As follow up to my last article on the FED, I figured I would explain what exactly the FED is and does…
Born out of the 1913 Act the Federal Reserve Board was
created.
The Federal Reserve System, or more commonly known as the
FED was created to carry out monetary policy. The FED is made up of the Board
of Governors (7), including the Federal Open Market Committee (FOMC) which is
made up of 12 different national banks of which 5 members are able to vote on
monetary policies even though the 7 members of the board have the majority.
The objective of the FED is to maximize employment, keep
prices stable, and oversee long term interest rates.
The FED has three tools to enact monetary policies to keep inline
with their objectives. These are not to be confused with Fiscal Policy. Fiscal
policy is enacted by Congress, which is why it is always easier to get monetary
policy done.
1. Open Market Operations - Buying or selling treasury
securities in the open market. When the FED buys they look to create other
buying (liquidity) mainly from consumers. This is the primary tool the FED uses
to impact interest rates. More importantly this is currently what the FED is
doing. (anytime you hear about the FOMC this is what the committee is
discussing)
2. Setting Federal Funds Rate or Discount Rates - Make short
term loans, each of the 12 National banks lend to their respective areas. This
is bank to bank transactions. When banks are in a bind they need money fast so by
keeping rates low, banks can lend a lot or vice versa. This in turn gives those
more local banks more or less money to lend to consumers.
3. Setting Reserve Requirements - Set the reserve required
for each bank. This also allows banks to hold more or less in bank reserves,
allowing more lending capability to consumers.
In short to see what the FED is doing just follow the money. If the FED
is buying, they are trying to stimulate the economy; if they are selling then
they are trying to curb the economy from accelerating to fast.
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