Tài chính doanh nghiệp - Chapter 2: The federal reserve and its powers

Power Point Slides for: Financial Institutions, Markets, and Money, 9th Edition Authors: Kidwell, Blackwell, Whidbee & Peterson Prepared by: Babu G. Baradwaj, Towson UniversityAndLanny R. Martindale, Texas A&M University 1Copyright© 2006 John Wiley & Sons, Inc.CHAPTER 2THE FEDERAL RESERVE AND ITS POWERS2Copyright© 2005 John Wiley & Sons, IncPurposes of a Central BankSupervise nation’s money supply and payments systemRegulate other financial institutions, especially depository institutions“Lender of last resort” when financial system has liquidity problemsNational government’s “fiscal agent” (i.e. depository bank)3Copyright© 2006 John Wiley & Sons, Inc.Two early central banking institutions did not survive the politics of their time. Bank of the United States, 1791-1811 Brainchild of Alexander Hamilton Federal charter Privately owned Public and private functionsbanknotes international transactionsSecond Bank of the United States, 1816-1836 Major issue in presidential politics. Andrew Jackson vetoed re-charter bill in 1832 4Copyright© 2006 John Wiley & Sons, Inc.Weaknesses in the 19th-Century Banking SystemUnstable money supply— No standard currency, mostly private banknotes “Hard currency” (gold/silver) hoarded, unevenly distributed No coordinated payments systemBanks were state-chartered and unregulated— No deposit insurance or minimum capital requirements No supervision of lending or accounting practices Frequent bank failuresDisruptions of business credit from bank failures prolonged and intensified economic downturnsExaggerated business cycle– “boom & bust”5Copyright© 2006 John Wiley & Sons, Inc.6Copyright© 2006 John Wiley & Sons, Inc.National Banking SystemCurrency Acts & National Banking Acts-1862, 1863, 1864 First federally standardized currency First systematic federal regulation of bankingKey Provisions: Federally chartered “National Banks” Periodic bank examinations Minimum capital and reserve requirements Maximum lending limits Standard banknotes- printed by US Treasury secured by U.S. bonds Federal tax on state banknotes7Copyright© 2006 John Wiley & Sons, Inc.Early National Banking System failed to address 3 related problemsDemand deposits (checking accounts) became highly popular as a result of the tax on state banknotesPyramiding of reserves was allowed: Banks could count deposits at other banks as reserves, so a “run” on one could cause others to run short as well.Call loans were the conventional form of bank financing. These loans were due when “called in” by the bank. Banks low on reserves called in loans, causing borrowers to withdraw their own deposits or default, causing more bank illiquidity and more “calls”. Panic would spread, dragging the economy into recession.8Copyright© 2006 John Wiley & Sons, Inc.Origins of the Federal Reserve SystemRepeated cycles of panic and recession strengthened political consensusCrash of 1907 shifted debate from whether to have central bank to how to structure oneFederal Reserve Act of 1913 embodied several compromises9Copyright© 2006 John Wiley & Sons, Inc.Initial Goals the Federal Reserve ActProvide an “elastic” currency— Federal Reserve Notes—standardized currency Ability to adjust money supply to changes in economy 12 regionally autonomous Federal Reserve BanksServe lender of last resort to keep banks liquidImprove payments system (check clearing)Supervise banks more vigorously10Copyright© 2006 John Wiley & Sons, Inc.Geography of the Fed11Copyright© 2006 John Wiley & Sons, Inc.Formal Organization of the Fed12Copyright© 2006 John Wiley & Sons, Inc.Power Structure of the Fed13Copyright© 2006 John Wiley & Sons, Inc.Today’s highly centralized Fed has 4 main organizational elementsThe 12 Federal Reserve BanksAbout 3,000 member commercial banksThe Board of GovernorsThe Federal Open Market Committee (FOMC)14Copyright© 2006 John Wiley & Sons, Inc.The 12 Federal Reserve Banks: Many operational functions, less autonomy Each FRB provides basic services in its district - processing checks and electronic payments issuing Federal Reserve Notes holding reserves of banks and other depository institutions monitoring regional economic conditions advising the Board of Governors helping make monetary policyThe Federal Reserve Banks are part of a coordinated national monetary policy 15Copyright© 2006 John Wiley & Sons, Inc.About 3,000 member commercial banks “own” the Federal Reserve Banks Member banks represent “dual banking” in the USAll National Banks must be members of the Fed About 17% of state banks choose to join Some 36% of all US banks are in, representing about 76% of depositsMember banks buy stock in the FRB for their district collect dividends set by the Fed but do not otherwise share profits elect 6 of 9 FRB directors but have no other vote or sayMembership is not the distinction it once was. As of 1980Fed services are available to any depository institution for a fee Reserve requirements apply to all U.S. depository institutions16Copyright© 2006 John Wiley & Sons, Inc.The Board of Governors runs the Fed 7 Governors appointed by President, confirmed by Senate No 2 Governors from same Federal Reserve DistrictGovernors have 14-year terms, expiring every 2 years.Governors’ terms are nonrenewableOne Governor serves as ChairmanChairman has 4-year term and may be reappointedWhen new Chairman is named, old one traditionally leaves (regardless of time left in underlying appointment as Governor) 17Copyright© 2006 John Wiley & Sons, Inc.FOMC sets monetary policy under Board of Governors’ control FOMC has 12 members - 8 permanent, 4 rotating7 Governors are permanent membersPresident of FRB of New York has permanent seatNew York Fed operationally executes FOMC directivesPresidents of 4 other FRBs rotate through 1-year termsFOMC’s actions substantially influence 2 major financial sector variables - size of the money supplylevel of short-term interest rates 18Copyright© 2006 John Wiley & Sons, Inc.Significant powers are concentrated in today’s centralized Fed Chairman is powerful figureBoard regulates key aspects of banking and finance beyond monetary policyIndependence enhances power19Copyright© 2006 John Wiley & Sons, Inc.Chairman is powerful figure in monetary policy sets agenda and chairs meetings of both Board of Governors and FOMCpublic face and voice of the Fed 20Copyright© 2006 John Wiley & Sons, Inc.Board regulates key aspects of banking and finance beyond monetary policy 21Copyright© 2006 John Wiley & Sons, Inc.Fed’s independence enhances its power No direct channels of political or fiscal pressure Fed is creature of Congress, but not directly under its authority Board is appointed by but not answerable to PresidentNo fiscal pressure; Fed funds itself—income exceeds expenses by about $20 billion/yearCongress thus has no “power of the purse” over FedUltimately independent within, not of governmentWhat Congress creates, Congress can modify or destroy.Fed remains independent because most politicians want it that way- mostly agree that monetary policy is not partisan issueindependent Fed can absorb some blame if economy faltersindependent Fed can take necessary but unpopular steps 22Copyright© 2006 John Wiley & Sons, Inc.23Copyright© 2006 John Wiley & Sons, Inc.Fed’s balance sheet reflects its relationship to money supply and financial system Main operating assets—Loans at Discount WindowUS Government Securities“CIPC”—Cash Items in Process of CollectionMain operating liabilities—Federal Reserve Notes in CirculationDepository Institution Reserves“DACI”—Deferred Availability Cash Items 24Copyright© 2006 John Wiley & Sons, Inc.Fed's Balance Sheet, 12/31/03Source: Board of Governors, Federal Reserve System.25Copyright© 2006 John Wiley & Sons, Inc.Fed has 3 major “Tools of Monetary Policy” Open Market OperationsDiscount RateReserve Requirements Fed’s use of these tools is discussed in detail in Chapter 326Copyright© 2006 John Wiley & Sons, Inc.Open market operations: most useful—and thus most important—tool Fed directly changes money supply by buying or selling US government securities on open secondary market—Pays for “buys” by crediting new reserves to special bank accounts of selected dealersCollects for sales by taking existing reserves back Only the central bank can unilaterally create or retire money in this way27Copyright© 2006 John Wiley & Sons, Inc.Effects of Open Market OperationsMoney supply changes immediately and dollar for dollar, making Open Market Ops flexible and preciseShort-term interest rates are pressured upward when Fed sells and downward when it buys28Copyright© 2006 John Wiley & Sons, Inc.Control of Open Market OperationsFOMC decides whether, when, and how much to buy or sellFOMC meets 8 times a yearThe FOMC issues policy directives to Open Market Desk at FRB of New York 29Copyright© 2006 John Wiley & Sons, Inc.Discount Rate: Interest rate at which Fed lends to depository institutions As Fed lends “at The Window”, money supply increasesChanges in Discount Rate theoretically affect incentives to borrowBanks in early 20th century relied on Window; now they have other choices for managing liquidity, are wary of “Discount Window scrutiny”Today, Discount Rate is more signal than direct control—Increase means Fed wants smaller money supply and higher ratesDecrease means Fed wants larger money supply and lower rates30Copyright© 2006 John Wiley & Sons, Inc.Reserve Requirements: least-used tool of monetary policy Depository institutions must reserve set percentage of certain types of depositsMost reserves are held at FRB for that District Reserves may also be held as vault cashMonetary Control Act of 1980 – subjects all US depository institutions to uniform reserve requirementssets limits within which Fed is to specify required reserve ratioReserve requirements are a structural controlChanges in reserve requirements have dramatic effects. Reserve requirements are not useful for “fine-tuning”31Copyright© 2006 John Wiley & Sons, Inc.32Copyright© 2006 John Wiley & Sons, Inc.33Copyright© 2006 John Wiley & Sons, Inc.