Federal Reserve System

Introduction

It all began on December 23, 1913 when President Woodrow Wilson created the Federal Reserve System by signing the Federal Reserve Act into law. The Fed is a decentralized central bank, in the sense that it is a quasi-government system that balances the interests of both the private banks and the populist sentiment. For the private banks, this means that private banks have members, usually executives, which sit on the board for each district. These members then elect the officials that serve for their district. The seven members of the board of governors are appointed by the President and confirmed by the Senate. This satisfies the populist sentiment portion, because the nominating and confirming bodies of the Senate and President are both elected offices.

There are two basic types of policy that affect the economy. For the purpose of this paper I will focus on monetary policy, rather than fiscal policy. Fiscal policy is laws enacted by the government, but monetary policy is conducted in the United States by the Fed. The two goals of the Federal Reserve, referred to as the dual mandate, are to maximize employment and maintain price stability. The Fed has many other functions to “promote the effective operation of the U.S. economy” (FRB, 2017) such as clearing all checks, making loans, and retiring old currency. The Fed has two policies they can use at their own discretion to conduct open market operations. These policies can be classified as either expansionary or contractionary.

Open Market Operations

The two types of open market operations conducted by the Fed are expansionary and contractionary policies. A contractionary policy is where the Fed sells fixed assets (treasuries), which causes the supply of loanable funds to go down, and, in turn, forces interest rates up. An expansionary policy is just the opposite, where the Fed buys treasuries, pumping loanable funds into the market, which causes interest rates to go down. An example of expansionary policy, or loose monetary policy, was during the credit easing program directed by Ben Bernanke. In this period of time the Fed bought 4.5 trillion in U.S. treasuries in an effort to keep interest rates up. This was a very concerning period of time because there was some worry among analysts that the Fed Funds rate would be forced negative. Currently we are in a tightening phase from the Fed. Although they are not directly selling treasuries back to the market, they are letting the 4.5 trillion accumulation roll off their balance sheet and not reinvest the proceeds. Using these rates, the Fed is able to control the supply and demand for the reserves they hold.

The Board of Governors

Typically, the Board of Governors is comprised of seven members. After the resignation of Vice Chairman Stanley, we were left with three open seats on the board. These positions are appointed by the President and confirmed by the Senate. With the resignation of Janet Yellen, we will see and unprecedented four unfilled seats on the board. The president must intervene and quickly nominate qualified individuals for these positons, because of the affect it has on the Federal Open Market Committee. Each member of the board is appointed and serves a fourteen year term. The terms are staggered so that every two years a term expires and a new appointment must be made. An interesting caveat of the board is that once a member’s term expires they may not be reappointed to the board. The only two exceptions to these rules are the Chair and Vice Chair. These positions are appointed in the same manner, but only serve four-year terms. However, they may be reappointed after their term expires.

The board regulates financial institutions along with the other twelve Reserve Banks and acts as the overarching regulator for all of the district banks (Fed, 2017). The board does this through many committees comprised of its members. The committees are as follows: Committee on Board Affairs, Committee on Consumer and Community Affairs, Committee on Economic and Financial Monitoring and Research, Committee on Financial Stability, Committee on Federal Reserve Bank Affairs, Committee on Supervision and Regulation, Committee on Smaller Regional and Community Banking, and Committee on Payments, Clearing, and Settlement. The governors are stretched extremely thin because each committee must still be manned by two governors. These seat vacancies lead to the problem where governors are serving on many, if not all, of the committees.

The Federal Open Market Committee

The Federal Open Market Committee (FOMC) is comprised of

...