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WIKI ANALYSIS| This article is part of WikiProject Definitions. Consider editing to improve it. View articles referencing this definition. |
The Federal Reserve is the third central bank of the USA. It was legally established on December 23, 1913, when US president Woodrow Wilson signed the Federal Reserve System Act. The Federal Reserve was blamed to have deepened the Great Depression after the crash of 1929. In a panicky reaction it then deflated money supply, causing a lasting and deep economic contraction.
In the inflationary period from 1973 - caused by the first oil shock - to 1981 chairman Paul Volcker managed to battle inflation successfully by raising the leading interest rate to more than 20%. At the same time Volcker succeeded in keeping the economy out of a drawn-out recession.
The policy style changed with the nomination of Alan Greenspan in 1987. Only 2 months into office Greenspan was confronted with the Black Monday of 1987, when the Dow Jones Industrials Average fell 22%, its biggest loss ever in a day. Remembering the fatal results of tight liqudity after the crash of 1929 Greenspan offered banks all the funds they needed in order to avoid a meltdown of the stock market. Alan Greenspan can also be credited with blowing up the biggest debt bubble of all times in the new millennium. By lowering the Fed Funds rate to a record low of 1% the Federal Reserve contributed heavily to the American housing boom that turned out to be a bubble based on easy credit. Greenspan conceded in 2008 to Congress that he erred on wrong side when the Federal Reserve thought that the financial industry should not be burdened with more oversight. At this time the USA had fallen in the biggest financial crisis ever.
Monetary Policy
The Federal Reserve follows a two-pronged policy. Its mandate says the Federal Reserve has to ensure economic growth while fighting inflation. It does so by providing or absorbing liquidity in its open market operations.
While the Fed's most important tool are its regular refinancing operations where it adjusts liquidity to prevent inflation, the current crisis has brought a host of new debt facilities which are used to intervene in both the market for mortgage backed securities and the commercial paper market.
After a rapid succession of rate cuts the Federal Reserve arrived at zero interest rate policy on December 16, 2008, when it cut the Fed Funds rate from 1% to a range between 0% and 0.25%, largely closing up to short maturities of Treasury debt which traded below the upper threshold the same day.
Goals of the Federal Reserve
The Federal Reserve (the Fed) is constantly monitoring the U.S. economy and conducting transactions in the open market, but what exactly is the Fed trying to accomplish? Why does the Fed change interest rates? Why does the Fed change banking reserve requirements? And perhaps most importantly, how does the Fed help each of us individually?
The Federal Reserve actually has the following six general goals that it is trying to meet—which were established by the U.S. Congress in the Employment Act of 1946 and the Full Employment and Balanced Growth Act of 1978. (Video Below)
Stability in the Financial System
One of the Fed's major concerns—especially as of late—is maintaining the stability of the financial system. After all, we have all grown accustomed to a stable, fluid financial system that allows us to save, invest and transfer money without having to worry about anything. A stable financial system allows potential homeowners to get mortgages, students to get loans, businesses to get financing, drivers to lease cars and consumers to use their credit cards. Without a stable financial system, the credit market grind to a halt and the economy stagnates.
Price Stability—Fighting Inflation
Inflation is the thief that robs us all of the purchasing power of our wages and our investments. We've all heard the stories about how gasoline used to be 10 cents per gallon, stamps cost a penny and you could buy a home for $15,000. Well, thanks to inflation, those prices are ancient history. When inflation rises, we get less bang for our buck. The Federal Reserve is actively monitoring prices so it can step in and fight inflation whenever it poses a threat.
Full Employment
The Federal Reserve wants to see full employment in the United States. Now, there is some debate as to what constitutes full employment, but it is generally agreed that a five percent unemployment rate, or less, constitutes full employment. The Fed recognizes that there will never be a time when there is no unemployment—due to people changing jobs and so on—but it does tailor its policies to try to accomodate an economic environment that makes it as easy as possible for anyone who is looking for work to find it.
Economic Growth
Life in the United States is best when the economy is growing. More people have jobs, American businesses are able to produce and sell more and the average quality of life for U.S. citizens tends to increase. Of course, when the economy is not growing, we see just the opposite. More people are unemployed, American businesses are not able to produce and sell as much and the average quality of life for U.S. citizens tends to decrease. Congress knows its constituants are happier when the economy is growing so it has given the Fed the task to ensure economic conditions are condusive to growth.
Interest Rate Stability
Business owners and consumers are both concerned with interest rate stability. Having an idea of where interest rates are going to be in the future has a dramatic impact on purchases today and planning for future purchases and financing.
The Fed—when focusing on interest rate stability—isn't necessarily concerned with whether interest rates are low or not. The Fed is more concerned with whether or not interest rates are stable. When interest rates are stable, it allows the government, businesses and individuals to effectively plan for the future, which enables the economy to thrive. Conversely, when interest rates are unstable, it becomes incredibly difficult for the government, businesses and individuals to plan for the future with any sort of assurity, which ultimately crimps economic growth.
Currency Stability
The U.S. dollar (USD) is the world's reserve currency and its value has a direct impact on the stability of the U.S. economy. When the U.S. dollar is strong, it enables U.S. consumers to import less expensive goods from other countries. When the U.S. dollar is weak, it allows U.S. manufacturers to export more goods to other economies.
The Fed isn't necessarily concerned with whether the U.S. dollar is strong or not. The Fed is more concerned with whether or not the value of the U.S. dollar is stable. When the value of the U.S. dollar is stable, it allows the government, businesses and individuals to effectively plan for the future, which enables the economy to thrive. Conversely, when the value of the U.S. dollar is volatile—bouncing back and forth and back and forth—it becomes incredibly difficult for the government, businesses and individuals to plan for the future with any sort of assurity, which ultimately crimps economic growth
The Federal Open Market Committee
The Federal Open Market Committee (FOMC) is the monetary policymaking body of the Federal Reserve System. It is responsible for formulation of a monetary policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments. The FOMC in its current form was created by the Banking Act of 1935.
The FOMC sets monetary policy by specifying the short-term objective for open market operations--purchases and sales of U.S. government and federal agency securities. Open market operations, the principal tool of monetary policy, affect the provision of reserves to depository institutions and, in turn, the cost and availability of money and credit in the U.S. economy. Currently, the objective is a target level for the federal funds rate (the rate that depository institutions charge on overnight sales of immediately available funds among themselves).
The FOMC also directs Federal Reserve operations in foreign currencies; such operations are coordinated with the U.S. Treasury, which has responsibility for formulating U.S. policies regarding the exchange value of the dollar.
The Federal Open Market Committee consists of twelve voting members: the seven members of the Board of Governors and five of the twelve Federal Reserve Bank presidents. The president of the Federal Reserve Bank of New York serves on a continuous basis; the presidents of the other Reserve Banks serve one-year terms on a rotating basis beginning on January 1 of each year. The rotating seats are filled from the following four groups of Banks, one Bank president from each group: Boston, Philadelphia, and Richmond; Cleveland and Chicago; Atlanta, St. Louis, and Dallas; and Minneapolis, Kansas City, and San Francisco.
All of the Reserve Bank presidents, even those who are not currently voting members, attend FOMC meetings, participate in the discussions, and contribute to the assessment of the economy and of policy options. The FOMC holds eight regularly scheduled meetings during the year, and other meetings as needed. At these meetings, the Committee reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth.
Transparency
The FOMC has changed its publicy policy substantially under the tenure of Alan Greenspan. The FOMC first announced the outcome of a meeting in February 1994. After making several further post-meeting statements in 1994, the Committee formally announced in February 1995 that all changes in the stance of monetary policy would be immediately communicated to the public. In January 2000, the Committee announced that it would issue a statement following each regularly scheduled meeting, regardless of whether there had been a change in monetary policy. In 2004 the FOMC cut the release time of the Minutes of the FOMC meeting from 6 to 3 weeks in order to give markets an even better idea about the thought process inside the Fed. The Federal Reserve chairmen usually appears twice a year on Capitol Hill to brief policymakers on the current situation of the economy and takes their questions. The Fed does not hold press conferences after its meetings as does its Eurozone counterpart, the ECB.
Short History Of FOMC Communications[1]
FOMC meetings were long held in relative secrecy. The Committee maintained extensive Minutes that were confidential and only published a sparse annual report called Records of Policy Actions until 1967. In a review of its policies in 1967 the FOMC decided to publish its minutes about 90 days after a FOMC meeting. At the same time the Federal Reserve introduced a new monthly bulletin covering financial and economic issues.
From June 1967 to March 1976, the Memorandum of Discussion served as the most detailed account of the discussion at each FOMC meeting. While Records of Policy Actions and Minutes of Actions were released during this period after 90 days, the more internally focused Memoranda of Discussion were made public with a lag of about five years.
It took until 1994 before the Fed started releasing a regular statement after its policiymaking meetings.
Complete transcripts of the FOMC meetings are made available at the Fed's website since 1967 with a delay of 5 years.
List of Fed Chairmen
- Charles S. Hamlin Aug. 10, 1914-Aug. 9, 1916
- W.P.G. Harding Aug. 10, 1916-Aug. 9, 1922
- Daniel R. Crissinger May 1, 1923-Sept. 15, 1927
- Roy A. Young Oct. 4, 1927-Aug. 31, 1930
- Eugene Meyer Sept. 16, 1930-May 10, 1933
- Eugene R. Black May 19, 1933-Aug. 15, 1934
- Marriner S. Eccles Nov. 15, 1934-Jan. 31, 1948
- Thomas B. McCabe Apr. 15, 1948-Mar. 31, 1951
- Wm. McC. Martin, Jr Apr. 2, 1951-Jan. 31, 1970
- Arthur F. Burns Feb. 1, 1970-Jan. 31, 1978
- G. William Miller Mar. 8, 1978-Aug. 6, 1979
- Paul A. Volcker Aug. 6, 1979-Aug. 11, 1987
- Alan Greenspan Aug. 11, 1987-Jan. 31, 2006
- Ben S. Bernanke Feb. 1, 2006-
The Chairman and the Vice Chairman of the Board are named by the President from among the members and are confirmed by the Senate. They serve a term of four years. A member's term on the Board is not affected by his or her status as Chairman or Vice Chairman.
Current Members of the Federal Reserve Board
- Donald L. Kohn (Vice Chairman)
- Elizabeth Duke
- Randall S. Kroszner
- Kevin Warsh
- Daniel K. Tarullo
Under the provisions of the original Federal Reserve Act, the Federal Reserve Board was composed of seven members, including five appointive members, the Secretary of the Treasury, who was ex-officio chairman of the Board, and the Comptroller of the Currency. The original term of office was ten years, and the five original appointive members had terms of two, four, six, eight, and ten years respectively. In 1922 the number of appointive members was increased to six, and in 1933 the term of office was increased to twelve years. The Board of Governors meets regularly, typically every other Monday. There are currently 2 empty seats at the board.
Current Members of the FOMC
- Ben S. Bernanke, Board of Governors, Chairman
- William C. Dudley, New York, Vice Chairman
- Elizabeth A. Duke, Board of Governors
- Charles L. Evans, Chicago
- Donald L. Kohn, Board of Governors
- Jeffrey M. Lacker, Richmond
- Dennis P. Lockhart, Atlanta
- Daniel K. Tarullo, Board of Governors
- Kevin M. Warsh, Board of Governors
- Janet L. Yellen, San Francisco
Alternate Members
- James B. Bullard, St. Louis
- Thomas M. Hoenig, Kansas City
- Sandra Pianalto, Cleveland
- Eric S. Rosengren, Boston
- Christine M. Cumming, First Vice President, New York
The Federal Reserve Banks
The 12 Federal Reserve Banks were established by Congress as the operating arms of the nation's central banking system. Many of the services provided to depository institutions and the federal government by this network of Reserve Banks are similar to services provided by commercial banks and thrift institutions to business customers and individuals.
Reserve Banks
- hold the cash reserves of depository institutions and make loans to them
- move currency and coin into and out of circulation, and collect and process millions of checks each day
- provide checking accounts for the Treasury, issue and redeem government securities, and act in other ways as fiscal agent for the U.S. government
- supervise and examine commercial banks that are members of the Federal Reserve System for safety and soundness
- participate in the activity that is the primary responsibility of the Federal Reserve System, the setting of monetary policy.
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