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The Federal Reserve
System
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This overview of the Federal Reserve
System is a digest of the publication The
Federal
Reserve System, Purposes and Functions, 8th edition,
December
1994, by the Federal Reserve Board of Governors.
Background
Financial panics
plagued
the nation
throughout much of the 19th century. Many bank failures, business
bankruptcies, and economic downturns could be traced to a poorly
regulated
banking system and the lack of a flexible money supply. A
particularly
severe crisis in 1907 finally led Congress to establish the National
Monetary
Commission to propose an institution that could deal with those
problems.
After considerable
debate,
Congress
passed the Federal Reserve Act which Woodrow Wilson signed into law on
Dec 23, 1913. The act stated that its purposes were to "provide
for
the establishment of Federal reserve banks, 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."
Over the years,
deficiencies in the
original act have been addressed in further legislation. The
International
Banking Act of 1978, sometimes known as the Humphrey-Hawkins Act,
included
an update of the objectives of the Federal Reserve, namely to achieve
economic
growth in line with the economy’s potential to expand; a high level of
employment; stable prices (meaning stability in the purchasing power of
the dollar); and moderate long-term interest rates.
Basic Duties
The Federal Reserve
comprises the Board
of Governors in Washington D.C., and twelve regional Federal Reserve
Banks.
Their responsibilities are to:
o
Conduct the
nation’s
monetary policy by influencing the money and credit conditions in the
economy.
o
Supervise
and regulate
banking institutions to ensure safety and soundness of the nation’s
banking
and financial system.
o
Maintain the
stability
of the financial system.
o
Provide
certain financial
services to the U.S. government, financial institutions, the public,
and
foreign official institutions, including a major role in operating the
nation’s payments system.
Board of
Governors
The Board of
Governors was
established
as a federal agency. It is made up of seven members appointed by
the President and confirmed by the Senate. The full term of a
member
is fourteen years with appointments staggered so that one term expires
on January 31 of each even-numbered year.
The Chairman of the
Board
is appointed
for a four year term starting midway through each Presidential
term.
Besides carefully monitoring domestic and international financial and
economic
developments, the Board supervises and regulates the operations of the
Federal Reserve Banks. The Board is supported by a Washington
staff
of about 1700.
The Board is audited
annually by a
major public accounting firm and is also subject to audit by the
General
Accounting Office, an arm of Congress. Monetary policy, which is exempt
from audit by the GAO, is monitored directly by Congress through
written
reports prepared by the Board.
Monetary
Policy
The Federal Reserve
conducts monetary
policy using three major tools: (1) open market operations to control
the
level of reserves in the depository system. (2) setting reserve
requirements
for depository institutions, and (3) setting the discount rate for
lending
reserves.
Policy regarding open
market operations
is the responsibility of the Federal Open Market Committee (FOMC)
comprising
the seven members of the Board, the president of the New York Federal
Reserve
Bank, and the presidents of four other reserve banks on a rotating
basis.
However, the Board has sole authority over changes in reserve
requirements
and the discount rate.
Federal
Reserve
Banks
Each Reserve Bank has
its
own board
of nine directors chosen from outside the Bank. Three, designated
Class A, represent commercial banks that are members of the Federal
Reserve
System. Three Class B and three Class C represent the public. The
member commercial banks in each district elect the Class A and B
directors.
The Board of Governors appoints the Class C directors, one of whom it
selects
as chairman. No Class B or Class C director may be an officer,
director,
or employee of a bank or a bank holding company. The directors in
turn nominate a president of the Reserve Bank, whose selection is
subject
to approval of the Board of Governors.
Reserve Bank
Services
The twelve Federal
Reserve
Banks provide
banking services to depository institutions within their district, and
to the federal government. For depository institutions they
maintain
reserve and clearing accounts and provide various payment
services.
These include collecting checks, electronically transferring funds, and
distributing and receiving currency and coin. For the federal
government
they act as fiscal agents. As such they maintain the Treasury
Department's
transaction account; pay Treasury checks; process electronic payments;
and issue, transfer, and redeem U.S. government securities.
Income of
the
Federal Reserve
The income of the
Federal
Reserve System
is derived primarily from the interest on U.S. government securities
that
it has acquired through open market operations. Other important
sources
of income are the interest on foreign currency investments held by the
System, interest on loans to depository institutions, and fees for
services
provided to depository institutions such as check clearing, fund
transfers,
and automated clearing house operations.
After it pays its
expenses,
the Federal
Reserve turns the rest of its earnings over to the U.S. Treasury.
About 95% of net earnings have been paid into the Treasury since
inception
in 1914. The Board of Governors audits the Reserve Banks every
year.
The Reserve Banks, like the Board, are subject to audit by the GAO, but
certain functions such as transactions with foreign central banks and
open
market operations are excluded from audit.
Member Banks
The nation's banks
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. Those
chartered
by the federal government (through the Office of the Comptroller of the
Currency in the Department of the Treasury) are national banks, and by
law are members of the System.
Banks chartered by
the
states are divided
into those that are members of the System and those that are not.
State-chartered
banks are not required to join the System, but they may elect to become
members if they meet the standards. As of June 30, 2006, there
were
a total of 7,480 commercial banks nationwide, of which 2,548 were
members
of the System. The Federal Deposit Insurance Corporation is
responsible
for supervising non-member banks.
Member banks must
subscribe
to stock
in their regional Federal Reserve Bank in an amount equal to 6 percent
of their capital and surplus. They receive a 6 percent annual
dividend
on their stock and may vote for Class A and Class B directors of the
Reserve
Bank. However the stock does not carry with it the control and
financial
interest that is normal for the common stock of a for-profit
organization.
It offers no opportunity for capital gain and may not be sold or
pledged
as collateral for loans. The stock is merely a legal obligation
that
goes along with membership.
Independence
of
the Fed
The Federal Reserve
System
is considered
to be an independent central bank. It is, but only in the sense
that
its decisions do not have to be ratified by the President or anyone
else
in the executive branch of government. However the entire system
is subject to the oversight of Congress because the Constitution gives
to Congress the power to coin money and set its value.
In 1913 Congress
delegated
that power
to the Fed, and could reclaim it at any time. The Fed must act
within
the framework of the overall objectives of economic and financial
policy
established by Congress. Thus the description of the System as
"independent
within the government" is more accurate.
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