The Federal Reserve Anthony Capellupo Cristina Pellegrino What

The Federal Reserve Anthony Capellupo & Cristina Pellegrino

What is the Federal Reserve? • Central bank of the United States • Promotes Five General Functions • • • Monetary Policy Stability of the Financial System Regulating and Supervising Banks Payment and Settlement System Consumer Protection and Community Development

The Structure of the Federal Reserve • The President appoints the Board of Governors and they are confirmed by the Senate. • 7 board members • 14 -year terms • 12 District Banks • Bank president is appointed by the Bank’s board of directors • Consists of 3 bankers and 6 members from the community or other industries • Must be approved by the Board of Governors • Federal Open Market Committee • • Meeting of Board of Governors (7) and Bank Presidents (12) Board chair also serves as FOMC chair Occurs 8 times throughout the year Voting: Board of Governors (7) + New York President (1) + Rotating Bank Presidents (4)

Biggest Problem with the Federal Reserve We can’t vote out individuals

Monetary Policy • Goals of Monetary Policy • Stable Prices • Employment • Moderate Long-Term Interest Rates • Tools of Monetary Policy • • • Open Market Operations Reserve Requirement Discount Rate Interest on Reserve Balances Forward Guidance

Transition Mechanism Federal Funds Rate Yield Curve Credit Market Aggregate Demand/ Aggregate Supply GDP/ Unemployment Inflation

Open Market Operations • Setting the target Federal Funds Rate, the rate banks charge each other for lending money • The Fed will buy or sell bonds from individual investors or institutions through primary dealers • Primary tool of monetary policy • Buying Bonds= Boosting Economy • The Fed pays for a bond with a deposit-> increases cash for banks-> increases reserves-> increases money supply • Selling Bonds= Slowing Economy • The Fed sells bonds in exchange for cash-> decreases cash for banks -> decreases reserves -> decreases money supply

Types of Open Market Operations • Defensive Open Market • The Federal Reserve is trying to keep the economy where it is • Dynamic Open Market • The Federal Reserve is trying to move the market in a certain direction

Reserve Requirement • Board of Governors sets a percentage of deposits that banks must keep in reserve • A lower reserve requirement increases ability to make more loans -> lower interest rates because there is more money to loan • Reserve requirements have been 10%

Discount Rate • Federal Reserves as the lender of last resort for banks • When the Federal Reserve makes a loan to a bank to increase its reserve, the interest rate on the loan is called the discount rate. • Lower rate -> increased money supply • Higher rate -> decreased money supply • Generally, there is a negative connotation surrounding banks that must use the Federal Reserve to meet reserve requirements. • This rate is usually higher than the Federal Funds Rate

Interest on Reserve Balances • In 2006, a law was passed allowing the Federal Reserve to pay interests on reserve accounts • If this rate is low compared to other options, banks will look to instead use reserves to make loans to earn a higher interest rate • If this rate is high compared to other options, banks will choose this rate because it is less risky

Forward Guidance • Communicate monetary policy goals, tools, and profess through different types of media to the public. • This is beneficial because it gives direction, but it is bad if the Fed does not follow through with their guidance • Expectations are usually priced into the market