THE FEDERAL RESERVE SYSTEM &PURPOSES FUNCTIONS • “TIME IS MONEY…” • Patrick Dede • Phirun Nop • Sayak Bhattacharya
The Federal Reserve System Structure of the system Monetary Policy and the Economy The Implementation of Monetary Policy The Federal Reserve in the International Sphere The Federal Reserve in the U.S. Payments System
THE FEDERAL RESERVE SYSTEM Federal Reserve System, the central bank of the United States, was founded by Congress in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system. As a central Bank, the FED is independent butsubject to oversight by the U.S. Congress.
Ben S. Bernanke Chairman Ben ShalomBernanke was sworn in on February 1, 2006, as Chairman and a member of the Board of Governors of the Federal Reserve System. Dr. Bernanke also serves as Chairman of the Federal Open Market Committee, the System's principal monetary policymaking body. He was appointed as a member of the Board to a full 14- year term, which expires January 31, 2020, and to a four-year term as Chairman, which expires January 31, 2010.
List of former president of the US FED • 10 août1914 - 9 août1916 : Charles S. Hamlin • 10 août1916 - 9 août1922 : William P. G. Harding • 1er mai1923 - 15 septembre1927 : Daniel R. Crissinger • 4 octobre1927 - 31 août1930 : Roy A. Young • 16 septembre1930 - 10 mai1933 : Eugene Meyer • 19 mai1933 - 15 août1934 : Eugene R. Black • 15 novembre1934 - 31 janvier1948 : Marriner S. Eccles¹ • 15 avril1948 - 31 mars1951 : Thomas B. McCabe • 2 avril1951 - 31 janvier1970 : William McChesney Martin Jr. • 1er février1970 - 31 janvier1978 : Arthur F. Burns • 8 mars1978 - 6 août1979 : G. William Miller • 6 août1979 - 11 août1987 : Paul Volcker • 11 août1987 - 31 janvier2006 : Alan Greenspan² • 31 janvier2006 - aujourd'hui : Ben Bernanke
Structure of the System • The Board of Governors of the Federal Reserve System (7 members + 12 Reserve Banks presidents) • The Federal Open Market Committee (7 member of the BoG + 5 Banks Presidents) • Federal Reserve Banks • Currency and Coin • Check Processing • Wire Transfers • Automated Clearinghouses • Board of Directors
Duties of the Federal Reserve Today, the Federal Reserve’s duties fall into four general areas: • conducting the nation’s monetary policy • supervising and regulating banking institutions • maintaining the stability of the financial system and containing systemic risk that may arise in financial markets • Providing financial services to depository institutions
MONETARY POLICY AND THE ECONOMY Goals of monetary policy are “to promote effectively the maximum employment, stable prices, and moderate long-term interest rates.” • Stable prices: Reduce the inflation • Full Employment: • Moderate the long term rate
CPI:+0.8% in Nov 2007 • Unemployment Rate:4.7% in Nov 2007 • Payroll Employment:+94,000(p) in Nov 2007 • Average Hourly Earnings:+$0.08(p) in Nov 2007 • PPI:+3.2%(p) in Nov 2007 • ECI:+0.8% in 3rd Qtr of 2007 • Productivity:+6.3% in 3rd Qtr of 2007 • U.S. Import Price Index:+2.7% in Nov 2007
How monetary policy affects the economy ? The FOMC sets the federal funds rate at a level it believes will foster financial and monetary conditions consistent with achieving its monetary policy objectives. “If the economy slows and employment softens, policy makers will be inclined to ease monetary policy to stimulate aggregate demand.” A change in the federal funds ratecan set off a chain of events that will affect : • short-term interest rates (T bills and Commercial papers), • longer-term interest rates (T notes, corporate bonds, fixed-rate mortgages ), • The foreign exchange value of the dollar, and stock prices.
The FED exercises this control by influencing the demand for and Supply of these balances through the following means: Open market operations Reserve requirements Contractual clearing balances Discount window lending The Instruments of the Monetary Policy
Limitations of Monetary Policy On the demand side, The US government influences the economy through changes in taxes and spending programs, which typically receive a lot of public attention and are therefore anticipated. On the supply side, The Subprime Crisis, disruptions in the oil market that reduce supply, agricultural losses, and slowdowns in productivity growth are examples of adverse supply shocks.
Guides to monetary policy Monetary Aggregates • M1: • Currency (and traveller’s checks) • Demand deposits • Similar interest-earning checking accounts • M2: • M1 • Savings deposits and money market deposit accounts • Small time deposits • Retail money market mutual fund balances • M3: • M2 • Large time deposits • Institutional money market mutual fund balances • Repurchase agreements • Eurodollars
Guides to monetary policy (2) Interest Rates have frequently been proposed as a guide to policy, not only because of the role they play in a wide variety of spending decisions but also because information on interest rates is available on a real-time basis.
Guides to monetary policy (2) The Taylor Rule:If inflation is picking up, the Taylor rule prescribes the amount by which the federal funds rate would need to be raised or, if output and employment are weakening, the amount by which it would need to be lowered. Foreign Exchange Rates: Exchange rate movements are an important channel through which monetary policy affects the economy, and exchange rates tend to respond promptly to a change in the federal funds rate.
3. The Implementation of Monetary Policy Federal Reserve Balances The Federal Reserve influences the economy through the market for balances that depository institutions maintain in their accounts at the Federal Reserve Banks. Demand for Supply of
Measures of aggregate balances Billions of dollars; annual averages of daily data
Consolidated Blanace Sheet of the Federal Reserve Banks December 31, 2004 (Millions of dollars)
Controlling the Federal Funds Rate Open Market Operation Required Reserve Balances Contractual Clearing Balances Discount Window Lending
Reserve Requirements • Depository institutions maintain a fraction of certain liabilities in reserve in specified assets. • The Fed can adjust reserve requirements by • Changing the required reserve ratios • The liabilities to which the ratios apply • Or both.
Open Market Operation Need to be able to Buy and sell quickly At its own convenience In whatever volume may be needed The U.S. Treasury Securities market is the broadest and most active of U.S. financial market.
Intended federal funds rate Change and level Change (basis points) DateIncreaseDecreaseLevel (percent) 2007December 11 ... 25 4.25 October 31 ... 25 4.50 September 18 … 50 4.75 2006June 29 25 ... 5.25 May 10 25 ... 5.00 March 28 25 ... 4.75 January 31 25 ... 4.50
Contractual clearing balance A contractual clearing balance is an amount that a depository institution agrees to hold at its Reserve Bank in addition to any required reserve balance. In return, the depository institution earns implicit interest, in the form of earnings credits, on the balance held to satisfy its contractual clearing balance.
Discount Window Lending • The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility--the discount window. • Three discount window programs offered: 1. Primary Credit 2. Secondary Credit 3. Seasonal Credit
Discount Rate http://www.frbdiscountwindow.org/historicalrates.cfm?hdrID=20&dtlID=52 Accessed 18/12/2007
The Federal Reserve in the International Sphere The U.S. economy and the world economy are linked in many ways. The U.S. dollar, which is the currency most used in international transactions, constitutes more than half of other countries’ official foreign exchange reserves. U.S. banks abroad and foreign banks in the United States are important actors in international financial markets. The activities of the Federal Reserve and the international economy influence each other.
International Linkages The Federal Reserve’s actions to adjust U.S. monetary policy are designed to attain basic objectives for the U.S. economy. But any policy move also influences, and is influenced by, international developments.
International Linkages US monetary policy actions influence exchange rates The dollar’s exchange value in terms of other currencies is therefore one of the channels through which U.S. monetary policy affects the U.S. economy.
International Linkages When interest rate increases, • The value of the dollar will rise. • The price in foreign currency of US goods traded on world market will rise • This will lower the dollar price of goods imported into the US
Foreign Currency Operations The Federal Reserve conducts foreign currency operations—the buying and selling of dollars in exchange for foreign currency—under the direction of the FOMC, acting in close and continuous consultation and cooperation with the U.S. Treasury, which has overall responsibility for U.S.
Foreign Currency Operations (2) • The purpose of Federal Reserve foreign currency operations is the changes in the international monetary system. • The most important of these changes was the transition in the 1970s from a system of fixed exchange rates to a system of flexible (or floating) exchange rates for the dollar in terms of other countries’ currencies.
Foreign Currency Operations (2) Sterilization • The process of a central bank or federal reserve insulating itself from the foreign exchange market to counteract the effects of a changing monetary base.
Foreign Currency Operations (3) Sterilization A purchase of foreign currency by the Federal Reserve increases the supply of balances when the Federal Reserve credits the account of the seller’s depository institution at the Federal Reserve. Conversely, a sale of foreign currency by the Federal Reserve decreases
International Banking Moreover, international banking institutions are important vehicles for capital f lows into and out of the United States. The international role of U.S. banks has a counterpart in foreign bank operations in the United States. U.S.
The Federal Reserve in the U.S. Payments System “By creating the Federal Reserve System, Congress intended to eliminate the severe financial crises that had periodically swept the nation, especially the sort of financial panic that occurred in 1907.”
Financial Services The U.S. payments system is the largest in the world The Federal Reserve therefore performs an important role as an intermediary in clearing and settling interbank payments. Settlement Process: • Debiting the accounts of the depository institution making the payment • Crediting the accounts of the depository institutions receiving the payment As the U.S. central bank, The FED is • Immune from liquidity problems—not having sufficient funds to complete payment transactions— • And credit problems that could disrupt its clearing and settlement activities.
Financial Services The Federal Reserve plays an important role when the Treasury needs to raise money to finance the government or to refinance maturing Treasury securities. • International Services As the central bank of the United States, The FED provide several types of services to these organizations, including maintaining non-interest-bearing deposit accounts (in U.S. dollars), securities safekeeping accounts, and accounts for safekeeping gold.
Federal Reserve Intraday Credit Policy Each day, the Reserve Banks process a large number of payment transactions resulting from the Banks’ role in providing payment services to depository institutions. The Reserve Banks extend intraday credit, to facilitate the settlement of payment transactions and to ensure the smooth functioning of the U.S. payments system The risk of providing this credit: The Federal Reserve has developed a policy that balances the goals of ensuring smooth functioning of the payments system and managing the Federal Reserve’s direct credit risk from institutions’ use of Federal Reserve intraday credit.
THE END THANK YOU!!!! Q&A Sources http://federalreserve.gov/ http://www.bis.org