Central Banks and the Federal Reserve System
The Structure of the Federal Reserve System:
The system as it exists now includes:
- The Twelve Federal Reserve Banks
- Board of Governors of the Fed Reserve System
- Federal Open Market Committee (FOMC)
- Federal Advisory Council
- Member banks (around 2000)
The FOMC makes decisions regarding open market operations, to influence the monetary base.
Open market operations are the most important tool that the Fed has for controlling the money
supply (along with reserve requirements and the discount rate). All actions are directed by the
Federal Reserve Bank of New York, where securities are bought and sold as required.
Open market operations:
Open market operations are the most important monetary policy tool because they can change the
reserves in the banking system and interest rates. The purchase of securities can lead to
expansionary monetary policy. For example, if the Fed purchases $100 million of bonds, the Fed will
add $100 million to the dealer’s deposit account to the Fed. This causes the reserves for the banking
system to increase by $100 as these are deposits that the seller will put into the banking system, and
is therefore an asset. The Fed will gain $100 million in assets in terms of securities, however they will
also have $100 million worth of liabilities as these are reserves that people have deposited into the
system, but will have to be paid back at some point. The T-accounts for the banking system and the
Fed can illustrate this:
If the Fed sells securities, it is a contractionary monetary policy and leads to a contraction of reserves
and deposits in the banking system, and hence to a decline in the monetary base and the money
supply. This is because the banking system will gain $100 million securities, however it will lose $100
million worth in reserves, and so the monetary base will decrease as the banking system loses $100
million and the Fed gains $100 million as reserves for their assets.
The Federal Reserve can also affect the amount of reserves by making a discount loan to the bank.
For example, if the Fed makes a $100 million discount loan to the First National Bank, the Fed will
credit $1000 million into the bank’s reserve account (this is the money the bank is borrowing).
Therefore the bank will gain $100 million of reserves as assets, however these will also be a liability
The Structure of the Federal Reserve System:
The system as it exists now includes:
- The Twelve Federal Reserve Banks
- Board of Governors of the Fed Reserve System
- Federal Open Market Committee (FOMC)
- Federal Advisory Council
- Member banks (around 2000)
The FOMC makes decisions regarding open market operations, to influence the monetary base.
Open market operations are the most important tool that the Fed has for controlling the money
supply (along with reserve requirements and the discount rate). All actions are directed by the
Federal Reserve Bank of New York, where securities are bought and sold as required.
Open market operations:
Open market operations are the most important monetary policy tool because they can change the
reserves in the banking system and interest rates. The purchase of securities can lead to
expansionary monetary policy. For example, if the Fed purchases $100 million of bonds, the Fed will
add $100 million to the dealer’s deposit account to the Fed. This causes the reserves for the banking
system to increase by $100 as these are deposits that the seller will put into the banking system, and
is therefore an asset. The Fed will gain $100 million in assets in terms of securities, however they will
also have $100 million worth of liabilities as these are reserves that people have deposited into the
system, but will have to be paid back at some point. The T-accounts for the banking system and the
Fed can illustrate this:
If the Fed sells securities, it is a contractionary monetary policy and leads to a contraction of reserves
and deposits in the banking system, and hence to a decline in the monetary base and the money
supply. This is because the banking system will gain $100 million securities, however it will lose $100
million worth in reserves, and so the monetary base will decrease as the banking system loses $100
million and the Fed gains $100 million as reserves for their assets.
The Federal Reserve can also affect the amount of reserves by making a discount loan to the bank.
For example, if the Fed makes a $100 million discount loan to the First National Bank, the Fed will
credit $1000 million into the bank’s reserve account (this is the money the bank is borrowing).
Therefore the bank will gain $100 million of reserves as assets, however these will also be a liability
