The Federal Reserve System

Although reserve requirement ratios have not been changed since the early 1990s, the level of reserve requirements and required reserve balances has fallen considerably since then because of the widespread implementation of retail sweep programs by depository institutions. Under such a program, a depository institution sweeps amounts above a predetermined level from a depositor's checking account into a special-purpose money market deposit account created for the depositor. In this way, the depository institution shifts funds from an account that is subject to reserve requirements to one that is not and therefore reduces its reserve requirement. With no change in its vault cash holdings, the depository institution can lower its required reserve balance, on which it earns no interest, and invest the funds formerly held at the Federal Reserve in interest-earning assets.

The Discount Window

The Federal Reserve's lending at the discount window serves two primary functions. It complements open market operations in achieving the target federal funds rate by making Federal Reserve balances available to depository institutions when the supply of balances falls short of demand. It also serves as a backup source of liquidity for individual depository institutions.

Although the volume of discount window borrowing is relatively small, it plays an important role in containing upward pressures on the federal funds rate. If a depository institution faces an unexpectedly low balance in its account at the Federal Reserve, either because the total supply of balances has fallen short of demand or because it failed to receive an expected transfer of funds from a counterparty, it can borrow at the discount window. This extension of credit increases the supply of Federal Reserve balances and helps to limit any upward pressure on the federal funds rate. At times when the normal functioning of financial markets is disrupted--for example after operational problems, a natural disaster, or a terrorist attack--the discount window can become the principal channel for supplying balances to depository institutions.

The discount window can also, at times, serve as a useful tool for promoting financial stability by providing temporary funding to depository institutions that are having significant financial difficulties. If the institution's sudden collapse were likely to have severe adverse effects on the financial system, an extension of central bank credit could be desirable because it would address the liquidity strains and permit the institution to make a transition to sounder footing. Discount window credit can also be used to facilitate an orderly resolution of a failing institution. An institution obtaining credit in either situation must be monitored appropriately to ensure that it does not take excessive risks in an attempt to return to profitability and that the use of central bank credit would not increase costs to the deposit insurance fund and ultimately the taxpayer.

In ordinary circumstances, the Federal Reserve extends discount window credit to depository institutions under the primary, secondary, and seasonal credit programs. The rates charged on loans under each of these programs are established by each Reserve Bank's board of directors every two weeks, subject to review and determination by the Board of Governors. The rates for each of the three lending programs are the same at all Reserve Banks, except occasionally for very brief periods following the Board's action to adopt a requested rate change. The Federal Reserve also has the authority under the Federal Reserve Act to extend credit to entities that are not depository institutions in “unusual and exigent circumstances”; however, such lending has not occurred since the 1930s.

Primary Credit

Primary credit is available to generally sound depository institutions on a very short-term basis, typically overnight. To assess whether a depository institution is in sound financial condition, its Reserve Bank regularly reviews the institution's condition, using supervisory ratings and data on adequacy of the institution's capital. Depository institutions are not required to seek alternative sources of funds before requesting occasional advances of primary credit, but primary credit is expected to be used as a backup, rather than a regular, source of funding.

The rate on primary credit has typically been set 1 percentage point above the FOMC's target federal funds rate, but the spread can vary depending on circumstances. Because primary credit is the Federal Reserve's main discount window program, the Federal Reserve at times uses the term discount rate specifically to mean the primary credit rate.

Reserve Banks ordinarily do not require depository institutions to provide reasons for requesting very short-term primary credit. Borrowers are asked to provide only the minimum information necessary to process a loan, usually the requested amount and term of the loan. If a pattern of borrowing or the nature of a particular borrowing request strongly indicates that a depository institution is not generally sound or is using primary credit as a regular rather than a backup source of funding, a Reserve Bank may seek additional information before deciding whether to extend the loan.

Primary credit may be extended for longer periods of up to a few weeks if a depository institution is in generally sound financial condition and cannot obtain temporary funds in the market at reasonable terms. Large and medium-sized institutions are unlikely to meet this test.

Secondary Credit

Secondary credit is available to depository institutions that are not eligible for primary credit. It is extended on a very short-term basis, typically overnight. Reflecting the less-sound financial condition of borrowers of secondary credit, the rate on secondary credit has typically been 50 basis points above the primary credit rate, although the spread can vary as circumstances warrant. Secondary credit is available to help a depository institution meet backup liquidity needs when its use is consistent with the borrowing institution's timely return to a reliance on market sources of funding or with the orderly resolution of a troubled institution's difficulties. Secondary credit may not be used to fund an expansion of the borrower's assets.

Loans extended under the secondary credit program entail a higher level of Reserve Bank administration and oversight than loans under the primary credit program. A Reserve Bank must have sufficient information about a borrower's financial condition and reasons for borrowing to ensure that an extension of secondary credit would be consistent with the purpose of the facility. Moreover, under the Federal Deposit Insurance Corporation Improvement Act of 1991, extensions of Federal Reserve credit to an FDIC-insured depository institution that has fallen below minimum capital standards are generally limited to 60 days in any 120-day period or, for the most severely undercapitalized, to only five days.

Seasonal Credit

The Federal Reserve's seasonal credit program is designed to help small depository institutions manage significant seasonal swings in their loans and deposits. Seasonal credit is available to depository institutions that can demonstrate a clear pattern of recurring swings in funding needs throughout the year--usually institutions in agricultural or tourist areas. Borrowing longer-term funds from the discount window during periods of seasonal need allows institutions to carry fewer liquid assets during the rest of the year and make more funds available for local lending.

The seasonal credit rate is based on market interest rates. It is set on the first business day of each two-week reserve maintenance period as the average of the effective federal funds rate and the interest rate on three-month certificates of deposit over the previous reserve maintenance period. [see 14 p.29]

2.3 The Federal Reserve in the International Sphere

The activities of the Federal Reserve and the international economy influence each other. Therefore, when deciding on the appropriate monetary policy for achieving basic economic goals, the Board of Governors and the FOMC consider the record of U.S. international transactions, movements in foreign exchange rates, and other international economic developments. And in the area of bank supervision and regulation, innovations in international banking require continual assessments of, and occasional modifications in, the Federal Reserve's procedures and regulations.

The Federal Reserve formulates policies that shape, and are shaped by, international developments. It also participates directly in international affairs. For example, the Federal Reserve occasionally undertakes foreign exchange transactions aimed at influencing the value of the dollar in relation to foreign currencies, primarily with the goal of stabilizing disorderly market conditions. These transactions are undertaken in close and continuous consultation and cooperation with the U.S. Treasury. The Federal Reserve also works with the Treasury and other government agencies on various aspects of international financial policy. It participates in a number of international organizations and forums and is in almost continuous contact with other central banks on subjects of mutual concern.

The Federal Reserve's actions to adjust U.S. monetary policy are designed to attain basic objectives for the U.S. economy. But any policy move also influences, and is influenced by, international developments. For example, monetary policy actions influence exchange rates. The dollar's exchange value in terms of other currencies is therefore one of the channels through which U.S. monetary policy affects the U.S. economy. If Federal Reserve actions raised U.S. interest rates, for instance, the foreign exchange value of the dollar generally would rise. An increase in the foreign exchange value of the dollar, in turn, would raise the price in foreign currency of U.S. goods traded on world markets and lower the dollar price of goods imported into the United States. By restraining exports and boosting imports, these developments could lower output and price levels in the economy. In contrast, an increase in interest rates in a foreign country could raise worldwide demand for assets denominated in that country's currency and thereby reduce the dollar's value in terms of that currency. Other things being equal, U.S. output and price levels would tend to increase--just the opposite of what happens when U.S. interest rates rise. Therefore, when formulating monetary policy, the Board of Governors and the FOMC draw upon information about and analysis of international as well as U.S. domestic influences. Changes in public policies or in economic conditions abroad and movements in international variables that affect the U.S. economy, such as exchange rates, must be factored into the determination of U.S. monetary policy.

Conversely, economic developments in the United States, including U.S. monetary policy actions, have significant effects on growth and inflation in foreign economies. Although the Federal Reserve's policy objectives are limited to economic outcomes in the United States, it is mutually beneficial for macroeconomic and financial policy makers in the United States and other countries to maintain a continuous dialogue. This dialogue enables the Federal Reserve to better understand and anticipate influences on the U.S. economy that emanate from abroad.

The increasing complexity of global financial markets--combined with ever-increasing linkages between national markets through trade, finance, and direct investment--have led to a proliferation of forums in which policy makers from different countries can meet and discuss topics of mutual interest. One important forum is provided by the Bank for International Settlements (BIS) in Basel, Switzerland. Through the BIS, the Federal Reserve works with representatives of the central banks of other countries on mutual concerns regarding monetary policy, international financial markets, banking supervision and regulation, and payments systems. (The Chairman of the Board of Governors and the president of the Federal Reserve Board of New York represent the U.S. central bank on the board of directors of the BIS.) Representatives of the Federal Reserve also participate in the activities of the International Monetary Fund (IMF) and discuss macroeconomic, financial market, and structural issues with representatives of other industrial countries at the Organization for Economic

Co-operation and Development (OECD). Following the Asian Financial Crises of 1997 and 1998, the Financial Stability Forum (FSF) was established to enable central banks, finance ministries, and financial regulatory authorities in systemically important economies to work together to address issues related to financial stability. The Federal Reserve also sends delegates to international meetings such as those of the Asia Pacific Economic Cooperation (APEC) Finance Ministers' Process, the G-7 Finance Ministers and Central Bank Governors, the G-20, and the Governors of Central Banks of the American Continent.

Foreign Currency Operations

The Federal Reserve conducts foreign currency operations--the buying and selling of dollars in exchange for foreign currency--under the direction of the FOMC, acting in close and continuous consultation and cooperation with the U.S. Treasury, which has overall responsibility for U.S. international financial policy. The manager of the System Open Market Account at the Federal Reserve Bank of New York acts as the agent for both the FOMC and the Treasury in carrying out foreign currency operations. Since the late 1970s, the U.S. Treasury and the Federal Reserve have conducted almost all foreign currency operations jointly and equally.

The purpose of Federal Reserve foreign currency operations has evolved in response to changes in the international monetary system. The most important of these changes was the transition in the 1970s from a system of fixed exchange rates--established in 1944 at an international monetary conference held in Bretton Woods, New Hampshire--to a system of flexible (or floating) exchange rates for the dollar in terms of other countries' currencies. Under the Bretton Woods Agreements, which created the IMF and the International Bank for Reconstruction and Development (known informally as the World Bank), foreign authorities were responsible for intervening in exchange markets to maintain their countries' exchange rates within 1 percent of their currencies' parities with the U.S. dollar; direct exchange market intervention by U.S. authorities was extremely limited. Instead, U.S. authorities were obliged to buy and sell dollars against gold to maintain the dollar price of gold near $35 per ounce. After the United States suspended the gold convertibility of the dollar in 1971, a regime of flexible exchange rates emerged; in 1973, under that regime, the United States began to intervene in exchange markets on a more significant scale. In 1978, the regime of flexible exchange rates was codified in an amendment to the IMF's Articles of Agreement.

Under flexible exchange rates, the main aim of Federal Reserve foreign currency operations has been to counter disorderly conditions in exchange markets through the purchase or sale of foreign currencies (called foreign exchange intervention operations), primarily in the New York market. During some episodes of downward pressure on the foreign exchange value of the dollar, the Federal Reserve has purchased dollars (sold foreign currency) and has thereby absorbed some of the selling pressure on the dollar. Similarly, the Federal Reserve may sell dollars (purchase foreign currency) to counter upward pressure on the dollar's foreign exchange value. The Federal Reserve Bank of New York also executes transactions in the U.S. foreign exchange market for foreign monetary authorities, using their funds.

In the early 1980s, the United States curtailed its official exchange market operations, although it remained ready to enter the market when necessary to counter disorderly conditions. In 1985, particularly after September, when representatives of the five major industrial countries reached the so-called Plaza Agreement on exchange rates, the United States began to use exchange market intervention as a policy instrument more frequently. Between 1985 and 1995, the Federal Reserve--sometimes in coordination with other central banks--intervened to counter dollar movements that were perceived as excessive. Based on an assessment of past experience with official intervention and a reluctance to let exchange rate issues be seen as a major focus of monetary policy, U.S. authorities have intervened only rarely since 1995.

A dollar intervention initiated by a foreign central bank also leaves the supply of balances at the Federal Reserve unaffected, unless the central bank changes the amount it has on deposit at the Federal Reserve. If, for example, the foreign central bank purchases dollars in the foreign exchange market and places them in its account at the Federal Reserve Bank of New York, then the supply of Federal Reserve balances available to depository institutions decreases because the dollars are transferred from the bank of the seller of dollars to the foreign central bank's account with the Federal Reserve. However, the Open Market Desk would offset this drain by buying a Treasury security or arranging a repurchase agreement to increase the supply of Federal Reserve balances to U.S. depository institutions. Most dollar purchases by foreign central banks are used to purchase dollar securities directly, and thus they do not need to be countered by U.S. open market operations to leave the supply of dollar balances at the Federal Reserve unchanged.

Foreign Currency Resources

The main source of foreign currencies used in U.S. intervention operations currently is U.S. holdings of foreign exchange reserves. At the end of June 2004, the United States held foreign currency reserves valued at $40 billion. Of this amount, the Federal Reserve held foreign currency assets of $20 billion, and the Exchange Stabilization Fund of the Treasury held the rest. The U.S. monetary authorities have also arranged swap facilities with foreign monetary authorities to support foreign currency operations. These facilities, which are also known as reciprocal currency arrangements, provide short-term access to foreign currencies. A swap transaction involves both a spot (immediate delivery) transaction, in which the Federal Reserve transfers dollars to another central bank in exchange for foreign currency, and a simultaneous forward (future delivery) transaction, in which the two central banks agree to reverse the spot transaction, typically no later than three months in the future. The repurchase price incorporates a market rate of return in each currency of the transaction. The original purpose of swap arrangements was to facilitate a central bank's support of its own currency in case of undesired downward pressure in foreign exchange markets. Drawings on swap arrangements were common in the 1960s but over time declined in frequency as policy authorities came to rely more on foreign exchange reserve balances to finance currency operations. In years past, the Federal Reserve had standing commitments to swap currencies with the central banks of more than a dozen countries. In the middle of the 1990s, these arrangements totaled more than $30 billion, but they were almost never drawn upon. At the end of 1998, these facilities were allowed to lapse by mutual agreement among the central banks involved, with the exception of arrangements with the central banks of Canada and Mexico.

Reciprocal currency arrangements can be an important policy tool in times of unusual market disruptions. For example, immediately after the terrorist attacks of September 11, 2001, the Federal Reserve established temporary swap arrangements with the European Central Bank and the Bank of England, as well as a temporary augmentation of the existing arrangement with the Bank of Canada. The purpose of these arrangements was to enable the foreign central banks to lend dollars to local financial institutions to facilitate the settlement of their dollar obligations and to guard against possible disruptions to the global payments system. The European Central Bank drew $23.5 billion of its swap line; the balance was repaid after three days. The other central banks did not draw on their lines. The temporary arrangements lapsed after thirty days.

The Federal Reserve is interested in the international activities of banks, not only because it functions as a bank supervisor but also because such activities are often close substitutes for domestic banking activities and need to be monitored carefully to help interpret U.S. monetary and credit conditions. Moreover, international banking institutions are important vehicles for capital f lows into and out of the United States.

Where international banking activities are conducted depends on such factors as the business needs of customers, the scope of operations permitted by a country's legal and regulatory framework, and tax considerations. The international activities of U.S.-chartered banks include lending to and accepting deposits from foreign customers at the banks' U.S. offices and engaging in other financial transactions with foreign counterparts. However, the bulk of the international business of U.S.-chartered banks takes place at their branch offices located abroad and at their foreign-incorporated subsidiaries, usually wholly owned. Much of the activity of foreign branches and subsidiaries of U.S. banks has been Eurocurrency business--that is, taking deposits and lending in currencies other than that of the country in which the banking office is located. Increasingly, U.S. banks are also offering a range of sophisticated financial products to residents of other countries and to U.S. firms abroad.

The international role of U.S. banks has a counterpart in foreign bank operations in the United States. U.S. offices of foreign banks actively participate as both borrowers and investors in U.S. domestic money markets and are active in the market for loans to U.S. businesses. (See chapter 5 for a discussion of the Federal Reserve's supervision and regulation of the international activities of U.S. banks and the U.S. activities of foreign banks.)

International banking by both U.S.-based and foreign banks facilitates the holding of Eurodollar deposits--dollar deposits in banking offices outside the United States--by nonbank U.S. entities. Similarly, Eurodollar loans--dollar loans from banking offices outside the United States--can be an important source of credit for U.S. companies (banks and non-banks). Because they are close substitutes for deposits at domestic banks, Eurodollar deposits of nonbank U.S. entities at foreign branches of U.S. banks are included in the U.S. monetary aggregate.

Conclusion

Federal Reserve makes its own contribution to the nation of economic and financial goals, working on finance and credit in the economy. As the country's central bank, it provides long-term economic growth within its capacity, while ensuring reasonable price stability. In a nutshell, the Fed seeks to implement its policies so as to combat the deflationary and inflationary pressures as they arise. And as a lender of last resort in a crisis situation, it is responsible for using the tools of their policies in order to prevent a national crisis of liquidity and financial panic.

Federal Reserve System has been entrusted to many monitoring and regulatory functions. For example, it is liable for the amount of credit used for the purchase or sale of securities, regulate overseas activities of all U.S. banks and foreign banks. Monitors compliance with laws governing bank holding companies, controls the banks, registered at the state and are members of the Fed, sets rules to protect consumers' interests.

Like the federal government, the Federal Reserve System was designed to be a compromise between national and regional powers. Its regional base--the 12 Reserve Banks--makes the System more flexible and innovative and ensures that its decisions and actions are broadly based. The Board of Governors, acting as general overseer of the Reserve Banks, helps coordinate the System's operations. And the System's most important function--formulating and implementing monetary policy--is carried out in light of both regional and national concerns by the FOMC, the Reserve Banks, and the Board of Governors.

The Federal Reserve's major functions account for its structure and for its unique position in the federal government. Accountable to the government but working independently within it, the System is able to pursue its monetary policy goals without undue pressures from short-term political considerations. Since its founding in 1913, the Federal Reserve System has evolved to meet the needs of a changing financial system and a growing economy. Its unique structure, however, remains its most outstanding feature and its greatest strength.

List of Literature

1. Dolan EJ. Etc. Money, banking and monetary policy. Under the general. Ed. V. Lukashevich, M.Yartseva.-St., 1994

2. Campbell R. McConnell, Stanley L. Brue. Economics. Principles, problems and policies. Volume 1. -M.: "The Republic" .- 1992.

3. Konstantinov AY U.S. investment banks and pricing in the market the first issue. / / USA: Economics, Politics, ideologiya.-1994g.-N4.-pp.32-42.

4. Noskov IJ Features of the activities of transnational banks in the U.S.. / / Finansy.-1994g.-N9.-p.46.

5. http://www.federalreserve.gov/paymentsystems/fisagy_about.htm

6. Stepanov Experience in organizing the work of central banks in foreign countries.Vopr ekonomiki.-1995g.-N10.-p.20.

7. Annual Report, 1995. Board of Governors of the Federal Reserve System. U.S. Government Printing Office.

8.Galbraith, John K. 1990. A Short History of Financial Euphoria. New York: Whittle Direct Books.

9.Kah, Gary. 1991. En Route to Global Occupation. Lafayette, La.: Huntington House. (article 5)

10.Mullins, Eustace. 1983. Secrets of the Federal Reserve. Staunton, Va.: Bankers Research Institute.

11.Shauf, Thomas. 1992. The Federal Reserve. Streamwood, IL: FED-UP, Inc.

12.Woodward, G. Thomas. 1996. "Money and the Federal Reserve System: Myth and Reality." Congressional Research Service

13. United States Code Annotated. 1994. U.S. Government Printing Office.

14. McConnell CR, Brue SL Economics: Principles, Problems and Policies. In 2 m. Per.from English. 11 th ed. T.I. : MM: Republic, 1992.

15. http://www.federalreserve.gov/aboutthefed/default.htm

16. http://www.federalreserve.gov/aboutthefed/default.htm

Appendixes

federal reserve bank policy foreign

Table 1 «Stockholders of the Federal Reserve Bank»

http://www.federalreserve.gov/aboutthefed/default.htm

DISTRICT - NEW YORK

Class A

Class B

Table 2 «The organizational structure of the U.S. Federal Reserve»

http://www.federalreserve.gov/aboutthefed/default.htm

Table 3 «Interest rates Required and Excess Reserve Balances, October- November 2010»

http://www.federalreserve.gov/paymentsystems/fisagy_about.htm

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