members of the Board of Governors appointed by the president of the US and confirmed by the Senate Restrictions are in place to ensure all regions are represented Activities The board administers monetary policy to influence the money supply They do this through open market operations reserve requirements and discount lending o The board holds 7 of the 12 seats on the FOMC This allows them to influence guidelines for open market operations FOMC o Set margin requirements amount of securities an investor must purchase in cash regulates bank holding companies and individual Fed Reserve banks and approves bank mergers o 12 member committee gives direction to the Fed s open market operations Consists of chairman of the board of governors and other members of the board the president of the district bank of NY and the presidents of the other district banks rotate in and out of the committee o They FOMC is the centerpiece of the Fed s policymaking The FOMC is crucial because its guidelines for open market operations give the Fed direction in influencing the monetary base V Authority within the Fed There are many checks and balances to prevent any one group from controlling the Fed These checks and balances led to a decentralization in its early years The economic downturn in the 1930 s called for a more centralized role for the Fed The banking acts of 1933 and 1935 gave the Fed the ability to set reserve requirements and the FOMC the ability to direct open market operations o Although power is divided among the Fed power is mainly vested in the chairman of the board and its members and the FOMC o Member banks own the shares in the Federal Reserve banks but have little control over their operations Strong distinction between ownership and control o Roles of the Board of Governors FOMC and Federal Reserve Banks in sum 7 member Board of governors o Key Role administer monetary policy by holding 7 12 seats on the FOMC Setting reserve and margin requirements Reviewing the discount rate set by the FRBs 12 Member FOMC o Key Role Direct the Fed s open market operations by Issuing policy directives to the Fed s trading desk 12 Federal Reserve Banks FRBs o Key Role Performing supervisory regulatory functions by Holding 5 12 seats on the FOMC Establishing the discount rate decide which banks can get loans Managing currency in circulation VI How the Fed Operates Ultimate purpose of the Fed is to manage the banking system and money supply However there is no constitutional mandate so it is subject to political pressure from legislators in Congress However the bank is still important in economic policymaking Dealing with external pressure o Fed s financial independence blocks some external pressure from congress the president etc o They are excluded from the annual appropriations process congress confirms or denies budget requests of federal agencies o President can exercise some control over the Fed because he appoints members of the board of governors o Congress can exercise some control because the Fed has no constitutional mandate so if their policies do not align somewhat with congress congress can amend their powers or revoke the Fed entirely Often conflicts between the Fed and the Treasury who represents the president of the US over economic policy Elected officials of the Fed lack the formal control over monetary policy that the treasury has so it often results in debates How the Fed uses its power over monetary policy o Public interest view the Fed acts in the interests of its constituency the general public Some evidence suggests the Fed does not always act this way o Principal agent view the Fed may have internal goals that might not align with the interest of the general public This view suggests that the Fed acts to increase its power and influence recall this happens when managers have little stake in the business Supporters of this view suggest the Fed may act to support the reelection of incumbents of other organizations unlikely to limit its power resulting in a political business cycle VII Fed independence Arguments for Fed independence o Monetary policy is too important and technical to be controlled by
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