The Federal Open Market Committee (FOMC) of the Federal Reserve System (Fed) meets approximately every six weeks to determine the nation's monetary policy goals and, specifically, to set the target for the federal funds rate (fed funds rate). The fed funds rate is the interest rate at which banks lend their balances at the Federal Reserve to other banks, usually overnight.
The FOMC has maintained the target federal funds rate at a range of 0 to 1/4 percent since its December 16, 2008 meeting. The fed funds rate has been kept at this historically low level due to over a year of low and often negative real GDP growth, significant numbers of non-farm employment losses and very high unemployment.
This lesson focuses on the January 27, 2010, press release by the Federal Open Market Committee on the current Federal Reserve monetary policy actions and goals.
- Explain the meaning of the January 27, 2010 Federal Open Market Committee decision concerning the target for the federal funds rate.
- Identify the current monetary policy goals of the Federal Reserve and the factors that have recently influenced monetary policy goals.
- Explain the structure and functions of the Federal Reserve System, Federal Reserve Banks, and the Federal Open Market Committee.
- Identify the monetary policy options and other tools available to the Federal Reserve to stimulate or contract the economy.
U.S. Monetary Policy - January 27, 2010
The Federal Reserve's Federal Open Market Committee (FOMC) monetary policy announcement after it's January 26-27 meeting began with some optimism about the future health of the U.S., economy. The purpose of the FOMC's monetary policy is to "influence the availability and cost of money and credit to help promote national economic goals."
The nation's overall economic goals, as established by the "Employment Act of 1946," are to "promote maximum employment, production, and purchasing power." Monetary policies are intended to achieve these goals. The Federal Reserve Act of 1913 had previously given the Federal Reserve responsibility for establishing monetary policy.
[NOTE: An overview of the Federal Reserve and monetary policy is included in this lesson after comments on the current FOMC monetary policy actions.]
Federal Open Market Committee Press Release: January 27, 2010
"Information received since the Federal Open Market Committee met in December suggests that economic activity has continued to strengthen and that the deterioration in the labor market is abating. Household spending is expanding at a moderate rate but remains constrained by a weak labor market, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software appears to be picking up, but investment in structures is still contracting and employers remain reluctant to add to payrolls. Firms have brought inventory stocks into better alignment with sales. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability."
The good news:
- Slower deterioration in the labor market
- Moderately expanding household spending
- Equipment and software spending is picking up
- Inventories are aligned with sales
The bad news:
- Labor market remain weak
- Income growth is slow
- Housing wealth remains lower
- Credit is tight
- Less investment in structures
- Employers are not hiring
- Contracting bank lending
The bottom line for the FOMC is that "although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability."
More good news: a very small chance of inflation in the near future.
The FOMC commented, "with substantial resource slack continuing to restrain cost pressures and with longer-term inflation expectations stable, inflation is likely to be subdued for some time.
The resulting policy action is to keep things essentially the same. "The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period." This statement is very similar to those in the last several FOMC statements.
The Fed will continue to use some of its new programs to encourage lending and growth of housing markets for a limited time. The plan is to gradually reduce the Fed's intervention as the economy improves.
"To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve is in the process of purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. In order to promote a smooth transition in markets, the Committee is gradually slowing the pace of these purchases, and it anticipates that these transactions will be executed by the end of the first quarter. The Committee will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets."
Some of the Fed's special programs to improve financial markets will wind down soon.
"In light of improved functioning of financial markets, the Federal Reserve will be closing the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility on February 1, as previously announced. In addition, the temporary liquidity swap arrangements between the Federal Reserve and other central banks will expire on February 1. The Federal Reserve is in the process of winding down its Term Auction Facility: $50 billion in 28-day credit will be offered on February 8 and $25 billion in 28-day credit will be offered at the final auction on March 8. The anticipated expiration dates for the Term Asset-Backed Securities Loan Facility remain set at June 30 for loans backed by new-issue commercial mortgage-backed securities and March 31 for loans backed by all other types of collateral. The Federal Reserve is prepared to modify these plans if necessary to support financial stability and economic growth."
For details about these special Federal reserve programs implemented to improve credit markets, go to Monetary Policy
and click on "Policy Tools."
The FOMC members vote on the policy statement. For the past year, these votes have been unanimous. This time, one member,
Thomas M. Hoenig from the Federal Reserve Bank of Kansas City, voted no because he believes "that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted." Many observers see this as a sign that the extremely low fed funds rate target may not last much longer.
Current Federal Open Market Committee members:
- Ben S. Bernanke , Chairman of the Board of Governors of the Federal Reserve
- William C. Dudley , Federal Reserve Bank of New York, Vice Chairman
- James Bullard , Federal Reserve Bank of St. Louis
- Elizabeth A. Duke , Board of Governors
- Charles L. Evans , Federal Reserve Bank of Chicago
- Richard W. Fisher , Federal Reserve Bank of Dallas
- Thomas M. Hoenig , Federal Reserve Bank of Kansas City
- Sandra Pianalto , Federal Reserve Bank of Cleveland
- Eric S. Rosengren , Federal Reserve Bank of Boston
- Daniel K. Tarullo , Board of Governors
Introduction to The Federal Reserve System, the FOMC, and Monetary Policy
The Federal Reserve System was created by Congress in 1913 "to provide the nation with a safer, more flexible, and more stable monetary and financial system." It is a federal system, composed of a central, governmental agency, the Board of Governors, in Washington, D.C., and twelve regional Federal Reserve Banks, located in major cities throughout the nation.
[NOTE: Much of the following is summarized from the Federal Reserve publication: "The Federal Reserve System: Purposes and Functions ," which is available online.]
The Federal Reserve’s duties fall into four general areas:
- Conducting the nation’s monetary policy by influencing monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates.
- Supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers.
- Maintaining the stability of the financial system and containing systemic risk that may arise in financial markets.
- Providing 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.
Most developed countries have a central bank whose functions are broadly similar to those of the Federal Reserve. The oldest, Sweden’s Riksbank, has existed since 1668 and the Bank of England since 1694. Napoleon I established the Banque de France in 1800, and the Bank of Canada began operations in 1935. The German Bundesbank was reestablished after World War II and is loosely modeled on the Federal Reserve. More recently, some functions of the Banque de France and the Bundesbank have been assumed by the European Central Bank, formed in 1998.
The Creation of the Federal Reserve System
During the nineteenth century and the beginning of the twentieth century, financial panics plagued the nation, leading to bank failures and business bankruptcies that severely disrupted the economy. The failure of the nation’s banking system to effectively provide funding to troubled depository institutions contributed significantly to the economy’s vulnerability to financial panics. After the crisis of 1907, Congress established a commission and institution that would help prevent and contain financial disruptions.
Congress passed the Federal Reserve Act in “to provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of re-discounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.” President Woodrow Wilson signed the act into law on December 23, 1913.
The twelve regional Federal Reserve Banks and their Branches carry out a variety of System functions, including operating a nationwide payments system, distributing the nation’s currency and coin, supervising and regulating member banks and bank holding companies, and serving as banker for the U.S. Treasury. The twelve Reserve Banks are each responsible for a particular geographic area or district of the United States. Each Reserve District is identified by a number and a letter. Besides carrying out functions for the System as a whole, such as administering nationwide banking and credit policies, each Reserve Bank acts as a depository for the banks in its own District and fulfills other District responsibilities.
|Federal Reserve Bank Districts|
|2||B||New York, New York|
|8||H||St. Louis, Missouri|
|10||J||Kansas City, Missouri|
|12||L||San Francisco, California|
The seven members of the Board of Governors are appointed by the President and confirmed by the Senate to serve 14-year terms of office. Members may serve only one full term, but a member who has been appointed to complete an unexpired term may be reappointed to a full term. The President designates, and the Senate confirms, two members of the Board to be Chairman and Vice Chairman of the Federal Reserve, for four-year terms.
The current chairman of the Federal Reserve is Ben S. Bernanke, Ph.D. Dr. Bernanke was sworn in on February 1, 2006, as Chairman and a member of the Board of Governors of the Federal Reserve System. Dr. Bernanke also serves as Chairman of the Federal Open Market Committee. He was appointed as a member of the Board to a full 14-year term, which expires January 31, 2020, and to a four-year term as Chairman, which expires January 31, 2010. Before his appointment as Chairman, Dr. Bernanke had been Chairman of the President's Council of Economic Advisers, from June 2005 to January 2006.
The Federal Open Market Committee (FOMC)
An important component of the Federal Reserve System is the Federal Open Market Committee (FOMC), which is made up of the members of the Board of Governors, the president of the Federal Reserve Bank of New York, and presidents of four other Federal Reserve Banks, who serve on a rotating basis. The FOMC oversees open market operations, which is the main tool used by the Federal Reserve to influence money market conditions and the growth of money and credit. Traditionally, the Chairman of the Board of Governors serves as the Chairman of the FOMC.
Federal Reserve Policy Tools
The Federal Reserve implements monetary policy through its control over the federal funds rate, the rate at which depository institutions trade balances at the Federal Reserve. It exercises this control by influencing the demand for and supply of these balances through the following means:
- Open market operations: the purchase or sale of securities, primarily U.S. Treasury securities, in the open market to influence the level of balances that depository institutions hold at the Federal Reserve Banks. Open market operations are used to meet the goal of the target federal funds rate. Open market operations are conducted by the Domestic Trading Desk at the Federal Reserve Bank of New York.
- Reserve requirements: requirements regarding the percentage of certain deposits that depository institutions must hold in reserve in the form of cash or in an account at a Federal Reserve Bank.
- Contractual clearing balances: an amount that a depository institution agrees to hold at its Federal Reserve Bank in addition to any required reserve balance.
- Discount window lending (discount rate): extensions of credit to depository institutions made through the primary, secondary, or seasonal lending programs.
By trading government securities, the New York Fed affects the federal funds rate, which is the interest rate at which depository institutions lend balances to each other overnight. The Federal Open Market Committee establishes the target rate for trading in the federal funds market. The target rate is currently set at a 0 to 1/4 percent range.
Figure 1 shows the recent history of the target federal funds rate through the January 27, 2010 target rate. Notice how the target rate has normally moved up and down in a cyclical pattern. This pattern of change is strongly correlated with the business cycles, generally increasing during expansionary periods and decreasing during contractions.
For detailed information about "Open Market Operations "
For more information about the U.S. Federal Reserve System and the Board of Governors of the Federal Reserve System
- For more information about the FOMC, go to "About the FOMC "
How Monetary Policy Affects the Economy
The initial link in the chain between monetary policy and the economy is the market for balances held at the Federal Reserve Banks. Depository institutions have accounts at their Reserve Banks, and they actively trade balances held in these accounts in the federal funds market at an interest rate known as the federal funds rate. The Federal Reserve exercises considerable control over the federal funds rate through its influence over the supply of and demand for balances at the Reserve Banks.
The FOMC sets the federal funds rate at a level it believes will foster financial and monetary conditions consistent with achieving its monetary policy objectives, and it adjusts that target in line with evolving economic developments. A change in the federal funds rate, or even a change in expectations about the future level of the federal funds rate, can set off a chain of events that will affect other short-term interest rates, longer-term interest rates, the foreign exchange value of the dollar, and stock prices. In turn, changes in these variables will affect households’ and businesses’ spending decisions, thereby affecting growth in aggregate demand and the economy.
Short-term interest rates, such as those on Treasury bills and commercial paper, are affected not only by the current level of the federal funds rate but also by expectations about the overnight federal funds rate over the duration of the short-term contract. As a result, short-term interest rates could decline if the Federal Reserve surprised market participants with a reduction in the federal funds rate, or if unfolding events convinced participants that the Federal Reserve was going to be holding the federal funds rate lower than had been anticipated. Similarly, short-term interest rates would increase if the Federal Reserve surprised market participants by announcing an increase in the federal funds rate, or if some event prompted market participants to believe that the Federal Reserve was going to be holding the federal funds rate at higher levels than had been anticipated.
Expansionary monetary policy actions: Decrease interest rates
- Reduce the target fed funds rate
- Open market operations: buy securities
- Reduce reserve requirements
- Decrease the discount rate
Contractionary monetary policy actions: Increase interest rates
- Increase the target fed funds rate
- Open market operations: sell securities
- Increase reserve requirements
- Increase the discount rate
Changes in short-term interest rates will influence long-term interest rates, such as those on Treasury notes, corporate bonds, fixed-rate mortgages, and auto and other consumer loans. Long-term rates are affected not only by changes in current short-term rates but also by expectations about short-term rates over the rest of the life of the long-term contract. Generally, economic news or statements by officials will have a greater impact on short-term interest rates than on longer rates because they typically have a bearing on the course of the economy and monetary policy over a shorter period; however, the impact on long rates can also be considerable because the news has clear implications for the expected course of short-term rates over a longer time period.
In the current economic environment, negative GDP growth, decreasing employment, and lack of adequate credit, the Fed has adopted a stimulatory policy. Given the very low level of interest rates, over the last year, the Federal Reserve has taken additional measures to open up financial markets and stimulate spending.
The Federal Reserve has established new programs to counter the "liquidity crisis" and the tight credit markets. These programs are intended to provide capital to different types of financial institutions "to strengthen market stability, improve the strength of financial institutions, and enhance market liquidity.
The first of these new Fed programs was the Term Auction Facility (TAF), created to improve bank liquidity. The TAF "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."
Click on the links to find out more about each program's purpose and specific goals:
- Term Auction Facility (TAF)
- Primary Dealer Credit Facility (PCDF)
- Term Securities Lending Facility (TSLF)
- Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (ABCP MMMF)
- Commercial Paper Funding Facility (CPFF)
- Money Market Investor Funding Facility (MMIFF)
- Term Asset-Backed Securities Loan Facility (TALF)
The common thread in these Fed programs' goals is to improve the balance sheets of financial institutions by supporting the value of their assets. One of the problems with bank holding has been uncertainty about the underlying value of the securities they hold. By replacing the banks' securities, such as mortgaged-backed securities, with those with more secure values, confidence in the banks will increase. In a more stable market with more predictable asset values, more narrowing and lending should result.
The FOMC continues to follow a very low interest rate policy to provide greater liquidity and loanable funds at very low cost to simulate borrowing and growth in the U.S. economy. As always, the FOMC is keeping an eye on the possibility of inflation, it's traditional number one priority. The increase in inflation in November (+0.4 percent) was a short-lived phenomena, as the CPI-U only increased by 0.1 percent in December. Without a threat of inflation, the FOMC's low interest rate policy is it's best option during the recession.
The depth of the 2008-2009 recession and the instability of credit markets required unprecedented involvement of the Federal Reserve. The Fed has promoted growth with policies to lower interest rates and through a variety of programs to provide bank liquidity and increase credit.
Given how low interest rates have been for the past year, there is little the Fed can do using it's traditional monetary policy tools - open market operations, the discount rate, and reserve requirements.
Federal Reserve efforts and potential for success in turning around the recession are depend on its ability to help improve bank stability and credit markets.
ASSESSMENT ACTIVITYNext, answer the question below on the interactive notepad.
1. During a recessionary period, why would the Federal Reserve and FOMC choose to keep interest rates low? How do low interest rates help to achieve the Fed's goal to stimulate the economy and help banks?
Take a look at data about your school's regional Federal Reserve district bank. 12 regional Federal Reserve Banks serve the United States.
From the Map of the Twelve Federal Reserve System Districts , you should identify the Federal Reserve Bank that serves your school's geographic area.
Take a look at your Federal Reserve Bank's web site for information about the economic health of their region and programs available to area businesses and consumers.
Are conditions in your region similar, better or worse than national economic conditions? Growth? Employment? Price level?
- Are there any particular characteristics about your region that impact it's economic health?
- What do the president and/or other leaders of your Federal Reserve Bank have say about current conditions?
- What programs and information services does your Federal Reserve Bank offer to consumers?