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468-4 - Chapter 4 THE FED MONETARY POLICY AND INTEREST...

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Chapter 4 - THE FED, MONETARY POLICY AND INTEREST RATES Federal Reserve Act in 1913 created our central bank, the Federal Reserve Bank, to stabilize the monetary and financial system, in response to numerous banking crises and panics in the late 1800s and early 1900s. Fed is quasi-private, quasi-public, operates independently financially, and can make decisions on monetary policy without approval of President or Congress. However, they have to work together with the President and Congress to promote economic growth and stability. 1. Major functions of Fed: 1) Conduct monetary policy, 2) regulate and supervise commercial banks, 3) maintain stability of financial system [e.g., 9-11 (p. 95), Y2K, etc.], and 4) provide financial and payment services for the economy and banking system, both domestic and international. 2. Structure of the Fed. Decentralized system of 12 regions, each with its own district Fed bank, see map on p. 92. Early 20th century politics significantly influenced the structure of the Fed, including Missouri having two district banks. Functions of Fed banks: a. Assist Monetary Policy. 5 of the 12 Fed presidents serve on the FOMC, the primary decision- making committee of the Fed (NY Fed president + 4/11). Fed banks also make loans to eligible commercial banks at the Fed's discount window , at the discount rate. b. Supervision and Regulation of commercial banks: 1) bank examinations for soundness, 2) warnings for unsafe banking activities, and 3) review applications for expanded activities (e.g., investment banking activities). c. Government Services. Fed serves as commercial bank for federal government, Department of the Treasury, accepting deposits like federal unemployment taxes, federal income taxes withheld, estimated tax payments, etc. Fed banks and branches help to sell Treasury securities and pay interest and principal on these securities, as well as savings bonds and government-sponsored securities of Fannie Mae and Freddie Mac (CH 7). d. New Currency Issue. Fed banks replace currency as it gets worn out, and issue new currency to meet increased cash demand. e. Check Clearing, see p. 96. About 40% of interbank check-clearing (16B checks) is done through Fed (for a fee), facilitated by commercial banks having accounts with the Fed. The other 60% is done through private check-clearing services. f. Wire Transfer Services. Fed banks and commercial banks are linked electronically through the Federal Reserve Communications System, specifically the Fedwire and Automated Clearinghouse (ACH) systems, allowing instant transfer of funds among 6,000 banks, see p. 97. g. Research Services. Each Fed bank has a large staff of professional Ph.D. economists who conduct research on the banking and financial system, the regional economy, the national economy, BUS 468 / MGT 568: FINANCIAL MARKETS – CH 4 Professor Mark J. Perry 1
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international economics, monetary history, monetary economics, etc. Some of this research is used to help formulate and implement monetary policy.
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