All Terrain Thinking

A Compendium of things I think are Important

Economics: It's not just whats' in your wallet

The FED

The Federal Reserve System (Fed) is the central bank of the United States - the equivalent of the Bank of Sweden, Bank of England, and the Bank of France which were established in 1656, 1694, and 1800.  The Fed represents the United States' third try at establishing a central bank. The first came in 1790 and the second in 1816 - each lasting twenty years. Between 1836 and the establishment of the Federal Reserve in 1914, the US was without a central bank.

In fact there are twelve Federal Reserve Banks - one for each of the twelve Federal Reserve Districts. The reason for the twelve banks is the long-standing aversion Americans had for the concentration of financial power.  By dividing the country into twelve smaller regions, the Fed would be more accountable to the interests of the people in a particular region.  If you were in Rhode Island, you were more likely to be able to influence policy by lobbying the regional Federal Reserve bank than you could a national system located in Washington, D.C.   Rhode Island is in the first district which includes almost all of New England and has its bank in Boston. The structure of the system is described in Diagram 1 below. The President of the United States, with Senate approval, appoints the seven members of the Board of Governors. Each Federal Reserve Bank has a president who is elected by the banks that are members of the system in that region.

The seven members of the Board of Governors and five bank presidents - one being the president of the New York City bank and the other four being rotating presidents of the remaining eleven banks  - form the Federal Open Market Committee (FOMC).  This is the group most responsible for setting monetary policy in the United States.  It is the meetings of this group that grab the headlines as the financial press attempts to anticipate the Fed's moves.  In 1998, for example, the business press was filled with stories centered on the Fed and its decisions regarding interest rates as it tried to help guide the economy through the Asian crisis by lowering interest rates.  Would the Fed lower rates to protect the economy from the Asian crisis?  Would the Fed raise interest rates to eliminate any inflationary pressure in the economy?  These questions were all directed at the decisions of the FOMC. 

Diagram 1
Structure of the Federal Reserve

In this section we will be examining the tools that the Fed can use to achieve its policy goals. Here we will learn what the Fed could do if it did want to increase interest rates or increase the money supply.  Before examining the tools, however, we need to look at what it is the tools are used to accomplish.  Below you have the Fed's function in its own words.

Today, the Federal Reserve's duties fall into four general areas:

1. Conducting the nation's monetary policy by influencing the money and credit conditions in the economy in pursuit of full employment and stable prices

2. Supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers (Federal Reserve Regulations)

3. Maintaining the stability of the financial system and containing systemic risk that may arise in financial markets

4. Providing certain financial services to the U.S. government, to the public, to financial institutions, and to foreign official institutions, including playing a major role in operating the nation's payments system.

In this section we will be focusing our attention on the first of these function - the ability of the Fed to control the money supply.  For some additional information on the Fed and other central banks, you might want to check out the following:

• Bank of England

As a first step toward an understanding this money supply process and the role of the Fed, we'll now look at the Banks  which can be considered the money creators. 

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