Transcript PwPt slides - The Federal Reserve

FEDERAL RESERVE: BEYOND MONETARY POLICY
Session V.
Session Goals:
Reading Material Distributed
(Promise of 50+ pages ‘a comin’)
Remaining Agenda
Outstanding Items Handled
Recap of Discussions as Platform
before Session Break
(Coalesce previous sessions/review last
week/general Purposes and Functions of Fed
today)
REMAINING SESSIONS
 10/19 Finish discussion
regarding early Fed; Purposes
and Functions
 10/26 No class; Homework
 11/2 FOMC and other
Committees
 11/9 Payments Mechanism
 11/16 Supervision/Regulation
 11/23 Thanksgiving holiday
 11/30 (open)
[Research/Publications-flexible]
 12/7
(open)
Guest speakers have been invited to address
class sessions in November.
Winning team of Fed Challenge may make a
presentation…TBD.
Outstanding Items from Last Session
Elasticity
Currency that can, by the
actions of the central
monetary authority,
expand or contract in
amount warranted by
economic conditions.

Source: Purposes and Functions
Let me give you a practical
illustration of elasticity of
currency. Currency may be
defined in two or three different
ways in the administration of a
bank. Currency usually is money--understood to be money---gold
or silver or paper. In times of
extreme distress the clearinghouse certificate takes the place of
money.
Banking and Currency Reform
(1918) Testimony p. 228
Elasticity: Bernanke
The Federal Reserve’s responsibility for managing the money supply was
established at its founding in 1913, as the first sentence of the Federal
Reserve Act directed the nation’s new central bank "to furnish an elastic
currency."1 However, the Federal Reserve met this mandate principally by
issuing currency as needed to damp seasonal fluctuations in interest rates,
and during its early years the Federal Reserve did not monitor the money
stock or even collect monetary data in a systematic way.
Chairman Ben S. Bernanke
Speech at the Fourth ECB Central Banking Conference, Frankfurt, Germany
November 10, 2006
Monetary Aggregates and Monetary Policy at the Federal Reserve: A Historical Perspective
http://www.federalreserve.gov/newsevents/speech/bernanke20061110a.htm
Money Supply (in keeping “with the times”
(IN 1907, THE DEFINITION MIGHT
SIMPLY BE THE “FLOW OF MONEY.”
Financiers of the Civil War
NORTH: J.P. MORGAN
SOUTH: “KING COTTON”
NOTE TO “SELF”:
WHY NOT RICE OR INDIGO?
Financial Institutions Regulated by the Fed
HTTP://WWW.FFIEC.GOV/NICPUBWEB/NICWEB
/NICHOME.ASPX
THE NATIONAL INFORMATION CENTER (NIC) IS
A CENTRAL REPOSITORY OF DATA ABOUT
BANKS AND OTHER INSTITUTIONS FOR WHICH
THE FEDERAL RESERVE HAS A SUPERVISORY,
REGULATORY, OR RESEARCH INTEREST,
INCLUDING BOTH DOMESTIC AND FOREIGN
BANKING ORGANIZATIONS OPERATING IN THE
UNITED STATES.
Buying of Securities
At times of panic and uncertainty, bankers and others rush to the security
of the safest securities, especially the debt of the U.S. Treasury.
This pushes down the interest rate that the Treasury has to pay to borrow
money, a measure that ordinarily is a useful gauge for the Fed.
(More on this topic, presented by Lou, coming in the 50+ pages available after session break)
Marriner S.
Eccles
Appointed chairman
(called “governor”
before 1935) of the
Federal Reserve Board
on November 15, 1934.
He resigned as
chairman on January
31, 1948, and remained
a Board member until
July 14, 1951.
 Eccles was born in Logan, Utah, in 1890.
 After his father’s death in 1912, took over the
family’s business interests and created a family
holding company, the Eccles Investment Company.
 By the mid-1920s, Eccles, his brother George, and
the Browning family controlled seventeen banks in
Utah, Idaho, and Wyoming, and organized the
First Security Corporation, believed to be the first
multibank holding company.
 Served as assistant to the secretary of the Treasury,
Henry Morgenthau Jr., before President Roosevelt
appointed him to be the chairman of the Federal
Reserve.
 Gained national attention for successfully
preventing the collapse of his bank in 1931. In
1933, Congress invited him to give his analysis of
the Great Depression. In his testimony, he
proposed a five-point program to fix the economy
that formed the basis of the New Deal.
Marriner S. Eccles
 Early in his tenure on the Federal Reserve Board, he pushed for the
restructuring of the Fed and was instrumental in drafting the Banking Act of
1935, which gave the Board centralized authority over the System.
 Eccles played a role in two high-profile events as well. In 1944, he was the US
delegate to the Bretton Woods Conference, which established an international
monetary system that included fixed exchange rates. The conference also
created the World Bank and International Monetary Fund.
 Later in this session, we’ll discuss the role Eccles played during the Korean
War.
 After his Fed service, Eccles returned to the banking business in Utah. He died
in 1977. In 1982, the Federal Reserve Building in Washington, DC, was
renamed in his honor.
Federal Reserve Buildings in WDC
Marriner S. Eccles
Building
Wm. McChesney Martin
Building
Boards of Directors
BOARDS OF DIRECTORS WILL BE DISCUSSED
DURING THE 11/2 SESSION.
FURTHER, A HANDOUT WILL BE AVAILABLE
THEN REGARDING THE ELECTION PROCESS.
 Gold custody is one of several financial services the
GOLD
Federal Reserve Bank of New York provides to
central banks, governments and official
international organizations on behalf of the
Federal Reserve System.
 Built during the construction of the building in the
early 1920s, the vault provides account holders
with a secure location to store their monetary gold
reserves.
 None of the gold stored in the vault belongs to the
New York Fed or the Federal Reserve System. The
New York Fed acts as the guardian and custodian
of the gold on behalf of account holders, which
include the U.S. government, foreign governments,
other central banks, and official international
organizations. No individuals or private sector
entities are permitted to store gold in the vault.
 Much of the gold in the vault arrived during and
after World War II as many countries wanted to
store their gold reserves in a safe location.
 At its peak, the vault contained over 12,000 tons
Further Facts
about the Federal
Reserve Bank of
New York’s Gold
Vault
of monetary gold. Since that time, gold deposit
and withdrawal activity has slowed and the vault
has experienced a gradual but steady decline in
overall holdings. However, the vault today
remains the world’s largest known depository of
monetary gold.
 As of 2012, the vault housed approximately
530,000 gold bars, with a combined weight of
approximately 6,700 tons. The vault is able to
support this weight because it rests on the
bedrock of Manhattan Island, 80 feet below
street level and 50 feet below sea level.
 Fort Knox, Kentucky stores a large portion of the
United States gold reserves, approximately 4,570
tons of gold bullion.
 The U.S. Bullion Depository was completed in 1936
Fort Knox, Kentucky
with the gold vault located under the ominous
building known as Fort Knox.
 The United States Treasury Department is in
charge of Fort Knox.
 Unfortunately no visitors are allowed at the U.S.
Bullion Depository.
FEDERAL RESERVE: BEYOND MONETARY POLICY
Session V.
1900s at a Glance
 It was a time of prosperity. Exports doubled from 1897 to 1907.
 Foreign capital flooded into the emerging markets of the U.S.
 Banks, insurance companies and brokerage firms boomed.
 J. P. Morgan merged companies. In a decade, more than 1,800
companies were merged, acquired or consolidated into just 93.
Even so, the political and financial waters were NOT calm.
Still Focusing on the 1900s
“ In 1901, McKinley was assassinated and succeeded by
Teddy Roosevelt….Five years into his presidency, in 1906,
the prosperity of the moment was disrupted by a
devastating earthquake in San Francisco, then the financial
center of the West, and that, in turn, sent shock waves
throughout the financial markets.
By the spring of 1907, the economy was weakening, stock
prices were sinking, gold reserves were low, and interest
rates were rising --- the makings of a financial perfect
storm.”
Source: In Fed We Trust
J.P. Morgan Props Up U.S. Economy
“By default, the gold standard and the absence of any U.S. bank often
left it to individuals to fill the gap, and that individual was often J.P.
Morgan. When the U.S. Treasury’s gold reserves fell dangerously low in
1893, Morgan rescued the government by organizing a private
syndicate to raise $100 million in gold for the United States and
personally guaranteeing that the gold wouldn’t flow back to Europe.”
Source: In Fed We Trust by David Wessel
The Makings of the Knickerbocker Trust
Collapse:
HEAVY LENDING TO COPPER
SPECULATORS…
READING FROM PAGE 31 IN FED WE TRUST
CLEARINGHOUSES:
RESPONSIBLE FOR STABILIZING CURRENCY
FLUCTUATIONS AND PROCESSING DRAFT
EXCHANGES (CHECKS) BETWEEN BANKS UNTIL
THE FED WAS FORMED.
Monday
October 21, 1907
 J.P. Morgan paid out $8M in
less than four hours.
 Sent his (young) deputy,
Benjamin Strong [later to
become the first president of
FRB-NY] to inspect
Knickerbocker’s books.
 Strong confirms Morgan’s
suspicions…Knickerbocker is
insolvent.
Two Familiar “Folks” Go to Jekyll Island
J. P. Morgan sends B. Strong ,
charged with backing a plan
proposed by Warburg (the
investment-international expert
later to become a member of the
Federal Reserve Board).
“The whole world is united in
agreement that we have about the
worst system of banking that
there is anywhere in existence.”
The Federal Reserve
Act of 1913, while a
compromise of
visions, was quite
flawed as David
Wessel points out in
his book, In Fed We
Trust.
The first great
flaw…no clear
leadership.
“The law provided for a weak federal Reserve
Board in Washington, chaired by the secretary
of the Treasury and including the comptroller
of the currency and five others to be appointed
by the President….
“It also mandated up to twelve regional or
“district” Fed banks, each to be owned by the
private banks in their districts…
“It was a classic American balancing between
centralized and decentralization, but the
legislation provided no clear division of
responsibilities between the Board (WDC) and
the regional banks, a feature that would prove
troublesome before and during the Great
Depression.”
Fed’s Flaws and Mis-steps of its
Adolescence the Leads to the Depression
 Absence of enlightened leadership in the late ‘20s and ‘30s (B. Strong
who had been elected the president of the FRB-NY and led the [entire]
organization died in 1928). Refer to page 48 of In Fed We Trust
 Tightened credit and lifted interest rates as an attack on speculation in
the stock market when the actual problems were an overall weak
economy and an absence of inflation.
 Domino effect tight credit had on small businesses, households and
farms led to a protracted depression.
Capsule of Congressional Banking Reform
 Federal Reserve Act of 1913
 Mc Fadden Act (1927)
 Glass-Steagall Act (1933)
 Securities Act (1933)
Created the Securities & Exchange Commission
 The Banking Act of 1935
Additional Congressional Measures
that Change the Landscape
Securties
FDIC
Congress passed the Glass-Steagall
Act of 1933, which separated banking
and securities firms.
This Act also prohibited banks from
being owned by nonfinancial
companies.
The Fed was given the authority to
supervise multibank holding
companies and to remove bank
officers. It could also restrict interest
payments on bank deposits.
In 1933, Congress also passed the
Banking Act, which established the
Federal Deposit Insurance
Corporation to insure consumers’
bank deposits.
Banking Act of 1933/Glass-Steagall Act
 Separated commercial and
investment banking.
 Required use of government
securities as collateral for Federal
Reserve notes.
 Placed open market operations under
the Fed.
 Required bank holding companies to
be examined by the Fed .
[A practice that was to have profound
future implications, as holding
companies became a prevalent structure
for banks over time].
The Banking Act
of 1935 Makes
More Changes to
the Fed:
WWII
Concessions
The Federal Reserve System formally committed
to maintaining a low interest rate peg on
government bonds in 1942 after the United
States entered World War II.
It did so at the request of the Treasury to allow
the federal government to engage in cheaper
debt financing of the war.
To maintain the pegged rate, the Fed was forced
to give up control of the size of its portfolio as
well as the money stock.
FOLLOWING WWII,
TWO NEW CONFLICTS BREAK OUT…
THE KOREAN CONFLICT (ABROAD)
A BATTLE BETWEEN THE FED VS. TREASURY
(AT HOME)
ON HOW TO FINANCE THE NEW WAR
 The Federal Reserve System formally committed to
Fed Becomes
Foe
Fed Chairman
Marriner S. Eccles
maintaining a low interest rate peg on government
bonds in 1942 after the United States entered World
War II.
 It did so at the request of the Treasury to allow the
federal government to engage in cheaper debt
financing of the war.
 To maintain the pegged rate, the Fed was forced to
give up control of the size of its portfolio as well as the
money stock. .
 Conflict between the Treasury and the Fed came to
the fore when the Treasury directed the central bank
to maintain the peg after the start of the Korean War
in 1950.
 The Board of Governors, including Marriner Eccles,
understood that the forced obligation -- to maintain
the low peg on interest rates-- produced an excessive
monetary expansion that caused inflation.
 The dispute came to a head in 1951, when
“Firing” of a
Fed Chairman
President Truman falsely told the press that the
FOMC had agreed to support the Treasury’s
interest rate peg.
In response, Eccles released the FOMC minutes that
showed otherwise. (cause for “firing”)
 The incident led to the Treasury-Fed Accord in
March 1951. The agreement ended the Fed’s
obligation to maintain the rate peg. It also gave the
Fed dominance in setting monetary and credit
policies and bolstered the central bank’s
independence.
 This eliminated the obligation of the Fed to
monetize the debt of the Treasury at a fixed rate
and became essential to the independence of
central banking and how monetary policy is
pursued by the Federal Reserve today.
Overview
Purposes and
Functions of
the Federal
Reserve System
Photo: M. Eccles Building
facing Constitution Avenue
in Washington, DC
The Federal
Reserve’s Duties Fall
into Four General
Areas:
 conducting the nation’s monetary policy by
influencing the monetary and credit conditions
in the economy in pursuit of maximum
employment, stable prices, and moderate longterm interest rates
 supervising and regulating banking institutions
to ensure the safety and soundness of the
nation’s banking and financial system
 maintaining the stability of the financial system
and containing systemic risk that may arise in
financial markets (lender of last resort)
 providing financial services to depository
institutions, the U.S. government, and foreign
official institutions, including playing a major
role in operating the nation’s payments system
Employment Act of 1946
As a result in changes in
economic thinking about
the government’s role…
Congress this legislation
to define the goals of
economic policy:
“to promote maximum
employment,
production, and
purchasing power.”
These goals were meant to guide the fiscal
policies of the President/Congress as well
as monetary policy of the Federal Reserve.
National
Monetary
Policy:
The goals of monetary policy are spelled out in
the Federal Reserve Act, which specifies that the
Board of Governors and the Federal Open
Market Committee should seek…
“to promote effectively the goals of maximum
employment, stable prices, and moderate longterm interest rates.”
Mission of the FOMC
 The FOMC is charged under law with overseeing open market
operations, the principal tool of national monetary policy.
 These operations affect the amount of Federal Reserve balances
available to depository institutions, thereby influencing overall
monetary and credit conditions.
 The FOMC also directs operations undertaken by the Federal Reserve
in foreign exchange markets.
Definition of these terms will be discussed throughout this session topic.
Board and Reserve Banks Share
Responsibilities:
SUPERVISING AND REGULATING CERTAIN
FINANCIAL INSTITUTIONS AND
ACTIVITIES.
PROVIDING BANKING SERVICES TO
DEPOSITORY INSTITUTIONS AND THE
FEDERAL GOVERNMENT.
Reserve Banks, as the Operating Arms of the Board,
Perform Services as the Fiscal Agent for United States Government
 Act as fiscal agents, paying
Treasury checks;
 Process electronic payments;
and
 Issue, transfer and redeem
U.S. government securities.
Joint Supervisory Responsibility
 The Board and Federal Reserve
Banks supervise approximately
900 state member banks and
5,000 bank holding companies.
Note: Numbers have not been updated in 2015.
 Some regulations issued by the
Board apply to the entire
banking industry, whereas
others apply only to member
banks.
Supervision and Regulation
Responsibilities Over:
--state-chartered member banks
--bank holding companies (companies
that control banks)
--foreign activities of member banks
--U.S. activities of foreign banks
--Edge Act and agreement corporations
(limited-purpose institutions that
engage in a foreign banking business).
Federal Reserve Bank Services:
 They provide financial services to
depository institutions including
banks, credit unions, and savings
and loans, much like those that
banks provide for their customers.
 These services include collecting
checks, electronically transferring
funds, and distributing and
receiving currency and coin.
Additional Payments-Related Responsibilities
 Develops policies and regulations to foster
the integrity/efficiency of the U.S. payment
and financial system;
 Works closely with other regulators,
central banks, and international
organizations to improve the payment and
financial system more broadly; and
 Conducts research on various topics
related to payment and clearing issues and
financial market infrastructures.
FEDERAL RESERVE: BEYOND MONETARY POLICY
Session V.
References
In Fed We Trust by David Wessel
Purposes and Functions
Federal Reserve Board publication
STABLE PRICES DEFINITION
Stable prices (in the long run) are a precondition for maximum
sustainable output growth and employment as well as moderate longterm interest rates.
When prices are stable and believed likely to remain so, the prices of
goods, services, materials, and labor are undistorted by inflation and
serve as clearer signals and guides to the efficient allocation of resources
and thus contribute to higher standards of living.
Money Stock
TOTAL QUANTITY OF MONEY AVAILABLE
FOR TRANSACTIONS AND INVESTMENT.
MEASURES OF THE U.S. MONEY STOCK INCLUDE
M1, M2, AND M3. (ALSO REFERRED TO AS THE
MONEY SUPPLY OR, SIMPLY, MONEY.)