The Federal Reserve System (“The Fed”): a “bank of last resort”

 

History:

 

The notion of a central bank was condemned by Thomas Jefferson as a dangerous centralization of power.

 

First Bank of the United States was established in 1791 (but only a 20 year charter)

 

Second Bank of the United States was established in 1816 by President Madison (again, only a 20 year charter).  Andrew Jackson ran for the presidency on an anti-central bank platform (a threat to the republic because of its economic power.  Disowned by the federal government in 1836.

 

On December 23, 1913, The Federal Reserve System, which serves as the nation's central bank, was created by an act of Congress.

 

Twelve District Banks:

 

Federal Reserve Bank of San Francisco

New York

Boston

Dallas

St. Louis

Atlanta

Richmond

Philadelphia

Cleveland

Chicago

Kansas City

Minneapolis

 

Reserve Bank Branches:

 

Federal Reserve Bank of San Francisco:

   

        Seattle

        Portland

        Los Angeles

        Salt Lake City

 

Seven (7) Governors:

 

Appointed by the President

Confirmed by the Senate

14-year terms (no reappointment)

 

Chairman and Vice Chairman:

 

The President designates, and the Senate confirms, two members of the Board to be Chairman and Vice Chairman, for four-year terms.  Reappointments to chair and vice chair are permitted.

 

    Paul Volker replaced G. William Miller as chairman in 1979.

 

Alan Greenspan was appointed by President Reagan in 1987 and reappointed by George Bush, Bill Clinton, and George W. Bush.  (Currently in his 5th term)

 

http://www.federalreserve.gov/bios/greenspan.htm

http://www.federalreserve.gov/bios/ferguson.htm

http://www.federalreserve.gov/bios/bies.htm

 

 

Other Central Banks (examples)

 

Bank of Japan

Banco Espana

Deutsche Bundesbank

Bank of England

 

Salaries:

 

Chairman’s Salary (2001): $161,239

Governors’ Salary (2001): $145,115

FRB Presidents (2001): Annual salaries range from $205,000 to $303,000

 

 

 

 

Economic Goals:

 

•Full employment

•Stable Prices

•Economic Growth

•An “equitable” distribution of income

 

Monetary Policy:

 

Monetary Policy is the use of interest rates and the money supply to achieve some economic goal.

 

 

Tools of Monetary Policy:

 

•Open Market Operations

•Discount Interest Rate

•Reserve Requirement (ratio)

•Moral Suasion (“jawboning”)

 

Moral Suasion (“jawboning”)

 

Attempt by the fed to change behavior through speeches and other Federal Reserve statements.

 

Greenspan's `irrational exuberance' comment jawbones markets down

 

Web posted 12/6/96

By FARRELL KRAMER
The Associated Press

NEW YORK (AP) - Wall Street stocks opened with a thud this morning following a global plunge caused by Federal Reserve Chairman Alan Greenspan's suggestion that the markets were irrationally high.

 

Reserve Requirement (ratio):

 

The proportion of a deposit that must be maintained as reserves in the bank’s vault or on deposit with the bank’s federal reserve bank.  The reserve requirement, r, determines the money multiplier.

 

Discount Rate:

 

The interest rate charged by a federal reserve bank when lending money to a member bank.

 

Open Market Operations:

 

Operations are designed and overseen by the Federal Open Market Committee (FOMC).  The committee is composed of:

 

 

Board of Governors (7)

Five Federal Reserve Bank Presidents (always includes the NY Fed President)

 

Open market operations involve the purchase and sale of government securities by the Federal Reserve Bank of New York.  Purchases increase the money supply; Sales of securities reduces the money supply.

 

FOMC Purchases Securities----

 

 

•Increases bank reserves

•Banks expand loans

•Money supply increases

•Interest rates fall

 

FOMC Sells Securities ---

 

 

•Decreases bank reserves

•Banks contract loans

•Money supply decreases

•Interest rates rise

 

Fractional Reserve Banking:

 

A banking system where banks are required to maintain only a fraction of a deposit as required reserves.  The excess reserves may be transformed into loans.

 

Assuming a 10 percent reserve ratio (requirement), a bank must maintain only $100 as reserves on a $1000 deposit, either in its vault or on deposit with its Federal Reserve Bank.  So:

 

             $1000 deposit

    Less    $ 100 required reserves

    Equals  $ 900 excess reserves

 

Expansion / Contraction Formula:

 

General Formula for the change in bank deposits in response to a change in reserves is:

 

Let r = 1 / reserve requirement

 

Change in Bank Deposits = Change in Reserves x 1 / r

 

•= $1,000•(1 + .90 + .902 + .903 +...)

•= $1,000•(1/1-.90)

•= $1,000•(1/.10)

•= $1,000•10

•= $10,000

 

 

•= $100•(1 + .90 + .902 + .903 +...)

•= $100•10

•= $1,000

 

•= $900•(1 + .90 + .902 + .903 +...)

•= $900•10

•= $9,000