Federal Reserve

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See also Federal Reserve Bank of New York, Federal Reserve bibliography, Federal Reserve Act, New York District Court and the Federal Reserve, primary dealers, Reform of the Federal Reserve, and repo.



The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States.

Created in 1913 by the enactment of the Federal Reserve Act (signed by Woodrow Wilson), it is a quasi-public and quasi-private banking system* that comprises:

  1. the presidentially appointed Board of Governors of the Federal Reserve System in Washington, D.C.;
  2. the Federal Open Market Committee;
  3. twelve regional Federal Reserve Banks located in major cities throughout the nation acting as fiscal agents for the U.S. Treasury, each with its own nine-member board of directors;
  4. numerous other private U.S. member banks, which subscribe to required amounts of non-transferable stock in their regional Federal Reserve Banks; and
  5. various advisory councils.

Since February 2006, Ben Bernanke has served as the Chairman of the Board of Governors of the Federal Reserve System. Donald Kohn is the current Vice Chairman (Term: June 2006–June 2010).

  • Source: The Economics of Money, Banking, and Financial Markets, Frederic Mishkin, 2007

For the history of the Federal Reserve please go to Wikipedia here and to the Federal Reserve Bank of New York's site.


The primary motivation for creating the Federal Reserve System was to address banking "panics".

Just before the founding of the Federal Reserve, the nation was plagued with financial crises. At times, these crises led to “panics,” in which people raced to their banks to withdraw their deposits.

A particularly severe panic in 1907 resulted in bank runs that wreaked havoc on the fragile banking system and ultimately led Congress in 1913 to write the Federal Reserve Act.

Initially created to address these banking panics, the Federal Reserve is now charged with a number of broader responsibilities, including fostering a sound banking system and a healthy economy."

Other purposes are stated in the Federal Reserve Act, such as "to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes."[1]

Current functions of the Federal Reserve System include:[2]

  • To address the problem of banking panics
  • To serve as the central bank for the United States
  • To strike a balance between private interests of banks and the centralized responsibility of government
    • To supervise and regulate banking institutions
    • To protect the credit rights of consumers
  • To manage the nation's money supply through monetary policy to achieve the sometimes-conflicting goals of
    • maximum employment
    • stable prices, including prevention of either inflation or deflation Deflation: Making Sure "It" Doesn't Happen Here Remarks by Governor Ben S. Bernanke Before the National Economists Club, Washington, D.C. November 21, 2002
  • moderate long-term interest rates
  • To maintain the stability of the financial system and contain systemic risk in financial markets
  • To provide financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation’s payments system
    • To facilitate the exchange of payments among regions
    • To respond to local liquidity needs
  • To strengthen U.S. standing in the world economy

Key laws

Key laws affecting the Federal Reserve have been:

Critics of the Federal Reserve System state that it is not able to accomplish these goals.[3]

Addressing the problem of bank panics

Bank runs occur because all banking institutions in the United States practice fractional-reserve banking and do not keep enough cash in reserve to give to all of their depositors simultaneously. Bank runs can lead to a multitude of social and economic problems. The Federal Reserve was designed as an attempt to prevent or minimize the occurrence of bank runs, and possibly act as a lender of last resort if a bank run does occur.

Elastic currency

One way to prevent bank runs is to have a money supply that can expand when money is needed. The term "elastic currency" in the Federal Reserve Act doesn't just mean the ability to expand the money supply, but also to contract it. Some economic theories have been developed that support the idea of expanding or shrinking a money supply as economic conditions warrant. Elastic currency is defined by the Federal Reserve as:

"Currency that can, by the actions of the central monetary authority, expand or contract in amount warranted by economic conditions."

Monetary policy of the Federal Reserve System is based partially on the theory that it is best overall to expand or contract the money supply as economic conditions change. In practice, the Federal Reserve has never contracted the monetary supply since the Great Depression, on the fear that contracting the money supply may cause a deflationary recession, and because according to the operating theory of the Federal Reserve, monetary supply should expand as the economy expands to accommodate larger volumes of transaction.

Lender of last resort

The Federal Reserve has the authority to act as “lender of last resort” by extending credit to depository institutions or to other entities in unusual circumstances involving a national or regional emergency, where failure to obtain credit would have a severe adverse impact on the economy.[4]

Through its discount and credit operations, Reserve Banks provide liquidity to banks to meet short-term needs stemming from seasonal fluctuations in deposits or unexpected withdrawals. Longer term liquidity may also be provided in exceptional circumstances. The rate the Fed charges banks for these loans is the discount rate (officially the primary credit rate).

In making these loans, the Fed serves as a buffer against unexpected day-to-day fluctuations in reserve demand and supply. This contributes to the effective functioning of the banking system, alleviates pressure in the reserves market and reduces the extent of unexpected movements in the interest rates.

For example, on September 16, 2008, the Federal Reserve Board authorized an $85 billion loan to stave off the bankruptcy of international insurance giant American International Group (AIG).[5] [6]

The Federal Reserve System's role as lender of last resort is criticized for shifting risk and responsibility away from lenders and borrowers and placing them on others in the form of taxes and/or inflation.

The banker's bank

In its role as the central bank of the United States, the Fed serves as a banker's bank and as the government's bank.

As the banker's bank, it helps to assure the safety and efficiency of the payments system. As the government's bank, or fiscal agent[7], the Fed processes a variety of financial transactions involving trillions of dollars.

Just as an individual might keep an account at a bank, the U.S. Treasury keeps a checking account with the Federal Reserve through which incoming federal tax deposits and outgoing government payments are handled. As part of this service relationship, the Fed sells and redeems U.S. government securities such as savings bonds and Treasury bills, notes and bonds.

It also issues the nation's coin and paper currency.

The U.S. Treasury, through its Bureau of the Mint and Bureau of Engraving and Printing, actually produces the nation's cash supply and, in effect, sells it to the Federal Reserve Banks at manufacturing cost, currently about 4 cents per bill for paper currency. The Federal Reserve Banks then distribute it to other financial institutions in various ways.[8]

Federal funds

Federal funds are the reserve balances that private banks keep at their local Federal Reserve Bank.[9][10] These balances are the namesake reserves of the Federal Reserve System. The purpose of keeping funds at a Federal Reserve Bank is to have a mechanism through which private banks can lend funds to one another. This market for funds plays an important role in the Federal Reserve System as it is what inspired the name of the system and it is what is used as the basis for monetary policy. Monetary policy works by influencing how much money the private banks charge each other for the lending of these funds.

Balance between private banks and responsibility of governments

The system was designed out of a compromise between the competing philosophies of privatization and government regulation. In 2006 Donald L. Kohn, vice chairman of the Board of Governors, summarized the history of this compromise:[11]

"Agrarian and progressive interests, led by William Jennings Bryan, favored a central bank under public, rather than banker, control. But the vast majority of the nation's bankers, concerned about government intervention in the banking business, opposed a central bank structure directed by political appointees.

The legislation that Congress ultimately adopted in 1913 reflected a hard-fought battle to balance these two competing views and created the hybrid public-private, centralized-decentralized structure that we have today."

In the current system, private banks are for-profit businesses but government regulation places restrictions on what they can do. The Federal Reserve System is the part of government that regulates the private banks. The balance between privatization and government involvement is also seen in the structure of the system. Private banks elect members of the board of directors at their regional Federal Reserve Bank while the members of the Board of Governors are selected by the President of the United States and confirmed by the United States Senate.

The private banks give input to the government officials about their economic situation and these government officials use this input in Federal Reserve policy decisions. In the end, private banking businesses are able to run a profitable business while the U.S. government, through the Federal Reserve System, oversees and regulates the activities of the private banks.

Government regulation and supervision

The Board of Governors is the part of the Federal Reserve System that is responsible for supervising the private banks. A general description of the types of regulation and supervision involved is given by the Federal Reserve:

"The Board also plays a major role in the supervision and regulation of the U.S. banking system. It has supervisory responsibilities for [12] that are members of the Federal Reserve System, bank holding companies (companies that control banks), the foreign activities of member banks, the U.S. activities of foreign banks, and Edge Act and agreement corporations (limited-purpose institutions that engage in a foreign banking business).

The Board and, under delegated authority, the Federal Reserve Banks, supervise approximately 900 state member banks and 5,000 bank holding companies. Other federal agencies also serve as the primary federal supervisors of commercial banks; the Office of the Comptroller of the Currency supervises national banks, and the Federal Deposit Insurance Corporation supervises state banks that are not members of the Federal Reserve System.

Some regulations issued by the Board apply to the entire banking industry, whereas others apply only to member banks, that is, state banks that have chosen to join the Federal Reserve System and national banks, which by law must be members of the System. The Board also issues regulations to carry out major federal laws governing consumer credit protection, such as the Truth in Lending, Equal Credit Opportunity, and Home Mortgage Disclosure Acts. Many of these consumer protection regulations apply to various lenders outside the banking industry as well as to banks.

Members of the Board of Governors are in continual contact with other policy makers in government. They frequently testify before congressional committees on the economy, monetary policy, banking supervision and regulation, consumer credit protection, financial markets, and other matters.

The Board has regular contact with members of the President’s Council of Economic Advisers and other key economic officials. The Chairman also meets from time to time with the President of the United States and has regular meetings with the Secretary of the Treasury. The Chairman has formal responsibilities in the international arena as well.

Preventing asset bubbles

The board of directors of each Federal Reserve Bank District also have regulatory and supervisory responsibilities. For example, a member bank (private bank) is not permitted to give out too many loans to people who cannot pay them back. This is because too many defaults on loans will lead to a bank run. If the board of directors has judged that a member bank is performing or behaving poorly, it will report this to the Board of Governors. This policy is described in United States Code:[13]

"Each Federal reserve bank shall keep itself informed of the general character and amount of the loans and investments of its member banks with a view to ascertaining whether undue use is being made of bank credit for the speculative carrying of or trading in securities, real estate, or commodities, or for any other purpose inconsistent with the maintenance of sound credit conditions; and, in determining whether to grant or refuse advances, rediscounts, or other credit accommodations, the Federal reserve bank shall give consideration to such information. The chairman of the Federal reserve bank shall report to the Board of Governors of the Federal Reserve System any such undue use of bank credit by any member bank, together with his recommendation. Whenever, in the judgment of the Board of Governors of the Federal Reserve System, any member bank is making such undue use of bank credit, the Board may, in its discretion, after reasonable notice and an opportunity for a hearing, suspend such bank from the use of the credit facilities of the Federal Reserve System and may terminate such suspension or may renew it from time to time."

The punishment for making false statements or reports which overvalue an asset is also stated in the U.S. Code:[14]

"Whoever knowingly makes any false statement or report, or willfully overvalues any land, property or security, for the purpose of influencing in any way...shall be fined not more than $1,000,000 or imprisoned not more than 30 years, or both."

These aspects of the Federal Reserve System are the parts intended to prevent or minimize speculative asset bubbles which ultimately lead to severe market corrections.

National payments system

The Federal Reserve plays an important role in the U.S. payments system. The twelve Federal Reserve Banks provide banking services to depository institutions and to the federal government. For depository institutions, they maintain accounts and provide various payment services, including collecting checks, electronically transferring funds, and distributing and receiving currency and coin. For the federal government, the Reserve Banks act as fiscal agents, paying Treasury checks; processing electronic payments; and issuing, transferring, and redeeming U.S. government securities.

In passing the Depository Institutions Deregulation and Monetary Control Act of 1980, Congress reaffirmed its intention that the Federal Reserve should promote an efficient nationwide payments system. The act subjects all depository institutions, not just member commercial banks, to reserve requirements and grants them equal access to Reserve Bank payment services. It also encourages competition between the Reserve Banks and private-sector providers of payment services by requiring the Reserve Banks to charge fees for certain payments services listed in the act and to recover the costs of providing these services over the long run.

The Federal Reserve plays a vital role in both the nation’s retail and wholesale payments systems, providing a variety of financial services to depository institutions. Retail payments are generally for relatively small-dollar amounts and often involve a depository institution’s retail clients—individuals and smaller businesses. The Reserve Banks’ retail services include distributing currency and coin, collecting checks, and electronically transferring funds through the automated clearinghouse system. By contrast, wholesale payments are generally for large-dollar amounts and often involve a depository institution’s large corporate customers or counterparties, including other financial institutions. The Reserve Banks’ wholesale services include electronically transferring funds through the Fedwire Funds Service and transferring securities issued by the U.S. government, its agencies, and certain other entities through the Fedwire Securities Service. Because of the large amounts of funds that move through the Reserve Banks every day, the System has policies and procedures to limit the risk to the Reserve Banks from a depository institution’s failure to make or settle its payments.

The Federal Reserve Banks began a multi-year restructuring of their check operations in 2003 as part of a long-term strategy to respond to the declining use of checks by consumers and businesses and the greater use of electronics in check processing. The Reserve Banks will have reduced the number of full-service check processing locations from 45 in 2003 to 4 by early 2011.[15]

Independent within government

These often cited works[16][17] are used to show why it is important for a nation's central bank (ie - monetary authority) to have a high level of independence.

This chart shows a clear trend towards a lower inflation rate as the independence of the central bank increases. The generally agreed upon reason independence leads to lower inflation is that politicians have a tendency to create too much money if given the opportunity to do it. The Federal Reserve System in the United States is generally regarded as one of the more independent central banks.

The Federal Reserve System is an independent government institution that has private aspects. The System is not a private organization and does not operate for the purpose of making a profit.

The stocks of the regional federal reserve banks are owned by the banks operating within that region and which are part of the system.[18]

The System derives its authority and public purpose from the Federal Reserve Act passed by Congress in 1913. As an independent institution, the Federal Reserve System has the authority to act on its own without prior approval from Congress or the President.[19]

The members of its Board of Governors are appointed for long, staggered terms, limiting the influence of day-to-day political considerations.Structure and Functions—The Fed's Structure

The Federal Reserve System's unique structure also provides internal checks and balances, ensuring that its decisions and operations are not dominated by any one part of the system.

It also generates revenue independently without need for Congressional funding. Congressional oversight and statutes, which can alter the Fed's responsibilities and control, allow the government to keep the Federal Reserve System in check. Since the System was designed to be independent whilst also remaining within the government of the United States, it is often said to be "independent within the government."

Thus, there has never been an audit of the System that was not kept a proprietary secret, not even made available to Congress in closed session, which has motivated almost 200 Congressmen to sponsor the Federal Reserve Transparency Act.

The 12 Federal Reserve banks provide the financial means to operate the Federal Reserve System. Each reserve bank is organized much like a private corporation so that it can provide the necessary revenue to cover operational expenses and implement the demands of the board. Member banks are privately owned banks that must buy a certain amount of stock in the Reserve Bank within its region to be a member of the Federal Reserve System. This stock "may not be sold, traded, or pledged as security for a loan" and all member banks receive a 6% annual dividend.

No stock in any Federal Reserve Bank has ever been sold to the public, to foreigners, or to any non-bank U.S. firm. Money and the Federal Reserve System: Myth and Reality - CRS Report for Congress, No. 96-672

These member banks must maintain fractional reserves either as vault currency or on account at its Reserve Bank; member banks earn no interest on either of these. The dividends paid by the Federal Reserve Banks to member banks are considered partial compensation for the lack of interest paid on the required reserves. All profit after expenses is returned to the U.S. Treasury or contributed to the surplus capital of the Federal Reserve Banks (and since shares in ownership of the Federal Reserve Banks are redeemable only at par, the nominal "owners" do not benefit from this surplus capital); the Federal Reserve system contributed over $29 billion to the Treasury in 2006.[20]

Audit of the Federal Reserve

Board of Governors

The seven-member Board of Governors is the main governing body of the Federal Reserve System. It is charged with overseeing the 12 District Reserve Banks and with helping implement national monetary policy.

Governors are appointed by the President of the United States and confirmed by the Senate one on January 31 of every even-numbered year, for staggered, 14-year terms.

By law, the appointments must yield a "fair representation of the financial, agricultural, industrial, and commercial interests and geographical divisions of the country," and as stipulated in the Banking Act of 1935, the Chairman and Vice Chairman of the Board are one of seven members of the Board of Governors who are appointed by the President from among the sitting Governors. (USC 12-241)[21]

As an independent federal government agency, Kennedy C. Scott v. Federal Reserve Bank of Kansas City, et al., 406 F.3d 532,(8th Cir. 2005) the Board of Governors does not receive funding from Congress, and the terms of the seven members of the Board span multiple presidential and congressional terms.

Once a member of the Board of Governors is appointed by the president, he or she functions mostly independently. The Board is required to make an annual report of operations to the Speaker of the U.S. House of Representatives.(USC 12|247).

It also supervises and regulates the operations of the Federal Reserve Banks, and US banking system in general.

Membership is generally limited to one term. However, if someone is appointed to serve the remainder of another member's uncompleted term, he or she may be reappointed to serve an additional 14-year term.

Conversely, a governor may serve the remainder of another governor's term even after he or she has completed a full term. The law provides for the removal of a member of the Board by the President "for cause." (USC 12|242)

The current members of the Board of Governors are:

  • Ben Bernanke, Chairman
  • Donald Kohn, Vice-Chairman
  • Kevin Warsh
  • Elizabeth Duke
  • Daniel Tarullo
  • Vacancy*
  • Vacancy*

Chairman Bernanke reappointed

On August 25, 2009 President Obama renominated Ben Bernanke to serve a second term as Chairman of the Federal Reserve. The Senate must confirm the nomination.

Three nominees clear Senate Banking Committee

The U.S. Senate Banking Committee on Wednesday approved the nomination of three new members to the Federal Reserve's powerful board, including Janet Yellen for vice chairman, clearing the way for a final vote by the whole Senate.

If the nominees, including Maryland regulator Sarah Raskin and MIT professor Peter Diamond, win confirmation, it would bring the central bank's board up to full strength -- with all seven members in place -- for the first time since early 2006.

The three nominees could give the Fed's board a somewhat dovish tilt when it comes to monetary policy. Yellen, who is currently president of the San Francisco Federal Reserve Bank, has consistently argued for an easy policy to help revive the economy and create jobs.

Raskin's nomination sailed through the panel on a 21-2 vote, but the panel voted 18-5 on Yellen's board nomination and 17-6 on her nomination to be No. 2. Diamond cleared on a 16-7 vote with the panel's top Republican voicing disapproval.

"I do not believe he is ready to be a member of the Federal Reserve," Senator Richard Shelby of Alabama said. "I do not believe the current environment of uncertainty would benefit from monetary policy decisions made by board members who are learning on the job."

Vice Chair Kohn submits resignation

Donald L. Kohn submitted his intent to resign Monday as a member of the Board of Governors of the Federal Reserve System, effective at the expiration of his term as Vice Chairman on June 23, 2010.

Kohn, who has been a member of the Board since August 2002 and served as its Vice Chairman since June 2006, submitted his letter to President Obama.

"The Federal Reserve and the country owe a tremendous debt of gratitude to Don Kohn for his invaluable contributions over 40 years of public service," Federal Reserve Chairman Ben S. Bernanke said. "Most recently, he brought his deep knowledge, experience, and wisdom to bear in helping to coordinate the Federal Reserve's response to the economic and financial crisis. In addition, Don helped lead the stress tests of major financial institutions; he directed the Board's ongoing efforts to increase the transparency of the Federal Reserve; and he has been leading an international effort within the Bank for International Settlements to help central banks focus on key issues and responses to the crisis. On a personal note, I would like to express my deep appreciation for Don's friendship and counsel during some very difficult times. He will be greatly missed."

Dr. Kohn was born in November 1942 in Philadelphia, Pennsylvania. He received a B.A. in economics in 1964 from the College of Wooster and a Ph.D. in economics in 1971 from the University of Michigan.

Dr. Kohn is a veteran of the Federal Reserve System. Before becoming a member of the Board, he served on its staff as Adviser to the Board for Monetary Policy (2001-02), Secretary of the Federal Open Market Committee (1987-2002), Director of the Division of Monetary Affairs (1987-2001), and Deputy Staff Director for Monetary and Financial Policy (1983-87). He also held several positions in the Board's Division of Research and Statistics: Associate Director (1981-83), Chief of Capital Markets (1978-81), and Economist (1975-78). Dr. Kohn began his career as a Financial Economist at the Federal Reserve Bank of Kansas City (1970-75).

Dr. Kohn has written extensively on issues related to monetary policy and its implementation by the Federal Reserve.

He was awarded the Distinguished Achievement Award from The Money Marketeers of New York University (2002), the Distinguished Alumni Award from the College of Wooster (1998), and the Honorary Degree, Doctor of Laws, from the College of Wooster (2006).

Dr. Kohn is the Chairman of the Committee on the Global Financial System (CGFS), an international central bank panel that monitors and examines broad issues related to financial markets and systems.

Dr. Kohn is married and has two adult children and four grandchildren.

A copy of his letter is attached.

Federal Reserve creates "term deposits"

The Board is amending Regulation D, Reserve Requirements of Depository Institutions, to authorize Reserve Banks to offer term deposits. Term deposits are intended to facilitate the conduct of monetary policy by providing a tool for managing the aggregate quantity of reserve balances.

Institutions eligible to receive earnings on their balances in accounts at Federal Reserve Banks (“eligible institutions”) may hold term deposits and receive earnings at a rate that does not exceed the general level of short-term interest rates.

Term deposits are separate and distinct from balances maintained in an institution’s master account at a Reserve Bank (“master account”) as well as from those maintained in an excess balance account. Term deposits do not satisfy an institution’s required reserve balance or contractual clearing balance and do not constitute excess balances.

Term deposits are not available to clear payments and may not be used to reduce an institution’s daylight or overnight overdrafts. The Board is also making minor amendments to the posting rules for intraday debits and credits to master accounts as set forth in the Board’s Policy on Payment System Risk to address transactions associated with term deposits.

Federal Open Market Committee

The Federal Open Market Committee (FOMC) created under (USC 12|263) comprises the seven members of the board of governors and five representatives selected from the regional Federal Reserve Banks. The FOMC is charged under law with overseeing open market operations, the principal tool of national monetary policy. These operations affect the amount of Federal Reserve balances available to depository institutions, thereby influencing overall monetary and credit conditions. The FOMC also directs operations undertaken by the Federal Reserve in foreign exchange markets. The representative from the Second District, New York, is a permanent member, while the rest of the banks rotate at two- and three-year intervals.

All the presidents participate in FOMC discussions, contributing to the committee’s assessment of the economy and of policy options, but only the five presidents who are committee members vote on policy decisions. The FOMC, under law, determines its own internal organization and by tradition elects the Chairman of the Board of Governors as its chairman and the president of the Federal Reserve Bank of New York as its vice chairman. Formal meetings typically are held eight times each year in Washington, D.C. Nonvoting Reserve Bank presidents also participate in Committee deliberations and discussion. The FOMC generally meets eight times a year in Telephone consultations and other meetings are held when needed.

Transparency issues

There has been considerable debate over a lack of transparency as to what is discussed in Federal Open Market Committee meetings. [22][23][24]

Since the FOMC sets monetary policy, which affects the entire U.S. economy, many people feel that it is important to know what the FOMC is doing.

January 26-27, 2010]

Federal Reserve Banks

There are 12 regional Federal Reserve Banks (not to be confused with the "member banks") with 25 branches, which serve as the operating arms of the system. Each Federal Reserve Bank is subject to oversight by a Board of Governors. (See generally USC 12|248)

Each Federal Reserve Bank has a board of directors, whose members work closely with their Reserve Bank president to provide grassroots economic information and input on management and monetary policy decisions. These boards are drawn from the general public and the banking community and oversee the activities of the organization. They also appoint the presidents of the Reserve Banks, subject to the approval of the Board of Governors. Reserve Bank boards consist of nine members: six serving as representatives of nonbanking enterprises and the public (nonbankers) and three as representatives of banking. Each Federal Reserve branch office has its own board of directors, composed of three to seven members, that provides vital information concerning the regional economy.[http://www.dallasfed.org/educate/everyday/ev4.html

The Reserve Banks opened for business on November 16, 1914. Federal Reserve Notes were created as part of the legislation, to provide a supply of currency. The notes were to be issued to the Reserve Banks for subsequent transmittal to banking institutions. The various components of the Federal Reserve System have differing legal statuses.

Legal status

The Federal Reserve Banks have an intermediate legal status, with some features of private corporations and some features of public federal agencies. Each member bank owns nonnegotiable shares of stock in its regional Federal Reserve Bank—but these shares of stock give the member banks only limited control over the actions of the Federal Reserve Banks, and the charter of each Federal Reserve Bank is established by law and cannot be altered by the member banks. While it is unusual, private individuals and non-bank corporations (with proof of a resolution of the board of directors indicating it intends to do so) may also purchase one or more shares of stock of any of the Federal Reserve Banks.

The stock is the same nonnegotiable stock as banks receive, cannot be sold and pays a small dividend. In Lewis v. United States,680 F.2d 1239 (9th Cir. 1982), the United States Court of Appeals for the Ninth Circuit stated that:

"The Reserve Banks are not federal instrumentalities for purposes of the FTCA (the Federal Tort Claims Act), but are independent, privately owned and locally controlled corporations."

The opinion also stated that:

"The Reserve Banks have properly been held to be federal instrumentalities for some purposes."

Another decision is Scott v. Federal Reserve Bank of Kansas City (Scott 8th Cir. 2005)in which the distinction between the Federal Reserve Banks and the Board of Governors is made.

Organization of the Federal Reserve

Board of Directors

A list of all of the members of the Reserve Banks' boards of directors is published by the Federal Reserve. [25]


The Federal Reserve Act provides[26] that the president of a Federal Reserve Bank shall be the chief executive officer of the Bank, appointed by the board of directors of the Bank, with the approval of the Board of Governors of the Federal Reserve System, for a term of five years.

The terms of all the presidents of the twelve District Banks run concurrently, ending on the last day of February of years numbered 6 and 1 (for example, 2001, 2006, and 2011). The appointment of a president who takes office after a term has begun ends upon the completion of that term. A president of a Reserve Bank may be reappointed after serving a full term or an incomplete term.

Reserve Bank presidents are subject to mandatory retirement upon becoming 65 years of age. However, presidents initially appointed after age 55 can, at the option of the board of directors, be permitted to serve until attaining ten years of service in the office or age 70, whichever comes first.

Primary Dealers

See primay dealers Between them, these dealers purchase the vast majority of the U.S. Treasury securities.

Member Banks

Each member bank is a private bank (e.g., a privately owned corporation) that holds stock in one of the twelve regional Federal Reserve banks.

All of the commercial banks in the United States can be divided into three types according to which governmental body charters them and whether or not they are members of the Federal Reserve System:

  • National banks --- Those chartered by the federal government (through the Office of the Comptroller of the Currency in the Department of the Treasury); by law, they are members of the Federal Reserve System.
  • State member banks --- Those chartered by the states who are members of the Federal Reserve System.
  • State nonmember banks ---|Those chartered by the states who are not members of the Federal Reserve System.

All nationally chartered banks hold stock in one of the Federal Reserve banks. State-chartered banks may choose to be members (and hold stock in a regional Federal Reserve bank), upon meeting certain standards.

Holding stock in a Federal Reserve bank is not, however, like owning publicly traded stock. The stock cannot be sold or traded. Member banks receive a fixed, 6 percent dividend annually on their stock, and they do not directly control the applicable Federal Reserve bank as a result of owning this stock. They do, however, elect six of the nine members of Reserve banks’ boards of directors.

Federal statute provides (in part):

"Every national bank in any State shall, upon commencing business or within ninety days after admission into the Union of the State in which it is located, become a member bank of the Federal Reserve System by subscribing and paying for stock in the Federal Reserve bank of its district in accordance with the provisions of this chapter and shall thereupon be an insured bank under the Federal Deposit Insurance Act [. . . .](USC 12|222)

Other banks may elect to become member banks. According to the Federal Reserve Bank of Boston:

"Any state-chartered bank (mutual or stock-formed) may become a member of the Federal Reserve System. The twelve regional Reserve Banks supervise state member banks as part of the Federal Reserve System’s mandate to assure strength and stability in the nation’s domestic markets and banking system. Reserve Bank supervision is carried out in partnership with the state regulators, assuring a consistent and unified regulatory environment. Regional and community banking organizations constitute the largest number of banking organizations supervised by the Federal Reserve System."[27]

For example, as of October 2006 the member banks in New Hampshire included Community Guaranty Savings Bank; The Lancaster National Bank; The Pemigewasset National Bank of Plymouth; and other banks.[28]

In California, member banks (as of September 2006) included Bank of America California, National Association; The Bank of New York Trust Company, National Association; Barclays Global Investors, National Association; and many other banks.[29]

List of member banks

The majority of US banks are not members of the Federal Reserve system.

FDIC-insured banks. N (national banks) and SM (state members) are members of the Federal Reserve System while the rest of the FDIC-insured banks are not members.

Each charter type is defined as follows:

  • SM = commercial bank, state charter and Fed member, supervised by the Federal Reserve (FRB)
  • NM = commercial bank, state charter and Fed nonmember, supervised by the FDIC
  • OI = insured U.S. branch of a foreign chartered institution (IBA)
  • SB = savings banks, state charter, supervised by the FDIC

While the OI, SA, and SB categories are not members of the system, they are sometimes treated as if they were members under certain circumstances.US CODE: Title 12,1468 Transactions with affiliates; extensions of credit to executive officers, directors, and principal shareholders

A list of all member banks can be found at the website of the Federal Deposit Insurance Corporation (FDIC). Most commercial banks in the United States are not members of the Federal Reserve System, but the total value of all the banking assets of member banks is substantially larger than the total value of the banking assets of nonmembers.[30]

Advisory Committees

The Federal Reserve System uses advisory committees in carrying out its varied responsibilities. Three of these committees advise the Board of Governors directly:

  • Federal Advisory Council
  • Consumer Advisory Council
  • Thrift Institutions Advisory Council

Of these advisory committees, perhaps the most important are the committees (one for each Reserve Bank) that advise the Banks on matters of agriculture, small business, and labor. Biannually, the Board solicits the views of each of these committees by mail.

Consumer Advisory Council

The Council's function is to advise the Board on the exercise of its responsibilities under various consumer financial services laws and on other matters on which the Board seeks its advice. Time permitting, the Council will discuss the following topics:

  • Proposed rules to implement the Credit Card Accountability Responsibility and Disclosure Act of 2009
  • Foreclosure issues
  • Short-term and small-dollar loan products

Reports by committees and other matters initiated by Council members may also be discussed. The Board invites comments from the public on any of these matters.

The Board's notice is attached.

Monetary policy

The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals. What happens to money and credit affects interest rates (the cost of credit) and the performance of the U.S. economy.

The Federal Reserve Act of 1913 gave the Federal Reserve responsibility for setting monetary policy.[31] [32]

Interbank lending is the basis of policy

The Federal Reserve implements monetary policy by influencing the interbank lending of excess reserves. The rate that banks charge each other for these loans is determined by the markets but the Federal Reserve influences this rate through the three tools of monetary policy which are described in the "Tools" section below. This is a short-term interest rate the FOMC focuses on directly. This rate ultimately effects the longer-term interest rates throughout the economy. A summary of the basis and implementation of monetary policy is stated by the Federal Reserve:

"The Federal Reserve implements U.S. monetary policy by affecting conditions in the market for balances that depository institutions hold at the Federal Reserve Banks...By conducting open market operations, imposing reserve requirements, permitting depository institutions to hold contractual clearing balances, and extending credit through its discount window facility, the Federal Reserve exercises considerable control over the demand for and supply of Federal Reserve balances and the federal funds rate. Through its control of the federal funds rate, the Federal Reserve is able to foster financial and monetary conditions consistent with its monetary policy objectives."

This influences the economy through its effect on the quantity of reserves that banks use to make loans. Policy actions that add reserves to the banking system encourage lending at lower interest rates thus stimulating growth in money, credit, and the economy. Policy actions that absorb reserves work in the opposite direction. The Fed's task is to supply enough reserves to support an adequate amount of money and credit, avoiding the excesses that result in inflation and the shortages that stifle economic growth.[33]

The goals of monetary policy include:

  • maximum employment
  • stable prices
  • moderate long-term interest rates
  • promotion of sustainable economic growth


There are three main tools of monetary policy that the Federal Reserve uses to influence the amount of reserves in private banks:

Tool Description
open market operations purchases and sales of U.S. Treasury and federal agency securities—the Federal Reserve's principal tool for implementing monetary policy. The Federal Reserve's objective for open market operations has varied over the years. During the 1980s, the focus gradually shifted toward attaining a specified level of the federal funds rate (the rate that banks charge each other for overnight loans of federal funds, which are the reserves held by banks at the Fed), a process that was largely complete by the end of the decade.[34]
discount rate the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility—the discount window.[35]
reserve requirements the amount of funds that a depository institution must hold in reserve against specified deposit liabilities.[36]

Open market operations

Open market operations put money in and take money out of the banking system. This is done through the sale and purchase of U.S. government treasury securities. When the U.S. government sells securities, it gets money from the banks and the banks get a piece of paper (I.O.U.) that says the U.S. government owes the bank money. This drains money from the banks. When the U.S. government buys securities, it gives money to the banks and the banks give the I.O.U. back to the U.S. government. This puts money back into the banks. The Federal Reserve education website describes open market operations as follows:

Open market operations involve the buying and selling of U.S. government securities (federal agency and mortgage-backed). The term 'open market' means that the Fed doesn’t decide on its own which securities dealers it will do business with on a particular day. Rather, the choice emerges from an 'open market' in which the various securities dealers that the Fed does business with—the primary dealers—compete on the basis of price. Open market operations are flexible and thus, the most frequently used tool of monetary policy.

Open market operations are the primary tool used to regulate the supply of bank reserves. This tool consists of Federal Reserve purchases and sales of financial instruments, usually securities issued by the U.S. Treasury, Federal agencies and government-sponsored enterprises. Open market operations are carried out by the Domestic Trading Desk of the Federal Reserve Bank of New York under direction from the FOMC. The transactions are undertaken with primary dealers.

The Fed’s goal in trading the securities is to affect the federal funds rate, the rate at which banks borrow reserves from each other. When the Fed wants to increase reserves, it buys securities and pays for them by making a deposit to the account maintained at the Fed by the primary dealer’s bank. When the Fed wants to reduce reserves, it sells securities and collects from those accounts. Most days, the Fed does not want to increase or decrease reserves permanently so it usually engages in transactions reversed within a day or two. That means that a reserve injection today could be withdrawn tomorrow morning, only to be renewed at some level several hours later. These short-term transactions are called repurchase agreements (repos) – the dealer sells the Fed a security and agrees to buy it back at a later date."

A simpler description is described in The Federal Reserve in Plain English:

"How do open market operations actually work? Currently, the FOMC establishes a target for the federal funds rate (the rate banks charge each other for overnight loans). Open market purchases of government securities increase the amount of reserve funds that banks have available to lend, which puts downward pressure on the federal funds rate. Sales of government securities do just the opposite—they shrink the reserve funds available to lend and tend to raise the funds rate.

By targeting the federal funds rate, the FOMC seeks to provide the monetary stimulus required to foster a healthy economy. After each FOMC meeting, the funds rate target is announced to the public.

Repurchase agreements

To smooth temporary or cyclical changes in the monetary supply, the desk engages in repurchase agreements (repos) with its primary dealers.

Repos are essentially secured, short-term lending by the Fed. On the day of the transaction, the Fed deposits money in a primary dealer’s reserve account, and receives the promised securities as collateral.

When the transaction matures, the process unwinds: the Fed returns the collateral and charges the primary dealer’s reserve account for the principal and accrued interest. The term of the repo (the time between settlement and maturity) can vary from 1 day (called an overnight repo) to 65 days.[37]

Federal funds rate and discount rate

The Federal Reserve System implements monetary policy largely by targeting the federal funds rate. This is the rate that banks charge each other for overnight loans of federal funds, which are the reserves held by banks at the Fed. This rate is actually determined by the market and is not explicitly mandated by the Fed.

The Fed therefore tries to align the effective federal funds rate with the targeted rate by adding or subtracting from the money supply through open market operations. The late economist Milton Friedman consistently criticized this reverse method of controlling inflation by seeking an ideal interest rate and enforcing it through affecting the money supply since nowhere in the widely accepted money supply equation are interest rates found.[38]

The Federal Reserve System also directly sets the "discount rate", which is the interest rate for "discount window lending", overnight loans that member banks borrow directly from the Fed. This rate is generally set at a rate close to 100 basis points above the target federal funds rate.

The idea is to encourage banks to seek alternative funding before using the "discount rate" option. The equivalent operation by the European Central Bank is referred to as the "marginal lending facility." ("A Look Inside Two Central Banks: The European Central Bank And The Federal Reserve", Volume 85, Issue 2, Federal Reserve Bank of St. Louis, 2003)

Both of these rates influence the prime rate which is usually about 3 percentage points higher than the federal funds rate.

Lower interest rates stimulate economic activity by lowering the cost of borrowing, making it easier for consumers and businesses to buy and build, but at the cost of promoting the expansion of the money supply and thus greater inflation. Higher interest rates may slow the economy by increasing the cost of borrowing. (See monetary policy for a fuller explanation.)

The Federal Reserve System usually adjusts the federal funds rate by 0.25% or 0.50% at a time.

The Federal Reserve System might also attempt to use open market operations to change long-term interest rates, but its "buying power" on the market is significantly smaller than that of private institutions. The Fed can also attempt to "jawbone" the markets into moving towards the Fed's desired rates, but this is not always effective.

Reserve requirements

Another instrument of monetary policy adjustment employed by the Federal Reserve System is the fractional reserve requirement, also known as the required reserve ratio.[1] The required reserve ratio sets the balance that the Federal Reserve System requires a depository institution to hold in the Federal Reserve Banks,[2] which depository institutions trade in the federal funds market discussed above.[3] The required reserve ratio is set by the Board of Governors of the Federal Reserve System.[4] The reserve requirements have changed over a time and some of the history of these changes is published by the Federal Reserve.[5]

Reserve Requirements in the U.S. Federal Reserve System[6]
Type of liability Requirement
Percentage of liabilities Effective date
Net transaction accounts
$0 to $10.3 million 0 01/01/09
More than $10.3 million to $44.4 million 3 01/01/09
More than $44.4 million 10 01/01/09

Nonpersonal time deposits 0 12/27/90

Eurocurrency liabilities 0 12/27/90

New facilities

In order to address problems related to the subprime mortgage crisis and United States housing bubble, several new tools have been created. The first new tool, called the Term Auction Facility, was added on December 12, 2007. It was first announced as a temporary tool but there have been suggestions that this new tool may remain in place for a prolonged period of time.[39]

Creation of the second new tool, called the Term Securities Lending Facility, was announced on March 11, 2008.[40]

The main difference between these two facilities is that the Term Auction Facility is used to inject cash into the banking system whereas the Term Securities Lending Facility is used to inject Treasury securities into the banking system.[41]

"The step goes beyond past initiatives because the Fed can now inject liquidity without flooding the banking system with cash...Unlike the newest tool, the past steps added cash to the banking system, which affects the Fed's benchmark interest rate...By contrast, the TSLF injects liquidity by lending Treasuries, which doesn't affect the federal funds rate. That leaves the Fed free to address the mortgage crisis directly without concern about adding more cash to the system than it wants"

Creation of the third tool, called the Primary Dealer Credit Facility (PDCF), was announced on March 16, 2008.[42] The PDCF was a fundamental change in Federal Reserve policy because now the Fed is able to lend directly to primary dealers, which was previously against Fed policy.[43]

The differences between these 3 new facilities is described by the Federal Reserve:[44]

"The Term Auction Facility program offers term funding to depository institutions via a bi-weekly auction, for fixed amounts of credit. The Term Securities Lending Facility will be an auction for a fixed amount of lending of Treasury general collateral in exchange for OMO-eligible and AAA/Aaa rated private-label residential mortgage-backed securities. The Primary Dealer Credit Facility now allows eligible primary dealers to borrow at the existing Discount Rate for up to 120 days."

Some of the measures taken by the Federal Reserve to address this mortgage crisis haven't been used since The Great Depression[45]

The Federal Reserve gives a brief summary of what these new facilities are all about:[46]

"As the economy has slowed in the last nine months and credit markets have become unstable, the Federal Reserve has taken a number of steps to help address the situation. These steps have included the use of traditional monetary policy tools at the macroeconomic level as well as measures at the level of specific markets to provide additional liquidity.

The Federal Reserve's response has continued to evolve since pressure on credit markets began to surface last summer, but all these measures derive from the Fed's traditional open market operations and discount window tools by extending the term of transactions, the type of collateral, or eligible borrowers."

Term auction facility

The Term Auction Facility is a program in which the Federal Reserve auctions term funds to depository institutions.[47]

The creation of this facility was announced by the Federal Reserve on December 12, 2007 and was done in conjunction with the Bank of Canada, the Bank of England, the European Central Bank, and the Swiss National Bank to address elevated pressures in short-term funding markets.[48]

The reason it was created is because banks were not lending funds to one another and banks in need of funds were refusing to go to the discount window. Banks were not lending money to each other because there was a fear that the loans would not be paid back. Banks refused to go to the discount window because it is usually associated with the stigma of bank failure.[49]

'Before its introduction, banks either had to raise money in the open market or use the so-called “discount window” for emergencies. However, last year many banks refused to use the discount window, even though they found it hard to raise funds in the market, because it was associated with the stigma of bank failure.'[50]

"The Board of Governors of the Federal Reserve System established the temporary Term Auction Facility, dubbed TAF, in December to provide cash after interest-rate cuts failed to break banks' reluctance to lend amid concern about losses related to subprime mortgage securities. The program will make funding from the Fed available beyond the 20 authorized primary dealers that trade with the central bank." [51] A quote from the article:

"The Fed's discount window, for instance, through which it lends direct to banks, has barely been approached, despite the soaring spreads in the interbank market. The quarter-point cuts in its federal funds rate and discount rate on December 11 were followed by a steep sell-off in the stockmarket...The hope is that by extending the maturity of central-bank money, broadening the range of collateral against which banks can borrow and shifting from direct lending to an auction, the central bankers will bring down spreads in the one- and three-month money markets. There will be no net addition of liquidity. What the central bankers add at longer-term maturities, they will take out in the overnight market.

But there are risks. The first is that, for all the fanfare, the central banks' plan will make little difference. After all, it does nothing to remove the fundamental reason why investors are worried about lending to banks. This is the uncertainty about potential losses from subprime mortgages and the products based on them, and—given that uncertainty—the banks' own desire to hoard capital against the chance that they will have to strengthen their balance sheets."[52]

Under the Term Auction Facility, the identity of the banks in need of funds is protected in order to avoid the stigma of bank failure.[53]

Foreign exchange swap lines with the European Central Bank and Swiss National Bank were opened so the banks in Europe could have access to U.S. dollars.

Federal Reserve Chairman Ben Bernanke briefly described this facility to the U.S. House of Representatives on January 17, 2008:

"The Federal Reserve recently unveiled a term auction facility, or TAF, through which prespecified amounts of discount window credit can be auctioned to eligible borrowers. The goal of the TAF is to reduce the incentive for banks to hoard cash and increase their willingness to provide credit to households and firms...TAF auctions will continue as long as necessary to address elevated pressures in short-term funding markets, and we will continue to work closely and cooperatively with other central banks to address market strains that could hamper the achievement of our broader economic objectives."

Chairman Ben S. Bernanke—The economic outlook Before the Committee on the Budget, U.S. House of Representatives January 17, 2008: [54]

"The TAF is a credit facility that allows a depository institution to place a bid for an advance from its local Federal Reserve Bank at an interest rate that is determined as the result of an auction. By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could help ensure that liquidity provisions can be disseminated efficiently even when the unsecured interbank markets are under stress.

In short, the TAF will auction term funds of approximately one-month maturity. All depository institutions that are judged to be in sound financial condition by their local Reserve Bank and that are eligible to borrow at the discount window are also eligible to participate in TAF auctions. All TAF credit must be fully collateralized. Depositories may pledge the broad range of collateral that is accepted for other Federal Reserve lending programs to secure TAF credit. The same collateral values and margins applicable for other Federal Reserve lending programs will also apply for the TAF."

Term securities lending facility

The Term Securities Lending Facility is a 28-day facility that will offer Treasury general collateral to the Federal Reserve Bank of New York’s primary dealers in exchange for other program-eligible collateral. It is intended to promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally. [55] Like the Term Auction Facility, the TSLF was done in conjunction with the Bank of Canada, the Bank of England, the European Central Bank, and the Swiss National Bank.

The resource allows dealers to switch debt that is less liquid for U.S. government securities that are easily tradable. It is anticipated by Federal Reserve officials that the primary dealers, which include Goldman Sachs Group. Inc., Bear Stearns Cos. and Merrill Lynch & Co., will lend the Treasuries on to other firms in return for cash. That will help the dealers finance their balance sheets.[56] The currency swap lines with the European Central Bank and Swiss National Bank were increased.

Primary dealer credit facility The Primary Dealer Credit Facility (PDCF) is an overnight loan facility that will provide funding to primary dealers in exchange for a specified range of eligible collateral and is intended to foster the functioning of financial markets more generally.[7] This new facility marks a fundamental change in Federal Reserve policy because now primary dealers can borrow directly from the Fed when this previously was not permitted.

Interest on reserves

As of October, 2008, the Federal Reserve banks will pay interest on reserve balances (required & excess) held by depository institutions. The rate is set at the lowest federal funds rate during the reserve maintenance period of an institution, less 75 basis points.[57]

As of October 23, 2008, the Fed has lowered the spread to a mere 35 bp.[58]

Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility

The Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (ABCPMMMFLF) is also called the AMLF. Borrower Eligibility:

All U.S. depository institutions, bank holding companies (parent companies or U.S. broker-dealer affiliates), or U.S. branches and agencies of foreign banks are eligible to borrow under this facility pursuant to the discretion of the FRBB.

Eligible Collateral:

Collateral eligible for pledge under the Facility must meet the following criteria:

  • was purchased by Borrower on or after September 19, 2008 from a registered investment company that holds itself out as a money market mutual fund;
  • was purchased by Borrower at the Fund’s acquisition cost as adjusted for amortization of premium or accretion of discount on the ABCP through the date of its purchase by Borrower;
  • is rated at the time pledged to FRBB, not lower than A1, F1, or P1 by at least two major rating agencies or, if rated by only one major rating agency, the ABCP must have been rated within the top rating category by that agency;
  • was issued by an entity organized under the laws of the United States or a political subdivision thereof under a program that was in existence on September 18, 2008; and
  • has a stated maturity that does not exceed 120 days if the Borrower is a bank or 270 days for non-bank Borrowers.

Commercial Paper Funding Facility

The Commercial Paper Funding Facility is also called the CPFF. On October 7, 2008 the Federal Reserve further expanded the collateral it will loan against, to include commercial paper.

The action made the Fed a crucial source of credit for non-financial businesses in addition to commercial banks and investment firms. Fed officials said they'll buy as much of the debt as necessary to get the market functioning again. They refused to say how much that might be, but they noted that around $1.3 trillion worth of commercial paper would qualify. There was $1.61 trillion in outstanding commercial paper, seasonally adjusted, on the market as of October 1, 2008, according to the most recent data from the Fed. That was down from $1.70 trillion in the previous week. Since the summer of 2007, the market has shrunk from more than $2.2 trillion.[59]

Money Market Investor Funding Facility

The Money Market Investor Funding Facility is also called the MMIFF. The Federal Reserve introduced a facility on October 21, 2008, whereby money market mutual funds can set up a structured investment vehicle of short-term assets which will be underwritten by the Federal Reserve Bank of New York.[60]

The program will run until April 30, 2009, unless extended by the FRB.

Quantitative policy

Another policy that can be used is a little used tool of the Federal Reserve (US central bank) that is known as the quantitative policy. With that the Federal Reserve actually buys back corporate bonds and mortgage backed securities held by banks or other financial institutions. This in affect puts money back into the financial institutions and allows them to make loans and conduct normal business.

The Federal Reserve Board used this policy in the early nineties when the US economy experienced the Savings and Loan crisis.


A few of the uncertainties involved in monetary policy decision making are described by the federal reserve:

  • While these policy choices seem reasonably straightforward, monetary policy makers routinely face certain notable uncertainties. First, the actual position of the economy and growth in aggregate demand at any time are only partially known, as key information on spending, production, and prices becomes available only with a lag. Therefore, policy makers must rely on estimates of these economic variables when assessing the appropriate course of policy, aware that they could act on the basis of misleading information. Second, exactly how a given adjustment in the federal funds rate will affect growth in aggregate demand—in terms of both the overall magnitude and the timing of its impact—is never certain. Economic models can provide rules of thumb for how the economy will respond, but these rules of thumb are subject to statistical error. Third, the growth in aggregate supply, often called the growth in potential output, cannot be measured with certainty.
  • In practice, as previously noted, monetary policy makers do not have up-to-the-minute information on the state of the economy and prices. Useful information is limited not only by lags in the construction and availability of key data but also by later revisions, which can alter the picture considerably. Therefore, although monetary policy makers will eventually be able to offset the effects that adverse demand shocks have on the economy, it will be some time before the shock is fully recognized and—given the lag between a policy action and the effect of the action on aggregate demand—an even longer time before it is countered. Add to this the uncertainty about how the economy will respond to an easing or tightening of policy of a given magnitude, and it is not hard to see how the economy and prices can depart from a desired path for a period of time.
  • The statutory goals of maximum employment and stable prices are easier to achieve if the public understands those goals and believes that the Federal Reserve will take effective measures to achieve them.
  • Although the goals of monetary policy are clearly spelled out in law, the means to achieve those goals are not. Changes in the FOMC’s target federal funds rate take some time to affect the economy and prices, and it is often far from obvious whether a selected level of the federal funds rate will achieve those goals.

Measurement of economic variables

A lot of data is recorded and published by the Federal Reserve. A few websites where data is published are at the Board of Governors Economic Data and Research page[61], the Board of Governors statistical releases and historical data page[62], and at the St. Louis Fed's FRED (Federal Reserve Economic Data) page.[63]

The Federal Open Market Committee (FOMC) examines many economic indicators prior to determining monetary policy.[64]

Net worth of households and nonprofit organizations

The net worth of households and nonprofit organizations in the United States is published by the Federal Reserve in a report titled, Flow of Funds.[65] At the end of fiscal year 2008, this value was $51.5 trillion.

Money supply

The most common measures are named M0 (narrowest), M1, M2, and M3. In the United States they are defined by the Federal Reserve as follows:

Measure Definition
M0 The total of all physical currency, plus accounts at the central bank that can be exchanged for physical currency.
M1 M0 + those portions of M0 held as reserves or vault cash + the amount in demand accounts ("checking" or "current" accounts).
M2 M1 + most savings accounts, money market accounts, and small denomination time deposits (certificates of deposit of under $100,000).
M3 M2 + all other CDs, deposits of eurodollars and repurchase agreements.

The Federal Reserve ceased publishing M3 statistics in March 2006, explaining that it cost a lot to collect the data but did not provide significantly useful information.[66]

The other three money supply measures continue to be provided in detail.

Consumer price index

The consumer price index is used as one measure of the value of the money. It is defined as:

"A measure of the average price level of a fixed basket of goods and services purchased by consumers as determined by the Bureau of Labor Statistics. Monthly changes in the CPI represent the rate of inflation. Core CPI excludes volatile components, i.e., food and energy prices."

The data consists of the US city average of consumer prices and can be found at The US Department of Labor's; Bureau of Labor Statistics[67]

The CPI taken alone is not a complete measure of the value of money. For example, the monetary value of stocks, real estate, and other goods and services categorized as investment vehicles are not reflected in the CPI. It is difficult to obtain a full picture of value across the full range of the cost of living, so the CPI is typically used as a substitute. The CPI therefore has powerful political ramifications, and Administrations of both parties have been tempted to change the basis for its calculation, progressively underestimating the true rate of decline in purchasing power.[68]

One of the Fed's main roles is to maintain price stability. This means that the change in the consumer price index over time should be as small as possible. The ability to maintain a low inflation rate is a long-term measure of the Fed's success.

Although the Fed usually tries to keep the year-on-year change in CPI between 2 and 3 percent,[69] there has been debate among policy makers as to whether or not the Federal Reserve should have a specific inflation targeting policy.[70][71][72]

Inflation and the economy

There are two types of inflation that are closely tied to each other. Monetary inflation is an increase in the money supply. Price inflation is a sustained increase in the general level of prices, which is equivalent to a decline in the value or purchasing power of money. If the supply of money and credit increases too rapidly over many months (monetary inflation), the result will usually be price inflation. Price inflation does not always increase in direct proportion to monetary inflation; it is also affected by the velocity of money and other factors. With price inflation, a dollar buys less and less over time.[8]

The effects of monetary and price inflation include:[8]

  • Price inflation makes workers worse off if their incomes don’t rise as rapidly as prices.
  • Pensioners living on a fixed income are worse off if their savings do not increase more rapidly than prices.
  • Lenders lose because they will be repaid with dollars that aren't worth as much.
  • Savers lose because the dollar they save today will not buy as much when they are ready to spend it.
  • Businesses and people will find it harder to plan and therefore may decrease investment in future projects.
  • Owners of financial assets suffer.
  • Interest rate-sensitive industries, like mortgage companies, suffer as monetary inflation drives up long-term interest rates and Federal Reserve tightening raises short-term rates.

'Unemployment rate'Bold text

The unemployment rate statistics are collected by the Bureau of Labor Statistics. Since one of the stated goals of monetary policy is maximum employment, the unemployment rate is a sign of the success of the Federal Reserve System.

Like the CPI, the unemployment rate is used as a barometer of the nation's economic health, and thus as a measure of the success of an administration's economic policies. Since 1980, both parties have made progressive changes in the basis for calculating unemployment, so that the numbers now quoted cannot be compared directly to the corresponding rates from earlier administrations, or to the rest of the world.[73]


The Federal Reserve is self-funded.

The vast majority (90%+) of Fed revenues come from open market operations, specifically the interest on the portfolio of Treasury securities as well as “capital gains/losses” that may arise from the buying/selling of the securities and their derivatives as part of Open Market Operations. The balance of revenues come from sales of financial services (check and electronic payment processing) and discount window loans.[74] The Board of Governors (Federal Reserve Board) creates a budget report once per year for Congress.

There are two reports with budget information. The one that lists the complete balance statements with income and expenses as well as the net profit or loss is the large report simply titled, Annual Report. It also includes data about employment throughout the system. The other report, which explains in more detail the expenses of the different aspects of the whole system, is called Annual Report: Budget Review. These are comprehensive reports with many details and can be found at the Board of Governors' website under the section Reports to Congress[75]

Net worth

Balance sheet

One of the keys to understanding the Federal Reserve is the Federal Reserve balance sheet (or balance statement). In accordance with Section 11 of the Federal Reserve Act, the Board of Governors of the Federal Reserve System publishes once each week the "Consolidated Statement of Condition of All Federal Reserve Banks" showing the condition of each Federal Reserve bank and a consolidated statement for all Federal Reserve banks.[76]

Federal Reserve statement of income for 2010===

The Federal Reserve Board on Monday announced preliminary unaudited results indicating that the Reserve Banks provided for payments of approximately $78.4 billion of their estimated 2010 net income of $80.9 billion to the U.S. Treasury. This represents a $31.0 billion increase in payments to the U.S. Treasury over 2009 ($47.4 billion of $53.4 billion of net income). The increase was due primarily to increased interest income earned on securities holdings during 2010.

Under the Board's policy, the residual earnings of each Federal Reserve Bank, after providing for the costs of operations, payment of dividends, and the amount necessary to equate surplus with capital paid-in, are distributed to the U.S. Treasury.

The Federal Reserve Banks' 2010 net income was derived primarily from $76.2 billion in income on securities acquired through open market operations (federal agency and government-sponsored enterprise (GSE) mortgage-backed securities, U.S. Treasury securities, and GSE debt securities); $7.1 billion in net income from consolidated limited liability companies (LLCs), which were created in response to the financial crisis; $2.1 billion in interest income from credit extended to American International Group, Inc.; $1.3 billion of dividends on preferred interests in AIA Aurora LLC and ALICO Holdings LLC; and $0.8 billion in interest income on loans extended under the Term Asset-Backed Securities Loan Facility (TALF) and loans to depository institutions. Additional earnings were derived primarily from revenue of $0.6 billion from the provision of priced services to depository institutions. The Reserve Banks had interest expense of $2.7 billion on depository institutions' reserve balances and term deposits.

Operating expenses of the Reserve Banks, net of amounts reimbursed by the U.S. Treasury and other entities for services the Reserve Banks provided as fiscal agents, totaled $4.3 billion in 2010. The Reserve Banks' operating expenses included assessments of $1.0 billion for Board expenditures and the cost of new currency. In 2010, statutory dividends totaled $1.6 billion and approximately $0.6 billion of net income was used to equate surplus to paid-in capital.

The preliminary unaudited results include valuation adjustments as of September 30 for TALF loans and consolidated LLCs. The final results, which will be presented in the Reserve Banks' annual audited financial statements and the Board of Governors' Annual Report, will reflect valuation adjustments as of December 31.

Federal Reserve profits in the financial crisis

"The Federal Reserve has made a $14bn (£8.6bn) profit on loan programmes that provided hundreds of billions of dollars in liquidity to the financial system since the start of the crisis two years ago, according to Fed officials.

The internal estimate is based on the difference between the fees and interest on the lending facilities and the interest the Fed would have earned had it invested the funds in three-month Treasury bills.

The central bank earned about $19bn in income from charging interest and fees to financial institutions and investors that tapped the new facilities to obtain much-needed funds during the turmoil. The interest the Fed would have earned by investing the same amount in T-bills was an estimated $5bn, leaving a $14bn gain since August 2007.

The Fed assessment underlines the possibility that other central banks could make a profit on their crisis-fighting measures - at least before adjusting for the risk they assumed.

The calculation, which has neither been audited, published nor risk-adjusted, only deals with its liquidity facilities.

Those include discount window and Term Auction Facility loans to banks, currency swaps with other central banks, purchases of commercial paper and financing for investors in asset-backed securities.

The figure is not a complete picture of Fed finances as it excludes its company-specific bail-outs and purchases of long-term assets.

The central bank is still exposed to the risk of substantial losses on its Maiden Lane portfolios - pools of assets financed as part of the bail-outs of Bear Stearns and AIG.

And the estimates do not include unrealised gains or losses on the Fed's portfolio of mortgage-backed securities and Treasuries purchased as part of its $1,750bn asset purchase programme that provides an additional stimulus to the economy.

The central bank earns interest on these securities as it does on its loans. But it could face losses if it has to sell them when interest rates are higher than when it purchased them.

The Fed declined to comment.

Some politicians have criticised the Fed for using billions of dollars of public funds to support the market and stricken groups such as AIG and Bear. The Fed's balance sheet has ballooned from $800bn in 2007 to about $2,000bn."


Many kinds of criticisms have been directed against the Federal Reserve System over the years. One critique, typified by the heterodox Austrian School, is that the Federal Reserve is an unnecessary and counterproductive interference in the economy.[77]

According to this theory, interest rates should be naturally low during times of excessive consumer saving (because lendable money is abundant) and naturally high when high net volumes of consumer credit are extended (because lendable money is scarce). These critics argue that setting a baseline lending rate amounts to centralized economic planning; a hallmark of socialist and communist societies; and inflating the currency amounts to a regressive, incremental redistribution of wealth.

Others state that the Federal Reserve System supports fractional-reserve banking, which they claim resembles an unsustainable pyramid scheme.

According to the Austrian Business Cycle Theory, a fiat money system is unsustainable, because the money supply must expand exponentially in order for all loans to be paid back with interest.

This theory is dismissed among some mainstream economists (Friedman, Milton "The Optimal Quantity of Money and Other Essays, pg 261–284)(Monetary Studies of the National Bureau, 44th Annual Report)(Friedman, Milton, "The 'Plucking Model' of Business Fluctuations Revisited", Economic Inquiry, pg 171–177)(Gordon Tullock, "Why the Austrians are wrong about depressions", The Review of Austrian Economics, Vol 2, Issue 1, 1988, pg 73–78) [78][79]

At one end of the spectrum are economic thinkers, such as Milton Friedman or the Austrian School, who want the Federal Reserve System abolished.[80]

They criticize the Federal Reserve System’s expansionary monetary policy in the 1920s, arguing that the policy allowed misallocations of capital resources and supported a massive stock price bubble much like today.

Legality' Some critics state that the Federal Reserve System is unconstitutional because Congress is empowered by the Constitution to coin money, and is not empowered to print money. Congressman Ron Paul, for example, argues that:

"The United States Constitution grants to Congress the authority to coin money and regulate the value of the currency. The Constitution does not give Congress the authority to delegate control over monetary policy to a central bank. Furthermore, the Constitution certainly does not empower the federal government to erode the American standard of living via an inflationary monetary policy."

The interpretation advanced by Paul and others is at odds with settled case law and the traditions of the government long before 1913. The question of Congress's power to define money was addressed most directly in the Legal Tender Cases, which found that the federal government had the power to define money in a manner "necessary and proper" to the execution of its enumerated powers.

Well before the Legal Tender Cases, the government had issued notes both directly and through chartered institutions, and these notes had circulated alongside those of private banks. The power of the government to issue such notes, without interference from states, was affirmed in McCulloch v. Maryland.

The specific claim that the government must back paper money with "precious metal" was dismissed as "frivolous" in Milam v. United States, citing the Legal Tender Cases. (Milam v. United States, 524 F.2d 629 (9th Cir. 1974)).

Similar claims have been made in several tax protester cases and consistently rejected.

Monetary policy is not delegated to banks, as Paul describes, but remains the responsibility of the government components of the system, the Board of Governors and FOMC. Similar regulatory boards exist to manage other government tasks, such as the as the Board of Governors overseeing the US Postal Service.

Excessive New York City influence

Historically in the United States, many people have complained that people in New York City have too strong of an influence on banking in the United States. This has been researched in a working paper written for the Federal Reserve Bank of Atlanta in 2003. The abstract for this working paper says:[81]

"In our previous research we have detected that New York City banking entities usually exert substantial influence on legislation, greater than their large proportion of United States’ banking resources. The authors describe how this influence affected the success or failure of central banking movements in the United States, and the authors use this evidence to support their arguments regarding the influence of New York City bankers on the legislative efforts that culminated in the creation of the Federal Reserve System. The paper argues that successful central banking movements in the United States owed much to the influence of New York City banking interests."

The Great Depression

Milton Friedman (1912-2006), a prominent figure within the Chicago School, argued that the Federal Reserve System caused the Great Depression by contracting the money supply at the very moment that markets needed liquidity. Since its entire existence was predicated on its mission to prevent events like the Great Depression, it had failed in what the 1913 bill had tried to achieve.[82]

According to Friedman and Anna Schwartz, waves of bank failures in 1931, 1932, and 1933 would have been avoided if the Federal Reserve had not been established. (Friedman and Schwartz, "A Monetary History of the United States", Princeton University Press, 1993 ISBN 0-691-00354-8 pg 311-312)

In an interview with Peter Jaworski (The Journal, Queen's University, March 15, 2002, Issue 37, Volume 129) Friedman said that ideally he would "prefer to abolish the federal reserve system altogether" rather than try to reform it, because it was a flawed system in the first place. He also said he would like to "abolish the Federal Reserve and replace it with a computer," meaning that it would be a mechanical system that would keep the quantity of money going up at a steady rate[83] and that "leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement."[84]

Ben Bernanke agreed that the Fed had made the Great Depression worse, saying in a 2002 speech:

"I would like to say to Milton [Friedman] and Anna [J. Schwartz]: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.[85] [86]

While the heterodox economic thinker, Murray Rothbard of the Austrian school, disagreed on the true origin of causality, he did agree that the Federal Reserve aggravated the Great Depression.[87]


One major area of criticism focuses on the failure of the Federal Reserve System to stop inflation; this is seen as a failure of the Fed's legislatively mandated duty to maintain stable prices.

These critics focus particularly on inflation's effects on wages, since workers are hurt if their wages do not keep up with inflation.[88]

They point out that wages, as adjusted for inflation, or real wages, have sometimes gone down (such as at the end of 2004).[89]

Milton Friedman alleged that the Fed caused the high inflation of the 1970s. When asked about the greatest economic problem of the day, he said the most pressing was how to get rid of the Federal Reserve.

In April of 2009 former Fed Chairman Paul Volcker criticized Fed's notion that a roughly 2% inflation rate is consistent with promotion of price stability, noting that with 2% inflation rate people in a generation are going to be losing half their purchasing power.[90]

United States Congressman Ron Paul, ranking member of the United States House Financial Services Subcommittee on Domestic and International Monetary Policy, Trade, and Technology of the House Banking Committee), has also criticized Federal Reserve policy for creating and downplaying excessive inflation. Monetary Inflation is the Problem by Ron Paul before the U.S. House of Representatives December 4, 2006:[91]

Ralph Nader, a consumer activist and presidential candidate in several elections, has criticized the inflation policies of the Federal Reserve for, he says, ignoring excessive inflation in stock prices and corporate welfare disbursements while showing consistent concern over any rise in ordinary people's wages.

Money issuing power

United States Congressman Dennis Kucinich, at the 2005 Monetary Reform Conference [92][93] [94], raised the question of why the Federal Reserve should have the power to issue the United States' currency. Kucinich has also questioned the idea that the Federal Reserve should be independent. He suggested that it should be "accountable" instead.

Private Ownership

Section 5 of the Federal Reserve Act of 1913 states that the Federal Reserve Banks are owned, through stock issuance, by private member banks.[95] The issue of private ownership has been one of controversy for numerous reasons.

Dennis Kucinich has repeatedly stated, "The Federal Reserve is no more federal than Federal Express"[96][97] Kucinich also stated that "we need to have public control over this if we're going to have public policies in the public interest."[98]>

One of the first criticisms of the private nature of the Federal Reserve system was Charles August Lindbergh who criticized the problem of private banks working against the best interests of the citizens: "The financial system has been turned over to the Federal Reserve Board. That Board administers the finance system by authority of a purely profiteering group. The system is Private, conducted for the sole purpose of obtaining the greatest possible profits from the use of other people's money."[99]


Some argue that the Federal Reserve System is not shrouded in excessive secrecy.[100]

Among many who disagree is the former assistant managing editor for the Washington Post, William Greider, who in his 1987 book, Secrets of the Temple: How the Federal Reserve Runs the Country, "presents an eloquent argument demonstrating conspiratorial control by the Fed," as reported by New York Times best-selling author Jim Marrs.("Secrets of Money and the Federal Reserve System", Jim Marrs, Rule by Secrecy, HarperCollins, 2000, pages 64-78)

Still, some of the decisions leave even expert policy analysts unsure about the logic behind them.[101]

Critics argue that such opacity leads to greater market volatility, because the markets must guess, often with only limited information, about how the Fed is likely to change policy in the future.

The jargon-laden fence-sitting opaque style of Fed communication, especially under the previous Fed Chairman Alan Greenspan, has often been called "Fed speak."[102][103][104]

In addition, the Fed sponsors much of the monetary economics research in the US. Some believe this makes it less likely for researchers to publish findings challenging the status quo that is the Federal Reserve.[105]

In 1993, Rep. Henry B. Gonzalez confirmed that the Fed did have tapes and transcripts of the meetings and could have complied with the FOIA requests, but had misrepresented the existence of the transcripts and chosen to ignore questions from Congress.[106]

After the existence of the transcripts was revealed, the Fed agreed to release the transcripts on a five-year time lag. The time period has been extended, so that for example 1992's transcripts were not released until 1998.

Some critics believe the Fed exacerbated this idea when it decided to stop publishing the M3 aggregate of financial data, which details the total amount of money in circulation at a time. Some of them argue that it is a way the Fed could hide an impending economic disaster from the public if it felt the need.[107]

The Fed said that economists did not need M3 when they had M2, despite the fact that the M3 was the only aggregate to contain information regarding the most extravagant monetary exchanges, and therefore would be needed to have a complete understanding of the overall monetary policy in the United States.

On November 7, 2008, Bloomberg News requested details of Fed lending under the U.S. Freedom of Information Act and filed a federal lawsuit seeking to force disclosure. [108]

"The Fed responded December 8, saying it’s allowed to withhold internal memos as well as information about trade secrets and commercial information. The institution confirmed that a records search found 231 pages of documents pertaining to some of the requests."

Past Congresses

Congressman Louis T. McFadden, Chairman of the House Committee on Banking and Currency from 1920–31, accused the Federal Reserve of deliberately causing the Great Depression. In several speeches made shortly after he lost the chairmanship of the committee, McFadden claimed that the Federal Reserve was run by Wall Street banks and their affiliated European banking houses.

In 1933, he introduced House Resolution No. 158, Articles of impeachment for the Secretary of the Treasury, two assistant Secretaries of the Treasury, the Board of Governors of the Federal Reserve, and the officers and directors of its twelve regional banks.

Quite a few Congressmen who have been involved in the House and Senate Banking and Currency Committees have been open critics of the Federal Reserve, including Chairmen Wright Patman, Henry Reuss, and Henry B. Gonzalez.

Currently, Congressman Ron Paul is the ranking member of the Monetary Policy Subcommittee and he is a staunch opponent of the Federal Reserve System. During each Congress Paul introduces a bill to abolish the Federal Reserve System (H.R. 2755—110th Congress, H.R. 2778—108th Congress, H.R. 5356—107th Congress, H.R. 1148—106th Congress).[109]

It has often been said that the Federal Reserve is a creature of Congress and it is the fluctuating opinion of that body that it answers to.[110]

111th Congress

See also the Reform of the Federal Reserve.

Federal Reserve bibliography

Please see Federal Reserve bibliography


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