The Federal Reserve

Group Members:

Brian “Joe” Biddle

Ryan Gusstason

Scott

Trevor Bristow

History of the Fed:

The Federal Reserve Bank serves as the United States of America’s central bank. From the beginning of the nation, the need for management of the country’s money supply, assistance in the fiscal operations of the federal government and stabilization of the nation’s credit was recognized.

Laws that created the Fed:

As an attempt to achieve these need and others, several attempts at creating centralized banking have been tried and all have failed save for the Federal Reserve System. Some of these failed attempts at creating structured central banking were the First and Second Banks of the United States, the Independent Treasury, the National Banking System, clearinghouse associations, and the National Reserve Association. These previous systems failed for many different reasons, lack of support, lack of financing, poor organization and economic events were at the root cause of their demise. It wasn’t until December 1913, with Woodrow Wilson’s signing of the Federal Reserve act, that the FRS became the official central bank of the United States of America.

Immediate problems with the Fed:

Almost immediately after the formation of the Federal Reserve System, its strength and design was being tested. The Fed’s first test was financing the war effort in Europe. This financial demand was a strong test of the FED’s ability to aid the federal government in fiscal issues. Another early problem addressed by the FRS was the need for monitoring the money supply. The FED accomplished this with OMOs, or Open Market Operations. Starting in the 1920s, the Fed used OMOs to be able to buy and sell government issued bonds on the open market. This buying and selling of bonds altered the interest rates and the supply of money in the nation’s economy, allowing the FED to put the economy in a favorable state. The greatest of the early issues for the Federal Reserve System was jump starting the economy after the Great Depression. This act took the Fed over a decade to return the economy back from its crippled state. Despite all of the above early challenges and others later in U.S. history, the nation still functions under the Federal Reserve System almost one hundred years later.

The structure of the Fed:

The structure of the FRS is a pyramid styled organization. The top of this organization is the chairman. The chairman serves as head of the Board of Governors. This board is made up of seven President approved and Congress confirmed governors. Within the Board of Governors lies the Federal Open Market Committee (FOMC). The responsibilities of the FOMC include the controlling and making of monetary policy decisions for the United States.

Below the Board of Governors are the Federal Reserve Banks. There are twelve of these banks and they represent various regions of the U.S. Federal Reserve Banks are often referred to as the “banker’s banks” due to their serving as the bankers for commercial banks. The Federal Reserve Banks serve as the nation’s actual bank, making payments, storing coin etc. whereas the Board of Governors make policies and economic decisions.

Under the Federal Reserve Banks, lie the commercial banks then the public. These commercial banks or member banks are the equivalent of the stockholders for the Reserve Banks. The public supply their money to the commercial banks that makes them indirectly a part of the Federal Reserve System.

Fed as an entity:

The question arises on whether or not the Federal Reserve System is public or private? In reality it’s neither but has elements of both. The president appointing top officials and the FED giving profits to the U.S. Treasury give the FRS public elements. Being made up of thousands of private banks would make one believe the FED is a private entity. Self funding and the lack of outside control of policy making decisions leads to the thinking that the FRS is an independent entity.

Fed reports:

On the other end, the FRS is dependent because is required to make annual reports to Congress and is subject to annual audits to ensure financial accountability. The Federal Reserve System is self described as “independent within the government.” Fed objectives and functions:
The main stated objective of the FRS is to conduct the nation’s monetary policy. Other objectives of the FRS include supervising and regulating banking institutions, maintaining a stable financial system, and lastly to provide financial services to the government, public, and foreign institutions.
To achieve these objectives, the FRS controls inflation without triggering a recession. The implicit function the FRS takes to control inflation occurs by managing credit. This function is the single largest component of the money supply in America. The FRS can restrict credit by raising interest rates and making credit more expensive. When this occurs, the money supply is reduced resulting in low or no inflation. When there is no risk of inflation, the FRS creates cheap credit by lowering interest rates. As a result of low interest rates the economy can thrive. For example, when there are low interest rates liquidity is increased and ultimately unemployment is reduced making the economy strong.
Fed’s tools to meet objectives:
The FRS conducts monetary policy using four major tools and one emergency tool that influence the money and credit conditions in our economy. The first occurs by open market operations. This is a way to control the level of reserves in the depository system. Monetary policy is the responsibility of the Federal Open Market Committee (FOMC).
The second tool occurs by setting reserve requirements for depository institutions. The reserve requirements make it so banks must hold 10% of their deposits on hand at the end of every day. The other 90% of their deposits may be lent out. At the end of the day, if a bank does not have enough cash on hand to meet the reserve requirements, it borrows money from other banks. This is known as the federal funds rate. Banks charge each other the federal funds rate when lending money. The federal funds rate is determined by the FOMC on a monthly basis.
The third tool occurs by setting the discount rate for lending reserves. The discount rate is the rate the FRS charges banks to borrow at the discount window. This rate is typically a percentage point above the federal funds rate. The reason why this rate is higher is to discourage excessive borrowing.
The fourth major tool the FRS use to achieve its objectives is the money supply. This is the total amount of currency held by the public. Money supply occurs in two forms. The first is M1. Which are currency and check deposits. The second is M2. This includes all of M1 plus money market funds, certificate of deposits, and savings accounts. The FRS increases the money supply by lowering the federal funds rate, which lowers the banks cost of maintaining reserve requirements. This gives the FRS more money to loan, which gives consumers more money in their pockets.
A fifth tool the FRS utilizes is the discount window. The FRS uses the discount window to lend money to banks at the Fed’s discount rate to meet the reserve requirement. The Fed’s discount rate is higher than the Fed funds rate. Banks only use the discount window when they cannot get overnight loans from other banks. This is the reason why the FRS usually only uses this tool in emergencies.
Information Fed uses:
The FRS uses information from the FOMC in determining its actions. The FOMC is in charge of overseeing the nation’s open market operations. For instances, the FRS uses the input from FOMC when buying or selling Untied States Treasury securities. The FRS uses a committee to make key decisions about interest rates and the growth of the United States.
The FOMC sets monetary policy. They do this by specifying the short-term objectives for the FRS during open market operations. This is a target level for the federal funds rate. The FOMC uses a committee to decide the path of the FRS. The committee participates in discussions regarding the assessment of the economy and policy options. They meet eight times a year, which is approximately once every six weeks. During these meetings, discussions occur regarding current and prospective business situations. The conditions of the financial markets and international financial developments are at the top of their agenda. Other important discussions include; trends in prices and wages, employment and production, consumer income and spending, residential and commercial construction, business investments and inventories, interests rates, money and credit aggregates, and fiscal policy.

How the Fed interacts with banking institutions and the government:

The Federal Reserve uses the Federal funds rate to control how much banks lend. Fed funds are the loans that banks make to each other to meet the reserve requirement (usually 10% of their deposits) set by the Federal Reserve. These loans are usually overnight, since the reserve requirement needs to be met at the end of each day. The Federal Reserve is responsible for setting the Fed funds rate. They do this each month through its Federal Open Market Committee or FOMC. At these meetings, they review the current economic and financial conditions of the economy, and then determine the monetary policy while assessing all the risks to sustain economic growth and price stability. This is how short-term interest rates, LIBOR, bank to bank loans, and the prime rate. So basically, most of the common rates that we are paying are determined by the Fed, this includes deposits, bank loans, credit cards, and mortgages. This means that for almost every American that has taken out a loan your personal debt and interest rates are determined by a board of twelve members. Understand that the goal of the Fed is to control inflation while avoiding recession, which requires substantial monitoring and accurately assessing risk and decision making. The FOMC meetings are also watched very closely by the stock market community, because the Fed Funds rate is a leading indicator to predict which way the economy will go. The Fed works directly with the U.S. Department of Treasury to work together in reducing the U.S. account deficit and improving the value of the dollar. One way they work together is by auctioning Treasury bills, notes, and bonds. They use the note, or yield, to determine interest rates to accommodate the proper inflation needed at that time.

How the Fed is funded:

The Fed is self funded which means that it operates on money it makes itself. Some of the ways the Fed makes money is on check cashing fees, electronic transfer fees, and interest on treasury securities, and the buying and selling of securities. The Fed examines the condition of the nation’s funds on a weekly basis that way they can see if any problems may occur. The Fed gets a lot of criticism especially because citizens believe that a central bank is counterproductive and unnecessary for the economy. Because of this structure, the Fed has most of the financial power and control; also, they are able to print more money when they feel the situation is necessary. Some people would argue that the Fed, or something similar needs to be in place to monitor the nation’s finances, and that it has worked and will continue to work going forward. On the other hand, some question the fact that it really has been working. America has suffered through some depressions, and our nation continues to dig deeper into financial trouble.
Principle assets and liabilities of the Fed:
The Federal Reserve holds a pretty large amount of assets and liabilities, as in trillions of dollars of dollars at any one time including over a trillion dollars of cash in circulation. Most of the liabilities held are federal reserve notes and deposits from financial institutions, which number more than 7,000. More debt from the US Treasury and other "hold-in" accounts are held in Federal Reserve banks. The majority of The Feds assets are nominal (face value) notes and bonds, and federal mortgage-backed securities. Over $200 Billion in foreign currency is also on the balance sheet. Currently the Fed has an excess of securities in attempts to damper long term rates. This unconventional move has been forecasted to last for several years, though The Fed does have tools available to drain assets and sell off securities to prevent unpredictable movement in the market. As a side note, the New York branch of the Federal Reserve bank carries HALF of the total assets and liabilities.
Role of the Fed:
The role of the Federal Reserve has changed since the downturn as it has become a lot more active in making decisions to head off economic distress. The Feds (Board of Governors and Federal Open Market Committee) primary goals have be to promote maximum employment, stable prices, moderate and long-term interest rates. To maintain these goals, the federal reserve does a few things. They have instituted new financial stability policies, attempted to be more transparent on future outlook, and be more aggressive in response to crisis in the market. Some of these responses to crisis have been creating special lending facilities to stabilize financial systems and promote financial growth. Also, implementing programs to support liquidity of financial institutions and foster economic improvement. Transparency as far as outlook gives businesses, the market, and every day consumers a better understanding of how things will play out. More educated decisions can be made if it is known what the intent and actions of the Federal Reserve will be.
Should the Fed be abolished:
I believe that a well regulated, transparent, less powerful Federal Reserve would be appropriate in today 's global economy. With that said, the Fed has been run with interests other than just the American people at heart. For example, even the rare audit of the Federal Reserve has limits as US Code Title 31 § 714, section B specifies what CANNOT be reviewed. Money can essentially be created out of thin air by buying up US treasury funds and selling "federal reserve notes." In reality, The Fed has tried too hard in some cases to spur job creation and spending and head off inflation by policy. Unfortunately, some of these moves are done before fully realizing the results of past decisions; ie. some of the economic problems could NOT be solved by monetary policy-making.
How the actions of the Fed relate to Finance 335:
The Federal Reserve is important to this class because the monetary policy established is the building block for the economy of this country and world wide. By raising or lowering the central interest rate, the Fed can influence how fast or how slow the economy will grow or contract. This has a direct influence on short term decisions, and in the long term, a culture of financing. The interest rate is connected to credit cards, consumer loans, and mortgages which affects in some way just about everyone in this country.

Bibliography:
Seth B. Carpenter, Jane E. Ihrig, Elizabeth C. Klee, Alexander H. Boote, and Daniel W. Quinn. "The Federal Reserve 's Balance Sheet: A Primer and Projections." federalreserve.gov. 5 NOV 2012
"US Code". law.cornell.edu. legal information institute. 1992.
Meltzer, Allan. "What 's Wrong With the Federal Reserve?" online.WSJ.com. July 9, 2012
About The US Economy. Kimberley Amadeo. 2012. U.S. Economy Guide. November 28, 2012. <http://useconomy.about.com/od/governmentagencies/p/Treasury.htm>
Next Wave. Admin. October 28, 2008. November 28, 2012. http://www.nextwave.org/banking/the-federal-reserve/
“Monetary Policy and the Economy.” September 18, 2006. November 23, 2012. http://www.federalreserve.gov/pf/pdf/pf_2.pdf

“Federal Open Market Committee.” May 30, 2012. November 25, 2012. http://www.federalreserve.gov/monetarypolicy/fomc.htm

PBS. PBS, n.d. Web. 03 Dec. 2012.
<http://www.pbs.org/newshour/economy/timeline/timeline3.html>.

"Federal Reserve Education." The Structure of the Federal Reserve System -. N.p., n.d. Web. 03 Dec. 2012. <http://www.federalreserveeducation.org/about-the-fed/structure-and-functions/>.

"Federal Reserve System." : The Concise Encyclopedia of Economics. N.p., n.d. Web. 03 Dec. 2012. <http://www.econlib.org/library/Enc/FederalReserveSystem.html>.

"The Ludwig Von Mises Institute." The Free Market: The Feds Before the Fed. N.p., n.d. Web. 03 Dec. 2012. <http://mises.org/freemarket_detail.aspx?control=478>.

Peer Evaluation:
Brian “Joe” Biddle: 10/10
Ryan Gusstason: 10/10
Scott 10/10
Trevor Bristow: 10/10

Bibliography: Meltzer, Allan. "What 's Wrong With the Federal Reserve?" online.WSJ.com. July 9, 2012 About The US Economy Next Wave. Admin. October 28, 2008. November 28, 2012. http://www.nextwave.org/banking/the-federal-reserve/ “Monetary Policy and the Economy.” September 18, 2006 “Federal Open Market Committee.” May 30, 2012. November 25, 2012. http://www.federalreserve.gov/monetarypolicy/fomc.htm PBS "Federal Reserve Education." The Structure of the Federal Reserve System -. N.p., n.d. Web. 03 Dec. 2012. &lt;http://www.federalreserveeducation.org/about-the-fed/structure-and-functions/&gt;. "Federal Reserve System." : The Concise Encyclopedia of Economics. N.p., n.d. Web. 03 Dec. 2012. &lt;http://www.econlib.org/library/Enc/FederalReserveSystem.html&gt;. "The Ludwig Von Mises Institute." The Free Market: The Feds Before the Fed. N.p., n.d. Web. 03 Dec. 2012. &lt;http://mises.org/freemarket_detail.aspx?control=478&gt;.