Federal Reserve System (Fed) is an independent federal agency with functions of the central bank and implements centralized control over the US commercial banking system.
The Fed is exactly the system of many organizations of different levels, volumes of power and forms of ownership (more detailed information about organization structure follows).
The Fed activity is based on the Federal Reserve Act of December 23, 1913.
It is well-known that one of the main functions of the central banking system in any country is the implementation of money-and-credit (monetary) policy and The Fed is no exception. The main purpose of the Federal Reserve Act money-and-credit The Fed policy (amendments of 1977) is “efficient promotion of maximal employment population goals, price stability and moderate long-term interest rates”.
The Fed monetary instruments
The main Federal Reserve System rates are the Federal funds rate and the Discount rate.
The Federal funds rate is the rate of interest according to which the US banks grant credits from their excess reserves for short terms (usually overnight) to other banks. Herewith, the interest at which one bank credits another omit one, is set by the bank itself though the Fed sets only the target price rate of federal funds. The real rate may differ from the target one due to the fact that first one represents the average weighted loan rate, negotiated between the borrowing bank and creditor bank. The real rate is called Federal funds effective rate. The task of The Fed is to maximally approach the Federal funds effective rate to its target level.
The Discount (account) rate is the interest rate at which the Fed grants loans to commercial banks to support liquidity. Discount rate is usually higher than Federal funds rate. That is why banks lacking the liquidity level, resort to taking the Fed loans as the extreme case. Therefore the Fed acts as a lender of last resort.
Currently the federal funds target level rate is 1.25-1.50%.
The up-to-date discount rate is 2.00%.
Open market operations represent the Fed actions for account dealing (as a rule government bonds) on the open market. The main goal of completing this sort of operation is the control over the short-term interest rates and money base size in order to influence the money stock. In other words, the open market operations are used to adjust the Federal fund effective rate to its target level. When the effective rate is higher than target one, the Fed increases the money supply by means of REPO dealings, that is, purchase of securities. In this way the bank reserves are increased and subsequently lead to the increase of short term loans volumes supply, thus decreasing the effective rate. In case the effective rate is below the target level, the decrease of money supply is completed by means of reverse REPO dealings, that is selling of securities. This leads to a decrease of bank reserves and a decrease in the supply of short-term credits, thus increasing the effective rate.
After the financial crisis of 2008, the approach to the open market operations implementation has substantially changed. Because of the decrease of short-term interest rates to nearly zero level, their subsequent decrease became impossible due to the open market operations (liquidity trap). In this way the federal reserve had to use quantitative easing to provide further stimulation of the economy by means of buying long term financial assets, but not only short-term government stocks, in this way decreasing long-term percent rates.
In fact, the quantitative easing is a variation of open market operations, along with purchasing a certain amount of stocks or other active assets from financial organizations having no reference to the percent rate. In such cases the goal is the money supply increase, not the percent rate decrease, which cannot be cut any further.
The Fed can determine the limit of loan minimal reserve coverage:
The higher the norm, the fewer loans can be offered on behalf of commercial banks, and that limits the money stock in the country, for it decreases the credit recourses and reduces credit multiplicator.
Changes to the minimal reserve coverage norm present a stronger instrument, abruptly alternating money market trends, and therefore, is not the preferred method.
The currently effective following requirements are:
- For the rate-sensitive liabilities up to $16.3 mln 0%;
- For the rate-sensitive liabilities from $16.03 mln up to $124.2 mln 3%;
- For the rate-sensitive liabilities over $124.2 mln 10%.
This financial instrument can be used for effective rate increase. Given that the policy of quantitative easing filled up the bank balances with excess reserves, subsequently the Fed can face the kind of problems that will prompt the need to raise the federal fund effective rate up to the target level. In this case, the Federal Reserve will use the interest, charged on the obligatory and excessive reserves therefore paying banks for withholding the balance of the Fed accounts.
The current interest rate charged on obligatory and excess reserves equals 0.25%, so that it corresponds the higher boundary of the federal funds effective rate target level, making no difference to the banks whether to hold their money on the Fed accounts or to loan the excess money to other banks.
This program is designed to support the consumer finance market and realized via purchase of derivatives from different kinds of consumer loans including automobile lending and credit-card debts. The mandatory condition of public funds exchange for the derivatives will be their maximal credit rating (AAA).
This is another instrument along with the interest charged on the obligatory and excessive reserves, which offers the Fed to cut the money stock growth.
The Fed governing body is represented by the board of governors. It consists of 7 members (currently one place remains vacant), the Board named by the President from among the members and are confirmed by the Senate for the period of 14 years with no right to extend their term.
The Court of directors is a government facility run by its chairman and its deputy, elected by the president out of seven members of the board for the period of 4 years without any limits to extend the term of office.
The Board of governors functions:
- Control over FRS system functioning;
- Decision making in regulatory affairs;
- Requirements for the definition for currency reserves.
Board of governors’ current composition:
- Jerome H. Powell, Chairman until January 31, 2028)
- Richard H. Clarida, Vice Chairman until January 31, 2022)
- Randal K. Quarles, Vice Chairman for Supervision until October 13, 2021)
- Michelle W. Bowman (board of governors member until January 31, 2020)
- Lael Brainard (board of governors member until January 31, 2026)
The United States is divided into 12 districts, each of which has its own Regional Reserve Bank, that altogether form the basic structure of the US Federal Reserve system. FRB are named after the cities of their head quarters location.
FRB have the status of separate legal identity but they give account of and report to those appointed by the US President and confirmed by the Senate Fed Board of governors.
Each regional department has its own board of governors consisting of 9 members and divided into A, B, C classes, having 3 persons in each one:
3 governors of A class are elected by the Fed member banks among their own representatives (one from the major banks, one from medium, one from small);
3 governors of B class are elected by the Fed bank members among the people who do not work in the banking system (one from the major banks, one from medium, one from small);
3 governors of С class are appointed by the Fed Board of governors.
Each regional department president is appointed with the Fed Board of governors’ consent
Functions of the Fed regional departments:
- Fixing discount rates with the Fed Board of governors’ consent;
- Following up on local economic and financial enterprises;
- Providing financial services to the US government and other depositories.
US Federal Reserve Banks:
- FRB of Atlanta
- FRB of Boston
- FRB of Dallas
- FRB of Kansas City
- FRB of Cleaveland
- FRB of Minneapolis
- FRB of New York
- FRB of Richmond
- FRB of San Francisco
- FRB of St. Luis
- FRB of Philadelphia
- FRB of Chicago
FRB of New York is the most important among 12 reserve banks. Its President has the right of permanent vote at the meetings of the Operations Committee open market while the heads of the other 11 FRB have the voting right in terms of rotation.
FRB funds are of corporate property pattern and are composed of these banks stock trading. The major customers are the commercial banks that do not get the voting right but can elect 6 out of 9 governors of local regional branches, and get dividends.
Federal Reserve Banks shares received by banks in exchange for surplus funds have some limitations: they can not be sold or exchanged, they are paid out by fixed return dividends – 6% annual interest, regardless of the Fed profits.
Any commercial bank which satisfies the Fed requirements can become a property owner (shareholder) of a local regional department.
FRB joint stock banks:
- Collection of fixed return dividend for FRB shares in return to the deposit;
- Participation in elections of 6 among 9 governors of local regional department (classes F and B).
Federal Open Market Committee consists of 12 voting participants, including all members of the Fed board of governors, the President of New York FRB on a permanent basis along with 5 FRB presidents, who get the right to vote on the basis of annual rotation.
According to the US Fed act, FOMC meetings are supposed to take place not less than 4 times a year. 8 annual meetings with 5-8 weeks intervals have been held since 1981. Every meeting of the Committee holds elections regarding interest rate, discusses the current economic situation, direction of monetary policy etc. 3 weeks after each meeting the FOMC site publishes minutes of major meeting results.
No less than twice a week the Committee also holds a vote regarding the long-term strategy concerning the leading economic indicators, inflation, labor market as well as the stock of money and national debt.
- Consumer advisory board
- Society of depository institutes advisory board
- Federal advisory board
- 29-30 January
- 19-20 March*
- 30 April - 1 May
- 18-19 June*
- 30-31 July
- 17-18 September*
- 29-30 October
- December 15-16*
*Meeting associated with a Summary of Economic Projections and a press conference by the Chair.