Chapter 04 Hout.docx - 1 Chapter 4 The Federal Reserve...

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1 Chapter 4 The Federal Reserve System, Monetary Policy and Interest Rates The Federal Reserve Founded by Congress under the Federal Reserve Act in 1913 in response to a series of U.S. financial panics which culminated in a particularly severe panic in 1907. Subject to oversight by Congress under its authority to coin money An independent central bank – its decisions do not have to be ratified by the President. The Fed was created to serve as a lender of last resort, as a bank regulator and as a monitor of the money supply. Current objectives of the Fed include stimulating sustainable non-inflationary economic growth while keeping employment high . Functions of the Federal Reserve Conduct monetary policy Supervise and regulate depository institutions Maintain financial system stability Provide payment and other financial services to the U.S. government, the public, FIs, and foreign official institutions. The Fed also assists in facilitating the nation’s payment systems. o The Fed operates the Fed Wire which facilitates trading of bank reserves and an Automated Clearing House (ACH), which is a similar payments mechanism for debit and credit transactions.. 1 The Fed is largely independent of Congress and the President, at least in the short run. 1The Clearing House Interbank Payments System (CHIPS) provides yet another payment mechanism. CHIPS is a private sector electronic network operated by about 100 U.S. and foreign banks to facilitate correspondent services and international transactions.
2 Structure of the Federal Reserve Divided into 12 Federal Reserve districts, each with a main Federal Reserve Bank. Each FRB has a nine member Board of Directors consisting as follows: o Six are elected by member banks in the district, of these six, three are non-bank business people. o Three are appointed by the Board of Governors of the Federal Reserve System. Federal Reserve Banks operate under the general supervision of the Board of Governors of the Federal Reserve. FRBs are nonprofit organizations, but they are owned by the member banks in their district. o Part of the independence of the Fed arises because the Fed generates positive net income from interest and fees so it is not directly dependent on Congressional funding. o The Fed now pays interest on bank reserves and this reduces the profitability of the Fed. o The Fed argues that paying interest minimizes reserve volatility. FRS member banks “own” the 12 Federal Reserve Banks The Federal Reserve Bank of New York (FRBNY) is generally considered the most important of the Federal Reserve Banks because so many of the largest U.S. and international banks are located in the New York district.

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