What is the Federal Reserve?

BilPrestonEsq

What is it? What led us to having the Federal Reserve in the first place? What does the Federal Reserve do for us now?

brainstorm

It sets interest rates by selling treasury bonds, I think.

WhoWee

A little background.
http://www.referenceforbusiness.com/...ve-System.html

WhoWee

"The Federal Reserve System is the central bank of the United States. The Fed is exclusively a banker's bank and does not conduct commercial banking activities. Its goal is to attain stable economic growth in the nation, and through its actions, influence the flow of money and credit in the economy. Specifically, the Fed is responsible for:

formulating monetary policy;
acting as lender of last resort for the nation's banks and depository institutions;
facilitating the collection and clearance of checks;
regulating and supervising banks and other financial institutions;
acting as fiscal agent for the United States Treasury;
distributing coin and currency to the public through depository institutions; and
implementing certain regulations of consumer credit legislation.
The system consists of the Board of Governors, the Federal Open Market Committee, 12 Federal Reserve Banks, 25 branches, member financial institutions, and advisory committees. "

talk2glenn

This is not quite right, but is a pretty pervasive myth.

What the Fed sets are target rates for things that are determined by the market, including the interest rate on Treasury's (which is a function of their price). It encourages the market to move towards target rates via a basket of powerful tools, but it cannot wave a magic wand and mandate that, say, Treasury bonds trade at a given interest rate.

You're right in principle, though: the Fed does try and maintain (among other things) a target interest rate by manipulating (buying and selling in) the debt market.

brainstorm

Your language is slightly more accurate than mine. My understanding was that if the Fed changes its bond rates to a new rate, all existing bonds will get traded at that rate in anticipation that the price of bonds with different rates would be modified in price according to their term and the total interest projected. So there's no mandate, as I understand it, but it would simply be irrational to buy a 1% bond when 3% bonds are available or sell a 4% bond for less that the comparable earning on a 3% bond. Put more simply, you trade bonds based on the interest earned for the life of the bond, regardless of interest rate, and this makes all bonds comparable to bonds issues at the current interest rate adjusted for term earnings. I'm not sure I'm explaining this right and I may be confusing myself.

BilPrestonEsq

So if it is their sole purpose to make sure things run smoothly why has the dollar decreased in value so much over time? Why do we have recessions?

WhoWee

This link provides an overview of how the Fed and Treasury work together.
http://www.investopedia.com/articles...34887342&close


The Federal Reserve sets the discount rate - that is the rate select commercial banks may borrow.

US Treasury Notes and Bonds are sold at auction - this link provides the current schedule.
http://www.treasury.gov/resource-cen...s/auctions.pdf

WhoWee

Running smoothly typically has meant keeping the proper level of liquidity in the market. Currently, the interest rate is being artificially suppressed to keep inflation down and (see Laffer curve) compensate for printing money (QE-2).

BilPrestonEsq

So all the dollars in existence came from the fed, with interest, loaned to commercial banks?

WhoWee

http://www.ny.frb.org/aboutthefed/fedpoint/fed01.html

"How Currency Gets into Circulation


There is about $829 billion dollars of U.S. currency in circulation; the majority is held outside the United States.
The Federal Reserve Banks distribute new currency for the U.S. Treasury Department, which prints it.
Depository institutions buy currency from Federal Reserve Banks when they need it to meet customer demand, and they deposit cash at the Fed when they have more than they need to meet customer demand. "

BilPrestonEsq

So what am I missing? Why isn't the Fed doing what it is supposed to do? Why more and more debt? Why more and more inflation? I want a real answer, WHY? Yeah their purpose is to keep things stable right? So why isn't the economy stable then? Someone please explain why the Fed does nothing that it is supposed to do. Why isn't there plan working at all? Again, what am I missing here?

WhoWee

The Fed controls liquidity and the discount rate. The interest rates are low - but stable. At the same time inflation has been fairly stable as well. Gas prices (and prices affected by fuel costs) are now increasing.

As for debt, there are several different types. The Fed can only affect the amount that banks might loan. Government spending (and borrowing) is outside the control of the Fed. Consumer credit is also beyond the scope of the Fed. Additionally, the stock, bond, and futures markets are all independent of the Fed.

Now, with all of that said - the Fed is currently engaged in QE-2 (Quantitative Easing 2).
http://money.cnn.com/2010/11/03/news...sion/index.htm
It is intended to stimulate the economy - but there are no guarantees.

BilPrestonEsq

This is what I am talking about. The inflation rate is stable? So it is constantly growing, as is debt. What is stable about that? So stability comes from the knowing that debt and inflation are going to continuously rise, until what? Stimulate the economy by QE-2! What happens when that translates into inflation? I want to seperate what the banking system does from everything else. These are all half answers. I understand what the Fed says it does, but has it accomplished any of its goals in stablizing the money supply for the good of the country and the world? Who gains from rising inflation and rising debt but bankers?

WhoWee

Let's not forget about all of the bad paper held by banks.

Ronnin

The FED's power resides in its ability to influence interest rates and market liquidity. They can also set the reserve percentage which directly influences how much banks can lend against their capitalization requirements. But, all of these "tools" cannot change the fact that the economy is not exactly humming along right now and for all the money the government has thrown at the problem we are going through a period of deleveraging. The country as a whole has taken a huge write down of assets and because of that "we" collectly don't have the worth we had before. Therefore "we" cannot borrow as much or at the same rates so some payback must occur to bring things back in line.

WhoWee

Bernanke - on the housing bubble - it's worth a read through - the quoted portion is part of his conclusion.
http://www.federalreserve.gov/newsev...ney.com/RENEWS

"The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter. The Federal Reserve is working not only to improve our ability to identify and correct problems in financial institutions, but also to move from an institution-by-institution supervisory approach to one that is attentive to the stability of the financial system as a whole. Toward that end, we are supplementing reviews of individual firms with comparative evaluations across firms and with analyses of the interactions among firms and markets. We have further strengthened our commitment to consumer protection. And we have strongly advocated financial regulatory reforms, such as the creation of a systemic risk council, that will reorient the country's overall regulatory structure toward a more systemic approach. The crisis has shown us that indicators such as leverage and liquidity must be evaluated from a systemwide perspective as well as at the level of individual firms.

Is there any role for monetary policy in addressing bubbles? Economists have pointed out the practical problems with using monetary policy to pop asset price bubbles, and many of these were illustrated by the recent episode. Although the house price bubble appears obvious in retrospect--all bubbles appear obvious in retrospect--in its earlier stages, economists differed considerably about whether the increase in house prices was sustainable; or, if it was a bubble, whether the bubble was national or confined to a few local markets. Monetary policy is also a blunt tool, and interest rate increases in 2003 or 2004 sufficient to constrain the bubble could have seriously weakened the economy at just the time when the recovery from the previous recession was becoming established.

That said, having experienced the damage that asset price bubbles can cause, we must be especially vigilant in ensuring that the recent experiences are not repeated. All efforts should be made to strengthen our regulatory system to prevent a recurrence of the crisis, and to cushion the effects if another crisis occurs. However, if adequate reforms are not made, or if they are made but prove insufficient to prevent dangerous buildups of financial risks, we must remain open to using monetary policy as a supplementary tool for addressing those risks--proceeding cautiously and always keeping in mind the inherent difficulties of that approach. Clearly, we still have much to learn about how best to make monetary policy and to meet threats to financial stability in this new era. Maintaining flexibility and an open mind will be essential for successful policymaking as we feel our way forward. "