The Federal Reserve System

Question 1

What are the three primary components of the Fed?

Answer 1

The Federal Reserve Board, the 12 Federal Reserve Banks and the Federal Open Markets Committee

Question 2

What is the maximum term that can be served by a Federal Reserve Board Member?

Answer 2

27.9 years, 14 years + a partial term, usually the remainder of the previous chairman’s term.

Question 3

How are the Federal Reserve Bank Presidents and FOMC related in terms of membership?

Answer 3

5 out of the 12 Presidents have the right to vote in the FOMC. The 7 others = FRB members

Question 4

How many Fed governors have Obama appointed?

Answer 4

5, 3 on new board cycle terms, 2 to complete partial terms left off by previous board members who left before the completion of their terms.

If every board member prior to his presidency had served until the end of their terms, he would have only needed to appoint 3.

2/7 seats are currently unfilled.

Question 5

How is the Chair of the FR Board appointed?

Answer 5

Appointed by President, confirmed through the Senate. President can appoint someone outside of the FRB at the end of each board cycle; if in the midst of a cycle, the President can only choose from members of the FRB.

Question 6

What role does the Fed Bank’s board of directors serve? How are they appointed?

Answer 6

Appoints Bank President, sets discount rate subject to FRB approval. 3 Class A, Class B, and Class C Directors. Class A Directors must be bankers; Class B and C directors cannot be bankers and instead usually come from industrial or commercial business backgrounds. Class A and B elected by FR Member Commercial Banks, Class C appointed by FRB.
9 Board of Directors per bank.

Question 7

Role of the FOMC?

Answer 7

Decides on Open Market Operations, most important power of the Fed, determines base through securities; federal funds rate through loans

Question 8

State the goals of the Fed

Answer 8

1. Maximum employment
2. Stable prices
3. Moderate long term interest rates
   Technically, goal 2 and goal 1 contradict each other, but 2% PCE inflation minimises shocks to employment. Goals 1 and 2 collectively called the “Dual Mandate” of the Fed.

Question 9

How has Fed behaviour changed since the Bernanke era?

Answer 9

Fed now pays interest on excess reserves, also acts as a warehouse for toxic assets and a financial intermediary

Question 10

Components of the Fed-controlled monetary base?

Answer 10

Federal Reserve Notes + Deposits, remainder of the base: Treasury Currency

Question 11

Traditional equation for the Fed Base?

Answer 11

B=S+I + L+Ct - D - NW (B = reserve deposits + federal reserve notes)

Just remember SICL-NWD

Question 12

Sources of the monetary base?

Answer 12

Securities + Net Loans + Treasury Currency

Question 13

Drains on monetary base?

Answer 13

Other deposits + Net worth

Question 14

Define Dynamic vs Defensive OMOs

Answer 14

Dynamic: intended to change the base
Defensive: to offset unintended changes in the base caused by either factors such as a change in I, L, other deposits, Reserve Deposits etc.

Question 15

Name the components of the Fed’s balance Sheet

Answer 15

Securities + Loans + International Reserves make up the asset component. Federal Reserve Notes (denoted as C) + Reserve Deposits + Other Deposits make up the liabilities portion.

Question 16

Name one Fed source of monetary base expansion

Answer 16

Securities: buying to increase the base, selling to decrease the base (Open Market Operations).

Question 17

How do repurchase agreements between a Fed and a non-bank trigger a change in the monetary base?

Answer 17

Repurchase agreements are written down as an increase in the Fed’s assets, and therefore an increase in B (since the nonbank is assumed to deposit either directly or indirectly the funds lent into a bank, in which they then turned into additional money).

Question 18

Causes of day-to-day changes in the base? Causes of year-to-year changes in the base?

Answer 18

Day-to-day caused by loans, year-to-year caused by securities sales and purchases.

Question 19

Historical status of the discount window?

Answer 19

Generally unused by banks as usage usually signals potential insolvency. Used to be an important source of monetary base in the 1930s, but fell out of favour due to the stigma of usage later on. Discount window rate now at a historical high, no longer 0.5% above the FFR.

1930s: significant source of funding
1930s-2003: banks discouraged from using the window, mainly used by failing banks
2003-2008: discount rate set slightly above the FFR, still used by failing banks
2008: Discount rate substantially higher

Question 20

Does the Fed own gold?

Answer 20

No, the fed does not own gold. However, it does own claims on gold but at the statutory price of 42.22/ounce. (which is far below the current market price for gold, and hence selling the gold would allow the treasury to profit handsomely. Originally, these certificates were sold at a price of 35/ounce of gold, although such sales ceased in 1973. As of now, the gold certificates only exist so the Fed can serve one of its roles as the custodian of gold for US governmental entities.

Gold originally sold to foreigners at 35
Sales suspended by 1973, official price increased to 38.
Under Ford, Burns allowed Americans to own gold, and started selling 1/360 of the gold reserves every month.
Under Carter, Miller continued but at a variable rate.
Volcker suspended sales eventually, gold stock by that time was still substantial (11 billion)

Question 21

Who owns the Fed?

Answer 21

Member banks get stock and dividend, although at a meagre rate of 6%. The Fed turns its profits over to the treasury, and in theory can provide infinite loans to the US govt at zero-interest rates (due to the turning over of interest profits). However, the Fed does claim to be secular in that it operates as an independent agency.

Question 22

How does Seigniorage work under the Fed?

Answer 22

Fed only receives a portion of the Seigniorage, since in a fractional reserve banking system it can only change the base. Thus, seigniorage is calculated as um/k where k is the money multiplier.

However, since the Fed nows pay interest on reserve deposits, the real seigniorage is only deltaC/P, and not deltaB/P since funds that are lent out by the Fed are deposited back by banks to earn a risk free rate of return equivalent to the federal funds rate. (Thus, the seigniorage component deltaR/P is eliminated since the Fed no longer profits due to its commitment to paying interest on excess reserves)

The rest of the seigniorage (k-1)um/k is received by banks, which are essentially endowed with additional reserves to lend out risk free (since the money didn’t exist in the first place)

Question 23

By how much did the monetary base increase from 2008 onwards?

Answer 23

840B to 4Trillion so around 4 times.

Question 24

State the new Bernanke Fed monetary base equation

Answer 24

B= S + I + L + J + Treasury Currency - NW - Other deposits

Question 25

How have currency, reserves, and excess reserves changed since 2008? What has been the effect on the monetary base?

Answer 25

Excess reserves have increased the base due to the Fed’s decision to pay interest on reserve deposits.

Question 26

Define QE

Answer 26

An unconventional form of central banking: essentially the electronic creation of money to buy government securities

Question 27

Why was there a dip in the volume of treasury securities held by the Fed in 2008?

Answer 27

Selloff to offset the massive expansion in the base caused by the acquisition of junk (lowgrade assets).

Question 28

What role does the FRB serve?

Answer 28

Sets the reserve requirement according to limits set by congress

Question 29

Length of a term as Federal Reserve Board Chairman?

Answer 29

4 years

Question 30

When the Fed buys something, reserves ______, when the Fed sells something, reserves ______

Answer 30

Increase, decrease. Since B = C+R, anything that changes reserves changes the monetary base.