The Federal Reserve

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					The Federal Reserve




          By
   A.V. Vedpuriswar



      Feb 10, 2008
                               Introduction
   The Federal Reserve ( The Fed) is the central bank of the US.
   It is widely considered to be the most influential central bank in the world.
   The Fed is quite independent.
   Unlike other central banks it is a network of 12 District Federal Reserve
    Banks.
   There are six / seven members of the Board of Governors of the Federal
    Reserve System who are nominated by the President and confirmed by the
    Senate.
    A full term is fourteen years. One term begins every two years, on February
    1 of even-numbered years. A member who serves a full term may not be
    reappointed.
   The president of the Federal Reserve Bank of New York serves
    continuously, while the presidents of the other reserve banks rotate in their
    service of one-year terms.
   Ben S. Bernanke is the current Chairman while Donald L. Kohn is the Vice
    Chairman
                 Monetary policy tools

   The Federal Reserve controls the three tools of monetary
    policy:
   Reserve requirements
   Open market operations
   The discount rate
                           FOMC
   The Federal Open Market Committee (FOMC) is the
    branch of the Federal Reserve Board that determines the
    direction of monetary policy.
   The FOMC consists of twelve members; the seven
    members of the Board of Governors of the Federal
    Reserve System; the president of the Federal Reserve
    Bank of New York; and four of the remaining eleven
    Reserve Bank presidents, who serve one-year terms on a
    rotating basis.
   The FOMC meets eight times per year to set key interest
    rates, such as the discount rate, and to decide whether to
    increase or decrease the money supply.
    The meetings of the committee, which are secret, are the
    subject of much speculation on Wall Street.
   Recent press releases illustrate how the FOMC takes
    FOMC Press Release Dated January 30,
                   2008
   The Federal Open Market Committee decided today to lower its
    target for the federal funds rate 50 basis points to 3 percent.
   Financial markets remain under considerable stress, and credit has
    tightened further for some businesses and households.
   Moreover, recent information indicates a deepening of the housing
    contraction as well as some softening in labor markets.
   The Committee expects inflation to moderate in coming quarters,
    but it will be necessary to continue to monitor inflation
    developments carefully.
   Today’s policy action, combined with those taken earlier, should
    help to promote moderate growth over time and to mitigate the
    risks to economic activity.
   However, downside risks to growth remain.
   The Committee will continue to assess the effects of financial and
    other developments on economic prospects and will act in a timely
    manner as needed to address those risks.
   Voting for the FOMC monetary policy action were: Ben S.
    Bernanke, Chairman; Timothy F. Geithner, Vice Chairman;
    Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin;
    Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and
    Kevin M. Warsh.
   Voting against was Richard W. Fisher, who preferred no
    change in the target for the federal funds rate at this
    meeting.
   In a related action, the Board of Governors unanimously
    approved a 50-basis-point decrease in the discount rate to
    3-1/2 percent.
    In taking this action, the Board approved the requests
    submitted by the Boards of Directors of the Federal
    Reserve Banks of Boston, New York, Philadelphia,
    Cleveland, Atlanta, Chicago, St. Louis, Kansas City, and
    San Francisco
Recent FOMC statements (Click for all
      Press Release

          statements)
      Release Date: January 30, 2008

      For immediate release

      The Federal Open Market Committee decided today to lower its target for the federal funds rate 50
      basis points to 3 percent.

      Financial markets remain under considerable stress, and credit has tightened further for some
      businesses and households. Moreover, recent information indicates a deepening of the housing
      contraction as well as some softening in labor markets.

      The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue
      to monitor inflation developments carefully.

      Today’s policy action, combined with those taken earlier, should help to promote moderate growth
      over time and to mitigate the risks to economic activity. However, downside risks to growth
      remain. The Committee will continue to assess the effects of financial and other developments on
      economic prospects and will act in a timely manner as needed to address those risks.

      Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner,
      Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I.
      Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred no
      change in the target for the federal funds rate at this meeting.

      In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the
      discount rate to 3-1/2 percent. In taking this action, the Board approved the requests submitted by the
      Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland,
      Atlanta, Chicago, St. Louis, Kansas City, and San Francisco.

      2008 Monetary Policy Releases
                        Federal Funds rate
   The interest rate at which a depository institution lends immediately
    available funds to another depository institution overnight.
   This is what news reports are referring to when they talk about the Fed
    changing interest rates.
   In fact, the FOMC sets a target for this rate, but not the actual rate itself
    (because it is determined by the open market).
   The short end of the yield curve moves up and down more than the long
    end.
   Monetary policy works with a lag.
   So anticipation is important.
   In 1998, the Fed lowered the rate from 5.5 to 4.75%.
   Between June 1999 and May 2000, the rate went up from 4.75 to 6.5%.
   During 2001 and 2002, the Fed brought down the rate from 6.5% to 1%.
   In the past 14 weeks, the Fed has cut rates by 225 basis points from
    5.25% to 3%.
                       Discount rate
   The discount rate is the rate that Federal Reserve Banks
    lend to member banks on a temporary basis.
   This helps the banks maintain the appropriate level of
    reserves.
   The central bank adjusts the supply of currency within
    national borders by adjusting the bank rate.
   When the central bank reduces the bank rate, it increases
    the attractiveness for commercial banks to borrow, thus
    increasing the money supply.
   When the central bank increases the bank rate, it decreases
    the attractiveness for commercial banks to borrow,
    consequently decreasing the money supply
    Each Federal Reserve Bank sets the discount rate for its
    own region subject to approval from the Federal Reserve
    Board in Washington.
                     Discount windows
   The Federal Reserve Banks offer three discount window
    programs to depository institutions:
    primary credit - loans are extended for a very short term
    (usually overnight) to depository institutions in generally
    sound financial condition. This is what is generally meant
    by the term discount rate
    secondary credit - Depository institutions that are not
    eligible for primary credit may apply for secondary credit to
    meet short-term liquidity needs or to resolve severe
    financial difficulties
    seasonal credit is extended to relatively small depository
    institutions that have recurring intra-year fluctuations in
    funding needs, such as banks in agricultural or seasonal
    resort communities
                     Reserve ratio

   Commercial Banks make money by lending out the money
    received from depositors.
   The Fed requires commercial banks to hold a certain
    amount of these deposits as reserves:
   Reserves are vault cash or deposits at the Federal
    Reserve
   Required Reserve Ratio (rr)
    Required Reserves = rr x Deposits
   Max increase in money supply = New money /Reserve
    ratio
             Open market operations


   The Fed adjusts money supply through buying and
    selling government securities.
   For example, to tighten the money supply, or
    decrease the amount of money available in the
    banking system, the Fed sells government securities.
   To loosen money supply, it may buy securities.
   A repo is a temporary measure.
   It involves the sale (now) and repurchase (later) of
    securities instead of an outright purchase.
              Board of Governors Model

   For every 100 basis points cut in Fed funds rate, GDP will
    change by
      0.6% at the end of 1 year
      1.7% at the end of two years
                    The Beige book
   Made public in 1983, the Summary of Commentary on
    Current Economic Conditions by Federal Reserve
    District, or Beige Book, rather than being filled with raw
    data, takes a more conversational approach.
   The book has 12 regional reports from each of the
    member Fed district banks, and one national
    summary..
   This is the first chance investors have to see how the
    Fed draws logical and intuitive conclusions from the raw
    data presented in other indicator releases.
   The Beige Book is published eight times per year, just
    before each of the FOMC meetings.
   The Beige Book aims to give to give a broad overview
    of the economy, bringing many variables and
    indicators into the mix.
   Discussion will be about things such as labor markets,
    wage and price pressures, retail and ecommerce
    activity and manufacturing output.
   Investors can see comments that are forward-looking
   The Beige Book will contain comments that look to
    predict trends and anticipate changes over the next
    few months or quarters.
   Investors and Fed watchers look to the Beige Book to
    gain insight into the next FOMC meeting.
   Is there language that shows fear about inflation?
    Do the reports suggest that the economy needs a
    financial boost to continue growing?
   To read the Beige Book effectively, one must become
    accustomed to "Fed speak“.
   Occasionally, the Beige Book will give evidence that
    may contradict what a previous indicator has
    presented; the Employment Report may suggest that
    there is slack in the labor market, while Beige Book
    reports may give anecdotal evidence that wage
    pressures are forming, or that certain specific labor
    markets are tight.
   The last thing the Fed wants to do with its words is corner
    itself into a pre-supposed policy decision prior to the next
    FOMC meeting.
    Investors won't ever see a definitive statement about the
    Fed going one way or the other with monetary policy , but
    there may be valuable clues in the Beige Book .
   The Fed directors and their staffs will try to obtain an
    economic pulse that can't be found in any other indicator's
    report.
   They will interview business leaders, bank presidents,
    members of other Fed boards and hundreds of other
    informal networks before writing the reports that will be
    compiled in the Beige Book.
                     M1, M2, M3
   M1: currency in circulation, demand, checkable
    deposits, non bank travellers’ checks.
   M2 : M1 + savings deposits, small denomination time
    deposits, retail money market mutual funds.
   M3 : M2 + institutional money funds, large
    denomination time deposits, repurchase agreements,
    Eurodollars.
   M3 is no longer used.
               Economic indicators

   The Fed looks at various indicators while setting
    policy.
   There is a complete economic calendar of events and
    data releases which are closely monitored by analysts
    and the Fed.
   See next slide.
The Economic Calendar ( Click for full year’s
               calendar)
US Economy: Various indicators (Click for
            full PDF file)