Page 320 - Encyclopedia of Business and Finance

eobf_F 7/5/06 3:02 PM Page 297

Federal Reserve System

ACTIVITIES AND
RESPONSIBILITIES OF THE
FEDERAL RESERVE SYSTEM
In conjunction with the FOMC and the twelve Reserve
Banks, the Board of Governors’ main concern is the devel-
opment of monetary policy, which it carries out through
three means:

1. The establishment of reserve-level rates (amounts
that member banks must set aside to be reserved
against deposits). These amounts depend on the
nation’s economic activity status, with emphasis
placed on price levels and the volume of business
and consumer expenditures. By the lowering of the
required reserve-level rate, banks can increase the
proportion of funds they are able to lend to cus-
tomers. By raising the required reserve-level rate, the
opposite effect takes place. Thus, the Fed can influ-
ence such factors as economic activities, the money
supply, interest rates, credit availability, and prices.
However, a change in a reserve-level rate usually
causes banks to change their strategic plans. In addi-
tion, a reserve-level rate increase is costly to banks.
Consequently, changes in reserve-level rates are
uncommon.
2. The approval of discount rates (interest rates at
which member banks may borrow short-term funds
Ben S. Bernanke (1955– ). Chairman of the Federal Reserve
from their Reserve Bank). When inflation threatens,
Board 2006–. AP IMAGES
a discount-rate increase tends to dampen economic
activity because then banks charge higher interest
rates to borrowers. On the other hand, a discount-
rate decrease is designed to stimulate business activ- and large, open-market operations comprise the
ity. The term discount window is often used when most powerful tool the Fed has to influence mone-
describing a Reserve Bank facility that extends credit tary policy.
to a member bank.
Other activities and responsibilities of the Federal
3. Another rate, the federal funds rate, is an important Reserve System include the following:
factor affecting day-to-day bank operations. This is
1. Supervision of the twelve Reserve Banks and their
the rate charged by one depository institution to
branches. With regard to the latter, the Board of
another for the overnight loan of funds. This hap-
Governors, through the Reserve Banks, uses both
pens when one bank is short of funds while another
on- and off-site examinations to maintain awareness
has a surplus. The rate is not fixed; it may change
of each member bank’s activities. These activities
from day to day and from bank to bank.
include the quality of loans, capital levels, and the
4. Open-market operations (the purchase and sale of availability of cash.
U.S. government securities in the open market).
These activities are conducted by the FOMC, of 2. Cooperative efforts of the U.S. Treasury and the
which the Board of Governors comprises the major- Fed. For example, the Fed acts as the Treasury’s fiscal
ity. The Fed buys and sells U.S. government securi- agent by putting paper money and coins into circu-
ties such as Treasury bills from banks and others lation, handling Treasury securities, and maintaining
several times a week. As a result, the amounts banks a checking account for the Treasury’s receipts and
payments.
have available to lend to borrowers are affected. For
example, when the Fed buys securities, banks have 3. Oversight of banking organizations, such as bank
more funds, so interest rates tend to drop. The holding companies (companies that own or control
opposite occurs when the Fed sells its securities. By one or more banks).

ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION 297