Federal Reserve System

The Federal Reserve

Structure of the Federal Reserve

Private Ownership: One of the unique features of the Fed is that its member banks privately own it. A member bank is a commercial bank that is a member of the Fed and holds shares of stock in it. All national banks must belong to the Fed. National banks are banks that receive their charter from the national government. State banks, which receive their charters from state governments, have the option to belong to the Fed or not. Today, all the large banks and almost 40 percent of all banks in the United States are members of the Fed.

Multiple Choice

Which of these best describes the Federal Reserve System (the Fed)?

• It is a mostly independent agency that supervises and manages the financial system.

• It is the agency through which Congress supervises and manages the financial system

• It is the agency through which the judiciary supervises and manages the financial system.

• It is the agency through which the executive branch supervises and manages the financial system.

Multiple Choice

Which statement is true about Federal Reserve System membership?

• Banks with state charters must join the Fed.

• Banks with national charters must join the Fed

• Banks with state charters are prohibited from joining the Fed.

• Banks with national charters are prohibited from joining the Fed.

The government did not have enough money to set up a new banking system, so it had to make the Fed a stock corporation. The government required banks to purchase shares when they joined. This process made the banks part owners of the Fed, just as someone might own shares in a private company. Private citizens cannot buy shares in the Fed, although they become indirect owners when they buy shares of stock in a Fed-member bank. The government does not own the Fed—private banks own the Fed by buying stock. 

Board of Governors A seven-member board of governors manages the Fed. The president of the United States appoints the members, and then the Senate approves them to serve a fourteen-year term of office. The appointments are staggered, so that there is one appointment every two years. The president and the Senate are careful to appoint people who will run the Fed for the good of the public. Because of this, people often say that the Fed is “privately owned, but publicly controlled.”

Multiple Choice

Which of these describes the Fed’s Board of Governors?

• There are fourteen of them, elected by popular vote every four years

• There are seven of them, chosen by the president and Congress to serve fourteen-year terms.

• There are fourteen of them, chosen by the president and Congress to serve seven-year terms.

• There are seven of them, each of them also serving in a Congressional financial subcommittee.

The board mainly oversees and guides. It sets general policies for its member banks to follow and controls certain aspects of state-chartered member bank operations. It helps make policies that affect interest rates and that determine how much credit is available. The board reports annually to Congress and puts out a monthly report about national and international monetary matters. 

Multiple Choice

Which of these exerts the most direct control over interest rates?

• the Board of Governors

• the Federal Reserve district banks

• the Federal Open Market Committee

• the Consumer Financial Protection Bureau

Federal Reserve District Banks

When it first began, the Fed worked as a system of twelve independent and equally powerful banks. Each reserve bank was responsible for a district. Some Federal Reserve notes today still have a district bank’s name in the seal. But better technology now means that the Fed does not have to have a structure based on geographic districts. The new Fed seal on our currency does not include any names of the district banks

Today the twelve Federal Reserve district banks and their branches are purposefully located near the institutions they serve. The district banks provide many of the same functions for banks and depository institutions that banks provide for us. For example, the district banks accept deposits from privately owned banks and also make loans to them.  

Multiple Choice

The Federal Reserve was structured around geographic locations, but with improved _____________, the district banks can locate near the institiutions they serve.

• airports

• technology

• currency

• phones

Federal Open Market Committee

The Federal Open Market Committee (FOMC) is the Fed’s main group for making monetary policy because it has the power to raise or lower interest rates. The FOMC has twelve voting members. Seven members are from the board of governors. One member is the president of the New York district Fed, and four members are district Federal Reserve Bank presidents who take turns serving one-year terms. The FOMC meets eight times a year to review the economy and to study issues. These issues include trends in construction, wages, prices, employment, production, and consumer spending. Its decisions have a direct impact on the cost and availability of credit. Although the FOMC makes its decisions in private, it announces them almost immediately. 

Responsibilities of the Fed 

Maintaining the Currency

Our currency is our paper money supply. Today our currency is made up of Federal Reserve notes that the U.S. Bureau of Engraving and Printing prints. The bureau prints the currency in amounts of $1, $2, $5, $10, $20, $50, and $100. Then it sends the currency to the Fed’s district banks for storage until the public needs it.

The Bureau of the Mint produces coins, which is the metal form of money. Coins include pennies, nickels, dimes, quarters, and the presidential dollar coin. After the bureau mints the coins, it ships them to the Fed district banks for storage. Member banks contact the Fed when they need more coins or currency. When banks come across coinage or currency that is mutilated or cannot be used for other reasons, they return it to the Fed for replacement. Then the Fed destroys the old money so that it does not go back into circulation. 

Multiple Choice

The Fed maintains the supply of money, but the government agency responsible for printing money is the

• Federal Reserve

• the President

• Congress

• Bureau of the Mint

Maintaining the Payments System

The payments system is more than the money supply. It also covers the electronic transfer of funds between businesses, state and local governments, financial institutions, and foreign central banks. Also, specialized actions called clearinghouses process the billions of checks that are written every year. The Fed works with all of these agencies so that the payments system operates smoothly. 

Multiple Choice

Although many people no longer write checks, the Fed is still responsible for processing the checks through _____________.

• clearinghouses

• member banks

• district banks

• Bureau of the Mint

Next to cash, checks are the most popular form of payment in the United States. But a 2003 law changed the way checks get processed. Checks used to be returned to the person who wrote them. Now only electronic images of the checks are returned to the issuer. Online banking is another major innovation in the banking system. People can now open a bank account anywhere in the country using the Internet. The Fed is overseeing processes to make sure that no abuses happen. 

Regulating and Supervising Banks

It is the Fed’s job to set up specific guidelines that govern banking behavior. The Fed also monitors, inspects, and examines different banking agencies to make sure that they follow banking laws. The Fed does not regulate all banks, but it is responsible for watching over foreign branches of its own member banks. It also watches over U.S. branches of foreign banks. The Fed also oversees many activities of state banks. This includes the operations of bank holding companies. These are firms that own and control one or more banks. The Federal Deposit Insurance Corporation (FDIC), the Comptroller of the Currency, or other state banking authorities oversee banks that the Fed does not directly inspect and regulate.

Financial Literacy and Consumer Protection 

The Consumer Financial Protection Bureau (CFPB) now oversees some consumer protection activities. But the Fed still provides a huge amount of financial information. For example, the Federal Reserve Board of Governors website offers reports, calculators, and many other helpful guides. These guides range from credit reports to identity theft to home loans

Multiple Choice

The Consumer Financial Protection Bureau also provides consumers with information about

• credit reports

• identity theft

• home loans

• all of these

If you buy furniture or a car on credit, the seller must disclose several items before you make the purchase. These items include the size of the down payment, the number and size of the monthly payments, and the total amount of interest over the life of the loan. The Fed decides all these items that the seller must reveal. 

Acting as the Government’s Bank

Another job of the Fed is to provide financial services to the federal government and its agencies. For example, the Fed has nationwide auctions of Treasury securities. It also sells, services, and redeems these securities for the Treasury. In the process, it maintains many demand-deposit accounts for the Treasury. Any check that is written to the U.S. Treasury is deposited in the Fed because the Fed acts as a bank for the government. Any federal agency check, such as a monthly Social Security payment, comes from accounts held at the Fed. The Fed can also move money from one part of the country to another so that the government can make payments wherever and whenever it needs to. 

Multiple Choice

The Federal Reserve serves as the bank for the U.S Treasury.

• True

• False

Conducting Monetary Policy

The Fed’s monetary policy changes interest rates by changing the size of the money supply. The Fed increases the money supply under an easy money policy. This causes interest rates to fall. This kind of policy stimulates the economy because people and businesses borrow more at lower interest rates. The larger money supply lowers the rate from 10 to 8 percent. The Fed limits the size of the money supply under a tight money policy. Shrinking the money supply drives up the cost of borrowing from 10 to 12 percent. This slows borrowing and economic growth because higher interest rates normally cause people to borrow and spend less. The Fed can use three major tools to drive monetary policy. Each tool works in a different way to change the amount of excess reserves. Excess reserves are the amount of money a bank can lend to others. 

Open Market Operations

The second tool of monetary policy is open market operations. These involve buying and selling government securities in financial markets. This is the Fed’s most popular tool. Every day, the Fed buys and sells billions of dollars of government securities through dealers

Multiple Choice

. Which of these is a feature of open market operations?

• The Fed sells government securities.

• The Fed lowers the prime interest rate.

• The Fed raises the reserve requirement

• The Fed purchases member bank reserves

The Discount Rate

As a central bank, the Fed can make loans to other banks. The discount rate is the interest the Fed charges on loans to financial institutions. The discount rate is the third major tool of monetary policy. Only financial institutions can borrow from the Fed. Private individuals and companies are not allowed to borrow from the Fed. 

Multiple Choice

______________ can borrow money from the Federal Reserve

• individuals

• corporations

• banks and financial institutions

• retailers

Raising the discount rate—If the discount rate goes up, fewer banks will want to borrow from the Fed. Then banks will have fewer excess reserves available to loan out. A higher discount rate usually makes all borrowing more expensive. This slows down economic growth. Lowering the discount rate—A bank may want to borrow from the Fed if it has an unexpected drop in its reserves. Or, a bank could also have high seasonal demands for loans. For example, a bank in an agricultural area might face heavy demand during the planting season. If enough banks acted on the lower discount rate, total MBRs would increase. This would expand the money supply.

The Fed directly sets the discount rate, but its monetary policy actions influence other interest rates. For example, changes can directly affect the prime rate. The prime rate is the lowest rate of interest that commercial banks charge their best customers. At many large banks, the prime rate is linked to other interest rates. Usually banks adjust their prime rate up or down whenever the Fed changes the discount rate. 

Multiple Choice

Which of these interest rates is set by the Federal Reserve?

• prime rate

• reserve rate

• discount rate

• monetary rate