Archive for the ‘Central Banks’ Category

Monetary Policy During the Recession of 2007-2009

Wednesday, May 6th, 2009

Fed Chairman Ben Bernanke is a student of the Great Depression; many commentators  (notably Milton Friedman and Anna Schwartz in A Monetary History of the United States, 1867-1960) believe that the Depression was longer than it would have been had the Fed adopted a more aggressive policy.  As the real estate bubble began to unwind there were problems in the credit market and the collapse of Wall Street institutions such as Bear Stearns and Lehman Brothers that led the Fed to act aggressively to not repeat the mistakes of the 1930s.

The time line of the current crisis in financial markets can be dated from the first problems at the Bear Stearns hedge fund in June and July 2007; economic growth slowed and the recession officially started in December 2007.  In March 2008 Bear Stearns collapsed and then Lehman followed in September 2008.

There are several ways to think about the Fed’s actions.  The primary tool that the Fed used early during the current crisis was to cut the Federal Funds rate.  The Fed had raised rates to 5.25% in June 2006 and rates remained at that level until the first rate cut (to 4.75%) in September 2007 (see here for the history of Federal Funds rate changes).  The Fed continued to cut rates six more times until rates were at 2% in April 2008.  The Fed then paused until the Lehman crisis and then cut rates twice in October 2008 and once again in December 2008 when rates reached the current target range between 0% to 0.25%.

Initially the Fed relied on rate cuts to heal the damage in the financial markets; but by late 2008 it became clear that financial markets were not responding rapidly to the rate cuts and so the Fed took further measures.  On December 16 the Fed announced:

The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level.  As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.  The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.  Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.  The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Under normal circumstances the Fed conducts open market operations by buying and selling short-term Treasury instruments (for a bit more detail, see here), but in December 2008 they widened the range of securities to include agency and mortgage-backed bonds (bonds issued by institutions such as Fannie Mae and Freddie Mac—see here for a brief explanation—that buy mortgages from banks, put them together in a package and then resell the package to investors).  The Fed’s goal in buying this paper was to improve conditions in the mortgage market.  The mechanism is as follows: Fannie and Freddie buy mortgages from banks and resell them to investors; the higher the price that investors are willing to pay, the lower the rate that a person taking out a mortgage will have to pay.  If buyers are reluctant to buy Fannie and Freddie paper than people who want to get mortgages will pay higher rates; but if the Fed aggressively buys this paper, then mortgage rates will come down.  So the Fed was trying to lower mortgage rates through its actions.

On March 18, the Fed provided more specific information about its actions:

To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion.  Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

The mechanism by which purchasing longer-term Treasuries might improve conditions in private credit markets is that the Fed will increase the price and lower the yield on Treasury bonds.  If investors are deciding whether to buy corporate bonds or Treasury bonds, the Fed’s action will make the corporate bonds look somewhat more attractive to the lower-yielding Treasuries, making it easier for those corporations to borrow in the future.

The reason that the Fed does not undertake such actions during normal times is that there is a greater risk associated with holdings of mortgage bonds (whose return depends on whether mortgages are paid off) than with Treasury paper (that the US government has always paid off).  The Fed clearly made a judgment that in this specific case (the sharp downturn in the economy and the problems in credit markets) that the risk was worth taking.

Whether this action will set a precedent for future Fed chairmen is an open question; one can easily imagine that there would be intense pressure on a future Fed chairman to purchase securities in markets that are in difficulty, with the result that monetary policy becomes more focused in coming years on specific sectors.  The Fed has successfully defended itself from outside pressure since it regained its independence in 1951 (see here for a bit more) but when the economy is weak there is always pressure on the Fed.

To summarize, when it became clear to the Fed that the economy was slowing sharply and that credit markets were in trouble, the Fed took extraordinary action: they cut rates to virtually zero and then announced that they would buy (in addition to the usual short-term Treasuries) longer-term Treasuries and agency mortgage debt.  With luck, this will shorten the economic crisis by restoring credit markets.  But such a large expansion of the Fed’s balance sheet presents an inflationary threat that will be described in another essay.

Understanding the Terms of the Board of Governors of the Fed

Wednesday, January 28th, 2009

The Federal Reserve System is a complex organization, comprised of twelve regional Feds and a Federal Reserve Board in Washington, DC.  In this article I describe the terms of the Board of Governors, the group that sets Fed policy (I have written elsewhere on the structure of the Fed).

The current structure of the Board of Governors (seven members with 14 year terms) dates back to 1935; under the original Federal Reserve Act (see here), there were five appointive members plus the Controller of the Currency and the Secretary of the Treasury (who was the ex-officio Chairman of the Board).

The Fed describes how the Board of Governors is nominated and how long they serve here, here and here:

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, for four-year terms.

A full term is fourteen years. One term begins every two years, on February 1 of even-numbered years.

Upon the expiration of their terms of office, members of the Board shall continue to serve until their successors are appointed and have qualified.

Thus, as I write in early 2009, there are seven current terms, with starting dates from February, 1, 1996 to February 1, 2008. But very few Fed governors serve all fourteen years of their terms, and with the difficult relations between the previous President and the Senate (see, for example, here), the Fed is operating with five governors.  President Obama, with a large Democratic majority in the Senate, should have no problem filling the two empty seats.

The Feb 1996-Jan 2010 term is vacant.

Elizabeth Duke took office on  August 5, 2008 to fill the Feb 1998-Jan 2012 term.

The Feb 2000-Jan 2014 term is vacant.

Donald Kohn took office on August 5, 2002, to fill the Feb 2002-Jan 2016 term. On June 23, 2006, Kohn was sworn in as Vice Chairman of the Board of Governors of the Federal Reserve System for a four-year term ending June 23, 2010.

Kevin Warsh took office on February 24, 2006, to fill the Feb 2004-Jan 2018 term.

Ben Bernanke was sworn in on February 1, 2006, as Chairman and a member of the Board of Governors of the Federal Reserve System. He was appointed as a member of the Board to a full 14-year term, Feb 2006-Jan 2020, and to a four-year term as Chairman, which expires January 31, 2010.

Daniel Tarullo took office on January 28, 2009 taking the  February 1, 2008 to January  31, 2022 term.

Presumably some time in 2009 President Obama will nominate two governors to fill the other vacant seats. But President Obama will not be able to replace Chairman Bernanke or Vice Chairman Kohn until 2010, although presumably pressure from the President could convince one or more Board members to resign before their terms expire.

Understanding Fed Open Market Operations

Wednesday, December 17th, 2008

The primary monetary policy tool of the Federal Reserve is the Federal Funds rate (see here for a description of the package of tools the Fed can use).  This article briefly describes the nature of monetary policy, the idea of targetting a rate and how the Fed actually conducts open market operations (for a fairly technical article about what the Fed does, written by the Fed, see this pdf).

The Fed is supposed to do many jobs (see here) that it tries to accomplish by changing the amount of money in the economy.  In the short run, the more money that is in the system, the more economic activity; but over longer horizons, more money results in more inflation.  The Fed has two policy choices: they can choose to either target the quantity of money or its price. These are two ways of targeting the same goal, but the difference is the feedback link.  A brief example may illuminate the distinction:

One can compare the Fed’s problem to the problem of maintaining a reasonable weight.  Someone who wants to maintain a particular weight could target their weight or the number of calories they eat every day.  If you target your weight, you could weigh yourself every day and on days when your weight is too high you could eat less and on days when your weight is too low you would eat more.  If you target calories, you would set a daily level of calories that you consume and adjust the number or calories that you consume when you see your weight rising or falling.  The idea is that if you target weight, you change your calorie levels more often, while if you target your calories, you allow your weight to vary before changing the number of calories you consume.  In principle these two strategies should lead to identical outcomes, but in practice there may be situations where one strategy leads to less variation than the other.

The Fed has experimented with both methods and has found that using an interest rate target works better than using a money supply target.  So the Fed sets an interest rate and then sees what is happening; if the economy is growing too quickly, they raise rates and if the economy is growing too slowly they cut rates.

The specific rate they target is the Fed Funds rate, “the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight” (see here for a recent history of Fed Funds rates).  Without getting into too much detail (and if you want more detail, see the pdf cited above) the Fed can buy and sell Treasury securities to add or withdraw reserves from the banking system.  The Fed does not buy Treasury securities at auction, but instead buys them from Treasury dealers, being careful not too own too much of any particular issue.

Fed Funds rates are not a fixed price and vary throughout the day (like the price of stocks or commodities) changing as traders buy and sell.  The range of Fed Funds rates is available here; the Fed decides on the size of their daily transaction by observing the market and estimating how much is necessary to keep the Fed Funds rate around the target rate set by the FOMC.  There is a reasonable amount of daily volatility in the Fed Funds rate; from the pdf article (table 5), the standard deviation was around .20% per day and the range between the high and low daily Fed Funds rate was over 100 basis points.  In recent days (late November and early December 2008 that I found here) the standard deviation and the range were similar.  So while the Fed targets a particular rate, most Fed Funds transactions are within 20 basis points either way, occasionally ranging to 50 or more basis points above or below the target.

The Fed will ask dealers for the price at which they are willing to buy or sell certain Treasury securities and then execute the transactions.  These transactions can be outright (permanently changing the Fed’s position) or temporary (unwinding after a certain number of days).  When the Fed executes a purchase, it writes a check to the dealer that is deposited creating more reserves in the financial system; when the Fed executes a sale, there are less reserves in the system. The effect on the economy depends on how the reserves are used.  When there are more deposits in a bank (after a Fed purchase of Treasuries), the bank has to decide what to do with the extra cash.  The bank can make more loans (expanding the economy) or the bank can allow the cash to sit in its account at the Fed.  During normal times, banks use these additional deposits but during crises banks may prefer to allow the money to sit in their accounts.

On December 16, 2008 the Fed announced a target for Fed Funds rates between 0 and 0.25% (see here); the Fed will add reserves to keep rates very low until the economy shows signs of recovery.  In the context of the weight target example above, the subject has lost much weight and is being offered a huge amount of calories every day.  If the patient is fundamentally healthy, then weight should return to normal and the daily calorie allotment will be cut.  If not…

Understanding Quantitative Easing

Tuesday, November 25th, 2008

The Fed is currently facing a problem that is different from the one it has faced for much of the past 50 years.  Since 1951 (when the Fed regained control of monetary policy from the Treasury), the Fed’s problem was managing the inflation rate; in recent months there has been some concern that prices might begin to decline and that the US might be facing a deflation.  Using traditional monetary policy, the Federal Reserve uses open market operations to achieve its objectives.  That is, the Fed sets a target for the Federal Funds rate and then buys and sells Treasury securities to maintain that rate (see here for a brief description of the policy tools the Fed has at its disposal),  But  the Fed cannot cut interest rates below zero to stimulate the economy, so when interest rates get low (as they are now) they use a different strategy.

Current Fed Chairman Ben Bernanke is a student of the Great Depression (see, for example, Essays on the Great Depression) and has spent much of his career thinking about how Fed policy might operate.  In a speech given in 2002, Bernanke spoke specifically about how the Fed might “cure deflation”.  He wrote:

Normally, money is injected into the economy through asset purchases by the Federal Reserve. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system–for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities. Each method of adding money to the economy has advantages and drawbacks, both technical and economic. One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.

As noted above, during normal times the Fed can buy Treasury securities to increase the amount of money in circulation; but the Fed is not limited to just buying Treasuries.  The Fed can buy other assets (”expand the menu of assets that it buys”), such as commercial paper.  In the early days of central banking, these securities served the role that Treasuries serve today (see section 13.2 of the Federal Reserve Act here, which allowed the Fed to buy short-term agricultural, industrial and commercial paper).

Further, the Fed can make direct low-interest-rate loans to banks; by providing banks with low-cost funds the Fed presumably creates the conditions that banks will be willing to make low-interest-rate loans to their customers.  But as we have seen in recent weeks, “calibrating the economic effects” of these measure is difficult; the Fed does not have much experience with these tools and cannot accurately estimate the effects of a given policy move (unlike open market operations, where the Fed has a very good idea of how weekly operations affect short-term interest rates and eventually the economy).

Finally, the Fed can work with the Treasury; the Treasury could issue additional securities which the Fed could then purchase, directly increasing the amount of money in circulation.

The Bank of Japan attempted quantitative easing in 2001 without much success (see here for a discussion); like much Japanese policy in recent years, policymakers seemed more concerned with stability than with ending the crisis.  The current Fed and Treasury seem less concerned with stability (see Bear Stearns, Fannie Mae, Lehman, Wachovia etc.) but whether their efforts will prevent a lengthy crisis is still uncertain.

How the Fed Communicates with the Markets

Tuesday, July 22nd, 2008

The Fed communicates in very specific ways to the markets. Because of its structure (seven governors and 12 regional Fed Presidents), the views of the different speakers often diverge on important issues. A good Fed chairman will use his power and influence to present a unified view of the Fed’s view of the current situation, but it is not uncommon that a specific Fed president (or less frequently, a governor) will present an alternate view, arguing that the interest rate policy is too tight or too loose. By understanding the different methods of Fed communication you can better understand what the Fed is saying and how to interpret a particular statement.

The primary communications are through:

  • Official FOMC statements and minutes
  • Official Speeches and Testimony
  • Questions and Answer sessions (often following speeches and testimony)

Official FOMC statements and minutes: When the FOMC has a meeting a policy statement is published shortly after the meeting ends (see here for the calendar of recent FOMC meetings and the associated statements and minutes; this site is the place to find the FOMC statement as is it released). These statements are fairly formulaic: a policy statement, a brief description of the economy as the FOMC sees it and the voting results. Unlike the ECB there is no press conference after the FOMC meeting, so instead there is an active debate among so-called Fed watchers about what the Fed really meant to say, with careful analysis of changes in wording. Economic analysts (including this one) will debate why the FOMC left out a phrase it had used in the past or the precise significance of a dissenting vote.

Approximately two weeks before each FOMC meeting the Fed publishes the “Beige Book” (see 2008 schedule here), officially titled the”Summary of Commentary on Current Economic Conditions by Federal Reserve District.” This is a collection of anecdotal information on each of the twelve Federal Reserve Districts that are collected and presented by an individual regional Federal Reserve Bank. The unusual aspect of the Beige Book is that the tone of the presentation is often sharply influenced by the views of the regional Fed (or more specifically the President of the regional Fed) who is the author of the report; on some occasions the view of the economy can shift sharply from one month to the next more as a result of the difference in perspective of the author than in any change in the economy itself. A careful reader of the Beige Book will determine the author of the particular presentation to see if the summary is merely a restatement of the specific bank president’s well known view of the economy.

Official Speeches and Testimony: There is a modest difference between speeches (usually invited lectures by a Fed official to a group of financial executives, see here) and testimony before Congress (usually a presentation by the Chairman of the Fed that is covered on television, but also presentations by other officials, see here). In general the Fed official will have a prepared text that will be released at the official time on the Fed’s web site (see the links above) and then may answer questions.

Questions and Answers: The most notable Congressional testimony is the Monetary Report to Congress, where the Chairman of the Fed goes to Congress twice a year (usually January and July) and visits both the House and Senate for separate presentations. In a curious tradition, the Senators or Congressmen often speak first, then the Chairman presents the report, and then there is a several hour question and answer session. While the large majority of the so-called questions are actually speeches by members of Congress designed to attract attention to a specific issue and the member of Congress who asks the question and often of little general interest (but see some videos on youtube here), there is occasionally a question that prompts the Chairman to say something more clearly than he has in the past. So these sessions are televised to trading rooms across America, even though there is little news made at any given time.

Fed Chairman Bernanke speaks relatively more clearly than his predecessor, Chairman Greenspan. Mr. Greenspan enjoyed posing rhetorical questions and speaking in a confusing way; markets would often react strongly to his testimony, often changing directions several times before the Chairman’s statement was fully understood. Chairman Bernanke does not seem to move markets as much, partially as a result of his plain speaking. The Chairman of the Fed is an important force in the markets but does not have superhuman powers, and thoughtful investors will evaluate his statements (and his views on the economy and markets) as one source of information among many.

Understanding the Policy Tools of the Fed

Monday, July 21st, 2008

The Fed has three traditional policy tools to implement monetary policy: (1) the Fed Funds rate; (2) the discount rate and (3) reserve requirements.

To understand these tools you must first understand a bit about how banks operate. Banks must keep deposits at the Federal Reserve (more about this below under the section describing reserve requirements and more here). The exact amount of deposits that each bank must hold depends on how much money is deposited in the bank during the week; some banks find they have extra deposits at the Fed, while others have too little. The market for these deposits is called the Federal Funds market, usually referred to as Fed Funds. The Fed owns a portfolio of Treasury securities; by buying or selling these securities, the Fed can increase or decrease the amount of money deposited at banks; these transactions are called open market operations.

In practice, the Fed Funds rate is the tool that the Fed uses most often; by intervening in the Fed Funds market (via open market operations) the Fed can raise or lower the interest rate charged by banks for loans to other banks. In recent years (with the exception of the period starting in the last few months of 2007) Fed policy could be characterized by the Fed Funds rate. When the economy appeared to be slowing the Fed would cut rates (Fed Funds were 1% in Summer 2003) and when the economy appeared to be expanding too rapidly the Fed would raise rates (Fed Funds were 5.25% in Summer 2006). As this tool became the center of much attention a Fed Funds futures market was created; traders can bet on the Fed Funds rate and other investors can use the price of these futures as a guide to the market’s expectation of future Fed policy (see here for the futures contract and here for an interpretation of the prices of Fed Funds futures and options).

The discount rate is not really used as a policy tool during normal times. The Fed wants banks that have temporary liquidity problems to be a bit reluctant to borrow directly from the Fed, preferring that instead they borrow from other banks. Maintaining a modest spread (normally 100 basis points; see here for transcripts of discount rate decisions of the last few years) between the discount rate and the Fed Funds rate discourages use of the discount window for a bank who is not having problems. But this meant that markets started to believe that if a bank used the discount window then the bank was having problems, so banks avoided using the discount window. In normal times, when the banking sector is profitable, this is not really a problem. But during the subprime crisis banks that had problems obtaining short-term finance (because they had big positions in risky mortgage securities, other banks were reluctant to lend them funds) still avoided the discount window, even when the gap between the discount rate and the Fed Funds rate was reduced in August to 50 basis points and several prominent banks borrowed money from the discount window. This led the Fed to create the auction funds from a “Term Auction Facility” (see here for more), that essentially provided discount rate loans with potentially smaller penalties as a way to get funds into the system.

Reserve requirements had been a policy tool of the Fed in the past but are no longer used for policy purposes. The Fed requires banks and other financial institutions to keep 10% (approximately, see here for details) of transactions accounts (essentially checking accounts) in vault cash or on deposit at the Fed or another institution. There have been modest changes to the reserve requirement rules in the last 25 years in ways that seem unrelated to policy concerns.

The Many Mandates of the Fed

Sunday, July 20th, 2008

The Federal Reserve Act states the objectives of monetary policy: “The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of [1] maximum employment, [2] stable prices, and [3] moderate long-term interest rates.” (numbers in [brackets] added)

If you have difficulty reconciling this sentence with textbook macroeconomics you are not alone. There is no obvious definition of maximum employment (zero unemployment?) or stable prices (zero inflation?) or moderate long-term interest rates, but in any case the Fed must do all three simultaneously. Even if we do not precisely understand the Fed’s official instructions from Congress, we can see that they are fairly broad; a Fed chairman can always claim that a particularly policy was aimed at one of the objectives.

In contrast, other Central Banks whose have a single objective to maintain price stability (for example the ECB, see here) and attach secondary importance to employment and growth. There are a number of other jobs for the Fed described in the Federal Reserve Act but they are of lesser importance.

Congress created the Fed and holds a good deal of power over it. The Humphrey-Hawkins legislation (see section 108 of the rather large pdf) required the Fed to report to Congress twice a year about how it is meeting its objectives; while the legislation expired in 2000, the Fed chairman voluntarily testifies before Congress twice a year (more often if there are important issues) and is required to answer a number of questions on various issues.

If Congress is not happy with the Fed’s performance they could theoretically redesign the system and replace the Fed with something else. While it would take a major crisis to provoke such a reaction, this scenario happened during the Great Depression. In 1942, Congress took interest rate policy away from the Fed and gave it to the Treasury Department (see here); the Fed only regained its independence in 1951.

So the Fed is very responsive to Congress. The Fed Chairman routinely endures lengthy questioning from Congress about many topics in an effort to be responsive to the concerns of Congress (a search on for Fed Chairman Bernanke produces over 1000 videos, many of which appear to involve Congressional testimony), and tries to carefully explain policy to preserve the Fed’s independence in the future.

The Fed chairman technically has two separate appointments: a term as governor (just like that of the other six governors) that lasts 14 years (unless the chairman initially takes the remainder of the term of another governor) and a four-year term as chairman (see here for Chairman Bernanke’s terms). Again, the chairman can remain chairman until a new chairman is nominated. The practical result is that Fed chairmen in recent years have worked closely with each new President; Chairman Greenspan was nominated initially by President Reagan and then renominated by Presidents Bush and Clinton. The current understanding in Washington appears to be that markets would be upset by the ouster of a Fed chairman who is doing well, making administrations reluctant to change. Chairman Bernanke’s handling of the current economic mess will likely determine whether he will be renominated when his term as Chairman expires in January 2010.

There is one important mandate that the Fed does not have: managing the external value of the Dollar. It is a curious relic of the 1951 Fed-Treasury accord that the Treasury is responsible for the Dollar, so that only the Secretary of the Treasury will speak about the Dollar’s value or order intervention in currency markets (which will be carried out by the Fed). Most economists believe that the value of the Dollar is largely determined by monetary policy, which is planned and executed by the Fed. But for legal/political reasons, the official authority is in the Treasury.

The Structure of the Fed

Saturday, July 19th, 2008

The Federal Reserve was created by Congress almost 100 years ago, when the economy and markets were very different from today. Creating a central bank was controversial at the time and the political compromises led to a peculiar structure (see here for the official version of the Fed’s history; there are numerous alternate versions of the Fed’s history, including this one that is considerably more skeptical).

The Fed consists of 12 regional Federal Reserves that were established in the large financial centers of 1913; there is only one regional Fed in the western US (in San Francisco) while there are two in Missouri (St. Louis and Kansas City). You can see the map here.

The decision making body of the Fed is the Federal Open Market Committee (FOMC). When you hear that the Fed cut rates it is by a vote of the FOMC. There are two sorts of members of the FOMC: seven governors, selected by the President, who serve 14-year terms. Due to a conflict between the Democratic Congress and a Republican President there are currently several vacancies; Board members can remain on the Board until their replacements are named or until their full 14-year term is completed. Few board members serve a 14-year term, so a two-term President is likely to have the opportunity to name all seven Board members.

The remaining five members of the committee come from the 12 Presidents of the regional Federal Reserve Banks (on a rotating basis), who are selected by the locally-based Directors of the Banks (see here, at the bottom of the page, for the list of which Fed President serves when).

The crucial policymaking is done at meetings of the FOMC in a large conference room in the Eccles Building in Washington, DC. Sitting at the table are the Chairman of the Fed (Ben Bernanke), the Vice Chairman of the Fed (Donald Kohn), the other five governors, the President of the New York Fed (Timothy Geithner), who is somewhat confusingly the Vice Chairman of the FOMC, and the other eleven regional Fed Presidents, four of whom are voting members of the committee at any time (the other seven participate in the discussion but do not vote). Also in the room are a number of high-level Board and regional Fed officials and economists who make presentations to the committee on various topics.

Recent Fed Chairmen (Bernanke, Greenspan and Volcker) have had a very important influence in Committee decision making. While there may be extensive debate on what the Fed should be doing, there are very few close votes. It has been said that three negative votes are sufficient to veto any policy decision, so in recent years most votes have been unanimous or with one or two members dissenting.

Understanding the Federal Reserve

Saturday, July 19th, 2008

The Fed is the US central bank. The US has a fairly complex history of central banking (see here for the official version); the Fed was officially created by Congress in 1913 but did not really get the independence that it enjoys today until 1951. The following essays address the structure of the Fed, the mandates (or objectives set by Congress) of the Fed, the tools with which the Fed tries to achieve those objectives and the methods with which the Fed communicates with the market,

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