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 a long period of low and often negative real GDP growth, significant numbers of non-farm employment losses, and a high unemployment rate.
This lesson focuses on the January 25, 2012, press release by the Federal Open Market Committee on the current Federal Reserve monetary policy actions and goals.
NOTE: On occasion, the FOMC holds unscheduled face-to-face or conference call meetings to make more timely policy decisions in response to unusual economic events or conditions. The policy decisions made as a result of any of these unscheduled meetings will be included in the lesson on the next scheduled meeting.
- Explain the meaning of the January 30, 2013, 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 30, 2013
The Federal Reserve System is the central bank of the United States. One of the key functions of the Federal Reserve is to implement monetary policy. For this purpose, the Federal Reserve established the Federal Open Market Committee (FOMC). The FOMC undertakes monetary policy actions to "influence the availability and cost of money and credit to help promote national economic goals." The FOMC meets approximately every six weeks to review and recommend monetary policy goals and actions.
The nation's overall macroeconomic goals, as established by the Employment Act of 1946 (Public Law 79-304, February 20, 1946), are to "promote maximum employment, production, and purchasing power." The Fed's monetary policies are intended to help achieve these goals. The Federal Reserve Act of 1913 had previously given the Federal Reserve responsibility for establishing monetary policy.
Students: What do you think of these as our national economic goals - promote maximum employment, production, and purchasing power? What do they mean? Should there be other national macroeconomic goals?
Take a look at the FOMC's January 30, 2013, monetary policy announcement for a better understanding of how the Federal Reserve's actions impact the current health and future prospects for the U.S. economy
Federal Open Market Committee Monetary Policy Press Release
Released: January 30, 2013
"Information received since the Federal Open Market Committee met in December suggests that growth in economic activity paused in recent months, in large part because of weather-related disruptions and other transitory factors. Employment has continued to expand at a moderate pace but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has shown further improvement. Inflation has been running somewhat below the Committee’s longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices. Longer-term inflation expectations have remained stable."
The first paragraph of recent FOMC announcements have begun, "Information received since the Federal Open Market Committee met in..." Since each announcement may signal a change in policy since the last meeting, the any economic changes since that meeting are the focus of the FOMC's policy decision. In this case, the FOMC statement began with a very different statement than previous announcements. "growth in economic activity paused in recent months, in large part because of weather-related disruptions and other transitory factors." Normally, the statement begins with a quick assessment of the strength of improvement or downturn.
The FOMC announcement went on to mention some specific factors influencing its decision. "Employment has continued to expand at a moderate pace but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has shown further improvement. Inflation has been running somewhat below the Committee’s longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices. Longer-term inflation expectations have remained stable."
Next, the FOMC provided a rational for its policy decision, based on its Congressional mandate. The focus was on slow employment growth and lack of inflationary pressure.
"Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. Although strains in global financial markets have eased somewhat, the Committee continues to see downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective."
The FOMC previously stated that the current pro-growth policies will continue until unemployment falls below 6.5 percent and inflation remains below the traditional 2.0 percent maximum goal.
What is the FOMC's current policy goal?
"To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee will continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative."
"The Committee will closely monitor incoming information on economic and financial developments in coming months. If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until such improvement is achieved in a context of price stability. In determining the size, pace, and composition of its asset purchases, the Committee will, as always, take appropriate account of the likely efficacy and costs of such purchases.
The FOMC has previously extended the timeline for the 0 to 1/4 percent fed funds rate target through at least the end of 2014, and more recently until unemployment and inflation limits are reached.
That policy was continued. "To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.
The FOMC decision was not unanimous. One FOMC member was concerned about the impact of the accommodative policies on long-term inflation.
"Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Charles L. Evans; Jerome H. Powell; Sarah Bloom Raskin; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations."
Students: You can read the FOMC announcement from the FOMC webpage . It may be more interesting and effective to read it from the original source Recently, the announcements have included a press conference by the Federal Reserve Chairman, Ben Bernanke. This announcement did not include a press conference. www.federalreserve.gov/newsevents/press/monetary/20110126a.htm
In summary, this announcement was very similar to those of the FOMC meetings over the past two and a half, years since the end of the recession. Keep interest rates low, provide greater liquidity, and keep an eye out for any changes in economic conditions, especially any signs of inflation.
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.
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.
A Brief History of Central Banks
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.
Find your Federal Reserve Bank district on the U.S. map, Figure 1, below. If your school is near a boundary between two banks districts, you can go to each of the districts for more detailed information about their district boundaries.
Students: You should be able to identify the Federal Reserve District bank that serves your school's geographic area. Federal Reserve System map .]
Fun Fact: Which state is the home to two Federal Reserve Banks? [Missouri - Federal Reserve Bank of Kansas City and Federal Reserve Bank of St. Louis.]
Who owns the Fed?
Though its name may sound like a government-run agency, the Federal Reserve System is an independent body, created by Congress and subject to audit by the Government Accountability Office(GAO). The twelve district banks are owned by the member banking institutions. The Federal Reserve Board members and Chairman are appointed by the President and confirmed by Congress. Each district bank has its own board of directors.
The Federal Reserve's website explains: "The Federal Reserve System fulfills its public mission as an independent entity within government. It is not "owned" by anyone and is not a private, profit-making institution.
As the nation's central bank, the Federal Reserve derives its authority from the Congress of the United States. It is considered an independent central bank because its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government, it does not receive funding appropriated by the Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms.
However, the Federal Reserve is subject to oversight by the Congress, which often reviews the Federal Reserve's activities and can alter its responsibilities by statute. Therefore, the Federal Reserve can be more accurately described as "independent within the government" rather than "independent of government."
The 12 regional Federal Reserve Banks, which were established by the Congress as the operating arms of the nation's central banking system, are organized similarly to private corporations--possibly leading to some confusion about "ownership." For example, the Reserve Banks issue shares of stock to member banks. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6 percent per year. Link: www.federalreserve.gov/faqs/about_14986.htm ]
What if the Fed Makes a Profit?
on January 10, 2013, the Federal Reserve System announced, "preliminary unaudited results indicating that the Reserve Banks provided for payments of approximately $88.9 billion of their estimated 2012 net income to the U.S. Treasury. Under the Board's policy, the residual earnings of each Federal Reserve Bank are distributed to the U.S. Treasury, after providing for the costs of operations, payment of dividends, and the amount necessary to equate surplus with capital paid-in. The profits were the return from the Fed's investment portfolio - treasury securities, mortgage-backed securities, other investments, and some income from services it provides to financial institutions.
The Federal Reserve Board of Governors
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., featured in Figure 2, below.
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.
Students: What do you think is the rationale for the mix of voting members on the FOMC - seven FRB Governors, the NY Fed president and four other reserve bank presidents?
From the Fed webpage: "The Federal Open Market Committee (FOMC) consists of twelve members--the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis. The rotating seats are filled from the following four groups of Banks, one Bank president from each group: Boston, Philadelphia, and Richmond; Cleveland and Chicago; Atlanta, St. Louis, and Dallas; and Minneapolis, Kansas City, and San Francisco. Nonvoting Reserve Bank presidents attend the meetings of the Committee, participate in the discussions, and contribute to the Committee's assessment of the economy and policy options."]
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 (since December, 2008.)
Figure 3, below, shows the recent history of the target federal funds rate through current period. 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. The fed funds rate target has been set at 0 to 1/4 percent since December 2008.
Want to know more?
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 of slow growth, high unemployment , and slow credit markets, 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.
Students: Can you explain the intended impact when the Fed uses its various policy options and tools. If the Fed sells securities, what will happen? If the Fed reduces rates, what will happen? If the Fed increases reserve requirements, what will happen?]
During the recession, the Federal Reserve established several 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. Most of these special program have been ended or "wound down" in the past year.
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."
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.
Remember, the Fed has two mandates, established by the Congress with the Employment Act of 1946. They are price stability (low inflation) and full employment. These two goals are often in conflict. When the economy is growing too slowly, demand for goods/services is low, and there is no anticipation of inflation. When growth is slow or negative, unemployment tends to be higher.
When the economy is growing too quickly, the opposite tends to result, higher inflation and low unemployment. Recently, the unemployment rate has fallen to just below 8 percent, but remains well above an acceptable level. With low inflation, Fed policy can focus on growth and stimulating employment.
The Federal Reserve is charged with using monetary policies to promote growth, promote full-employment and maintain stable prices. The FOMC committed to an expansionary set of policies at the beginning of the recession in 2008 and has added additional actions since that time.
The January 30, 2013, FOMC meeting resulted in essentially the same policies as have been identified over the last couple of years - low interest rates, programs to provide banking system liquidity, and a generally stimulatory policy.
While the FOMC's initial statement was mildly optimistic, the extension of the current low fed fund rate target until unemployment drops to below 6.5 percent was recognition that the economic recovery may be a long process.
What can either the Fed, Congress, or the executive branch do to speed up the recovery?
Take a look at data about your school's Federal Reserve district bank. 12 regional Federal Reserve banks serve the United States.
From the Map of the Twelve Federal Reserve System Districts , identify the Federal Reserve district bank that serves your school's geographic area.
Explore your Federal Reserve district bank's web site for information about the economic health of your region and programs available to your area's businesses and consumers.
- Are economic conditions in your region of the United States similar, better or worse than national economic conditions? Growth? Employment/unemployment? Price level changes?
- Are there any particular characteristics about your region that impact it's economic health - better or worse than other regions?
- What do the president and/or other leaders of your Federal Reserve Bank have say about current regional economic conditions?
- What programs and information services does your Federal Reserve Bank offer to businesses, consumers or schools?
Take another look at the map of the regional Federal Reserve Banks. Do the sizes and boundaries of the twelve regions make sense to you? Remember, this map was drawn in 1913 when the population and level of economic activity of the western and southern regions was very much smaller.
Do you think the map would look different if the regions were established and the map was drawn today?]