The Federal Reserve System: Structure and Monetary Policy (HOM 31-B)

hello everybody welcome to history of money professor barth here history professor at arizona state university we are here lecture 31 the federal reserve system structure and monetary policy now i suspect some of the viewers will know most of this information and understand the federal reserve already and i also suspect that many more viewers maybe even the vast majority of viewers know little to nothing or little maybe next to nothing about the federal reserve system it's a complicated structure and it is one that is not really easily explainable myself i wasn't a finance major i stud i was a actually a secondary ed ed teacher i taught high school for two years and then i got my master's degree and then phd in history it wasn't until my early 20s that i even really knew anything at all about the federal reserve and even then even after that when i started to become interested in what the fed is and what it does and even then it took me a long time it's a lot a lot of study before i really felt like i had a good handle on what the fed does in this video today i want to try to crystallize the basic function the structure and and policy of the federal reserve system in a in layman's terms in in the simplest way possible without compromising too much the uh the complexities that are very much involved wrapped up in the system and i think you'll have a pretty good grasp fairly good grasp of of what the fed is and and when i say the fed that of course is shorthand for the federal reserve so let's begin by looking at the structure of the federal reserve system you'll notice as it says system and it is a system composed of different parts first of all we have a board of governors the board of governors meet in washington dc consists of seven members who serve 14 year long terms and those terms are staggered so a term begins for for one mem for one governor will begin every two years and their term begins february first so every two years a new term begins and it's a 14 year long term now you have a few anomalies like alan greenspan who is part of the federal reserve board of governors for 19 years and the reason for that was because he filled a vacancy and then when that term ran out he was able to to be appointed to a full proper 14-year term he was at the fed between 1987 and 2006. ordinarily it's a 14-year long term and it's appointed by the us president okay this was a difference between the aldrich plan which we talked about in a previous lecture appointed by the u.s president confirmed by the senate stagger terms 14 years the the president of the united states then of that group appoints the chair and the vice chair and these are four year long terms for the for the chair and the vice chair and and the president may reappoint a chair for as long as as as that [Music] as that member's term is still is still within this 14-year period okay so a chair can be reappointed this happened with ben bernanke it happened with alan greenspan and the main charge of the board of governors it's to oversee the 12 federal reserve district banks and then all seven members of the board of governors serve on the fomc the federal open market committee but wait on that okay first of all this is uh this is where the board of governors meet this is the eccles building in washington dc it was erected in 1937 when mariner stoddard eccles was chairman of the federal reserve board of washington and it was actually named the echoes building in the early 80s in honor of him this is where they meet and this federal reserve board oversees the 12 regional federal reserve banks the district banks and here are the districts these have been to districts since the beginning they're based on 1913 population numbers or distribution you'll notice district 2 is the the most powerful the wealthiest the federal reserve bank of new york also notice how large district 12 is because the west was less populated in those days i'm here in phoenix so i'm in district 12. here are the the 12 districts now what are these federal reserve banks well to begin with the structure of the banks each bank includes a has a board of directors and it has nine members now how are those nine member board of directors selected are they nominated by the u.s president no no no they're not six of the nine members are elected by the member banks in that district so whatever member banks are in that district elect the board of directors get to that in a moment of those six that the member banks select three of them three of those six may represent the interests of the of of those banks and then the other three that the member banks select are supposed to represent the interest of the public okay how real of a distinction is that really you know between between the three that represent the public versus the three that represent the banking industry uh i don't know exactly one of the reasons why we don't know is because the you know the what goes on uh at these at the fed is is not completely uh well known or transparent but i suspect that it might be close to nominal if if not nominal altogether could be wrong about that but three of the three of those six are supposed to represent the interest of the public the other three may represent exclusively the interests of those banks then the remaining three of the nine members of that board directors are appointed by the board of governors in washington d.c all right and of course the board of governors is appointed by the u.s president so you have an indirect link there but uh no no government appointees here and then the board of directors nominate the president of that bank he used to be called governor now it's called the president of that bank which is essentially the chief executive officer of that federal reserve bank the board of governors in washington d.c then must approve that nomination now on this question of member banks what is a member bank remember bank member banks are private commercial institutions right commercial banks could be credit unions any sort of commercial private commercial depository institution that owns stock in the federal reserve bank in their district okay member bank senate district owns stock in the federal reserve bank and to be a member bank to be a member of the federal reserve system you must own stock equal to three percent of your combined capital and surplus at that bank so three percent of your capital that's how much stock you must own in that in your federal reserve bank but this is not stock in the sense that we think of stock being traded on in the new york stock exchange this stock is non-transferable can't be sold it can't be traded all right member banks automatically receive they are entitled to an annual dividend on that stock of six percent not a bad dividend not a bad dividend six percent you are entitled to a six percent dividend on the stock you own in the federal reserve bank and then anywhere any profits at the fed at that federal reserve bank that exceeds six percent go automatically to the us treasury okay that's the deal that was that was worked out so for example in 2015 the federal reserve system all the 12 banks collectively made a profit of get this 100 billion dollars billion dollars of that two and a half billion dollars was distributed as dividends to member banks and then 97 billion dollars was distributed to the us treasury so that's quite a that's a lot of money to you as trader actually 2015 was a record year uh for uh profit uh the profits made by the federal reserve system but still two and a half billion distributed to member banks that's not a small amount either but those were the dividends um now what are these banks exactly are they private are they public well i'll tell you what they're definitely not public they're not public they're not considered public in fact actually the courts have ruled on the nature of these federal reserve banks not the federal reserve board but the federal reserve banks there's a case lewis versus the united states in 1982 without going into details of the case the court concluded that the 12 federal reserve banks are quote independent privately owned in locally controlled corporations nevertheless this is where the nuances then comes in they have properly been held to be federal instrumentalities for some purpose purposes an instrumentality that is often how how these are how these are described um they these federal reserve banks were federally created many of their profits actually go to the u.s treasury and yet the stock is privately owned they act completely independently not within a federal reserve system but independently of government of any government accountability or anything of that nature they are tax exempt uh and so it's a strange a strange thing here's a another case in 2005 scott versus federal reserve bank of new york city the court made a distinction between the board of governors which is a federal it called a federal agency and even this has some problems a federal agency but the federal reserve banks again are federally created instrumentalities there are restrictions though again that a purely private corporation doesn't face for example the member banks at the federal reserve cannot come together as the stockholders at that federal reserve bank and change its charter or change its structure like any like any other corporation has the the right to do and again they can't transfer their stock and have to give surplus dividends away to the us treasury but they are essentially private private institutions and they have a lot of assets so i mentioned the profits that were made um what about their assets well this is the current i looked it up yesterday actually to get the most updated numbers this is november 2020 the collective assets of the 12 federal reserve banks amount to 7.15 trillion dollars that's a lot of money now of those banks the wealthiest is the federal reserve bank of new york and this is always the case the federal reserve bank of the north of new york has always been the wealthiest of the 12 banks and they have as of november 2020 close to four trillion dollars in of assets absolutely incredible and then the federal reserve bank of san francisco is second place and they have 725 billion dollars of assets and then it goes down from there with the other district banks and actually the assets of the federal reserve system have gone through the roof just this year alone after the coronavirus the eruption of of that whole thing back in march here's a graph from the federal reserve bank of st louis they provide a lot of good statistical graphs on their site these are assets of the federal reserve banks collectively and look at this however hovered around 1 trillion actually just shy of 1 trillion for all of the federal reserve banks before 2008. okay now it's over 7 trillion okay so before 2008 the collective assets of the federal reserve banks were under a trillion dollars then there was a big jump in 2009 and you're talking about three to four trillion dollars the balance sheet really went up and then it's hovering around four trillion dollars four to five trillion dollars and then look at that just huge spike in march of 2020 it's where it went from under five trillion dollars now to to over seven trillion dollars of of assets the fed in response to coronavirus eliminated reserve balance requirements and and made huge asset purchases in order to shore up the markets be interesting to see what the consequences of that will be in the uh near future more on the fed's response to coronavirus in a moment and then the other element of the federal reserve system the federal open market committee or fomc okay they had the board of governors appointed by president sit washington dc oversee the system then you have the 12 district banks privately held privately owned with restrictions on what they can and can't do and then you have the fomc now the fomc was not created until 1933 okay before 1933 each district bank each of the 12 private banks conducted their own independent autonomous monetary policy by 1933 there was a banking reform and this created the fomc now initially the fomc just consisted of all 12 district presidents of the of the of the federal reserve banks then in 1935 the composition was changed to its current to its current structure the fomc includes all seven members of the board of governors there was a committee committee all seven members of the board of governors it includes the president of the new york fed so the president of the new york fed always sits on the fomc and then the remaining four members are a rotation of the other 12 district presidents rotation of four of the 12 or of the 11 because the new york fed always sits on the fomc a rotation of the remaining 11 for the remaining 11 district presidents they meet eight times a year in washington dc at the eccles building usually the meetings are about seven weeks apart and at these meetings they deliberate and determine basically fed monetary policy what is the fed's monetary policy and this the one of the the chief aims here one of the chief uh things that they do in the fomc meetings is a set target rates the federal funds target rate get to that in a second okay that's the fomc so that's the other element of the federal reserve system um you could add another element there's a a a council called the federal advisory council that consists of 12 members of the 12 representatives of the banking industry and the federal advisory council will uh confer with the board of governors and the fomc and so that's another element but this is the basic structure okay here's a meeting of the fomc of course there are other people present here than just the uh the board of governors and the new york fed president and four other district presidents but there's a meeting ben bernanke so this was during bernanke's term as fedcher right does that kind of make sense yeah uh i told you it's confusing it's a little confusing now what the heck does the fomc do okay because that's the big the our big question here all right the fomc is in charge of well it's a you know federal open market committee well what does that mean and what is this target rate that they said well the federal reserve commits or conducts monetary policy through what is what are called open market operations open market operations but what they do initially at the fomc is they set the a target for the federal funds rate now what is the federal funds rate or the fed funds rate the federal funds rate is is the interest rate at which member banks borrow money overnight from other member banks at the fed in order to retain their the minimum reserve balance that they need on deposit at the fed so if you have access reserved reserves at the federal at the fed because there's a you know each member bank has to keep let me run each member bank has to keep minimum reserve balance at the fed right it's varied depending on the year actually right now it's zero uh since the coronavirus but ordinarily depending on the size of the institution it can be anywhere from three to ten percent and you keep your these reserve balances at the fed and then if you exceeded the the requirement there's an incentive to lend to other member banks who need to meet their reserve requirement okay and and the the member bank loaning money to another member bank will charge an interest rate and that interest rate they negotiate okay that's a negotiated interest rate well the fomc exists to try to uh to set what that interest rate is going to be so they come up with a target rate and usually it's a range right now the target rate is extraordinarily low it's zero to zero point two five percent okay and so the fed is aiming for this federal funds rate to be somewhere between zero and zero point two five percent now how does the fomc the federal reserve influence this interest rate okay they do it through open market operations but before that i'm getting too far ahead of myself don't you this stuff's a little complicated when the rate when the federal funds rate is falling when it's going down okay as it did in march of 2020 dramatically we'll see a graph here in a second when the rate is falling and the interest rate is falling at which member banks borrow from one another at the fed what that essentially is it's a benchmark it tells you something about this the currency supply and its supply of credit in the in the economy that that means essentially you have an expansion of credit and currency okay so a lower interest rate equals more credit more currency available okay when the rate is rising when it's going up what that means is uh credit and currency is being drawn back in there's a contraction okay it might be slow it might be more rapid depending on the period there are periods of fed history where it was a rapid rise in the interest rate a pretty you know severe contraction and supply of credit and of currency so that's what this means it's a huge huge number a huge figure in in the u.s economy this federal funds rate all right there we are the fomc sets the target federal funds rate so they say you know right now zero to 0.25 okay so you know not too long ago it was one 1.5 to 1.75 and the way they influence what is the uh the actual federal funds rate because remember the federal funds the these member banks they negotiate what the interest rate is okay it's not dictated to them by the federal reserve they negotiate what the interest rate is and so the federal reserve wants to influence it the target rate is the range at which they would like to see that interest rate be and then the actual interest rate which is the weighted average of all these negotiated uh deals between member banks that's called the federal funds effective rate that's the actual effective rate currently this weighted average at which remember banks borrow from one another at the fed so in order to influence the federal funds effective rate to meet the target the federal use what's called open market operations it has other tools in its chess but for for our purposes here i want to focus on open market operations what does this mean this means that the fed will act in the market and will either buy or sell securities usually government bonds usually treasury bonds but it can be any sort of security it can be mortgage bonds it can be all sorts of different securities they'll either buy or sell those securities with primary dealers who have accounts with them with depository institutions at the federal reserve with those member banks okay so if the federal reserve wants to cause the federal funds rate to go down what they do is they will buy securities treasury bonds whatever they will purchase securities by securities and then in purchasing that deposit funds in that primary dealer's account at the at that member bank okay so they'll deposit the funds in that member bank in that member bank's account at the fed essentially increasing their reserve balance okay so you know the fed purchases these securities that increases the reserve balance of of the member bank now that they have greater reserves and they're at the fed they can you know they're more willing to lend to other depository institutions to other member banks which causes the effective federal funds rate to fall now when the fed purchases these securities what they'll do most of the time they don't always just print money and give it to the bank that's it doesn't work quite like that although sometimes it does effectively but more often than not they just digitally add it they'll add a zero to a bank's account at the fed okay it's just kind of digitally created um add a zero to the bank's account then if the bank wants to have new federal reserve notes they can decrease their reserve balance at the federal reserve and that's when the federal reserve will give them actual federal reserve notes so that's if the the fed wants to influence the target rate in a downward direction now let's say the federal reserve in you know uh later decides it wants you know to to raise the federal funds rate how do you raise the federal funds rate how do you cause the rate to go up well instead of purchasing securities and and depositing funds in member banks account the fed will sell securities sell its assets that it has at the federal reserve bank sell it and then those primary dealers will will buy those securities from the fed and then the fed will get money for that sale by withdrawing funds from the member banks account okay withdrawing funds from the members member banks account which will diminish their reserve balance at the fed and that's will will make will make the federal funds rate the effective rate go up because there's less money available to lend to other banks at the fed i told y'all that was this is a little confusing does this make sense man you know i said i was going to try to do it in layman's terms maybe i'm uh maybe maybe that's not quite possible i hope this makes somewhat sense and and no actually it's it's way it's way more complicated than than even as i'm giving you the just fundamentals here okay um you could spend a lifetime studying what goes on at the fed uh these are elementary principles here so open market operations in short fed increases the money supply either by you know digitally or sometimes by printing new notes causing putting new notes into circulation increases the money supply by purchasing securities the fed decreases the money supply by selling securities okay and then drop sucking that money back into the fed okay thus decreasing the money supply thus increasing the federal funds rate okay that's open market operations now this is important open market operations are not subject to any federal audit they are not subject to any government audit so we don't know exactly all that goes on we don't know about what purchases are made at what price from which dealer none of that is subject to audit it's all undercover okay there are many people who would like to change that and who would like to introduce more transparency at the fed fed greatly opposes that putting my cards on a table i fully support a an audit of the federal reserve i think the american people have a right to know what what the federal reserve does in in in its dealings you know not just buying and selling securities in open market but also it's transactions with foreign central banks and other entities but as of november 2020 these are not subject to audit nor are any of the proceedings or deliberations of the fomc so that's all all done uh secretly and and uh you know there are real concerns about about that and about what what goes on at the fed i'll probably make i might make another video about that at some future date okay here's a chart of the effective federal funds rate so not the target rate but the actual weighted average effective federal funds rate through the year so it's 1955. and you'll see just by the way the shaded areas are periods of economic downturn you'll notice rates were going up in the 1960s and a big turn downward then in the 70s chaos uh we'll get to that in a later lecture but that was during all the inflation of the 1970s and then to arrest the inflation the fed spiked rates look at this at the peak at 18 wow that was necessary it was necessary because inflation was going out of control that was under paul volcker chairman of the fed made some really tough decisions there uh a huge spike in the federal funds rate and look at that since then it's been going down down down down down quite low after the dot-com crash this fueled a housing bubble and uh sorry to go rate started go up again around 2006 then he and then after 2009 like zero this was unprecedented unprecedented in fed history then around 2016 it started to go up again and then coronavirus did away with that and so now we're back down to zero this is the effective rate this is the target range okay and it this represents the upper limit so the target is usually it's a not usually it's always a range right now zero to 0.25 percent so you hear the up here the upper limit is 0.25 yeah look at this so 0.25 percent after 2009 this again unprecedented period and then the fed kind of cautiously moved it up usually the fed never it's very rare that the fed will will move more than a quarter okay we're definitely not more than half a percentage point that's quite rare but you see going up up up president trump was not happy about this by the way got into quite a bit of a public scuffle with uh the fed chair jerome powell over over this there was question will trump remove jerome powell for raising interest rates even then it was still only two and a half percent that's pretty dang low historically look at that i mean it's still that wasn't that high but trump trump did not did not like that um well you know presidents do have and congresses have an interest in low interest rates because temporarily it helps the economy supposedly and but it can have consequences it can have quite severe con consequences but yeah look at that this was look at that drop that's in march of 2020 just plunge very very uh unusual atypical move by the fomc in response to the coronavirus and now we're back down here that was a huge home my wife and i actually refinanced our house uh saved a lot of money saving 400 a month because that refinance yeah yes not bad but um yeah i don't like this i don't like this but it is what it is um now what you're like what the heck does this have to do with me why should i care about this who cares well first of all the the federal funds rate has an enormous impact on the economy all right and you know again i already mentioned how it affects the supply of currency and credit okay when rates are going down currency and credit expands when rates are going up currency and credit contracts a bit that has an impact on you one way in which it has an impact is on what's called the prime rate the prime rate this is the interest rate used by the banks for lending to ordinary customers clients and businesses all right so this is the rate that that that you the american can can borrow money and this is tied very very closely to the federal funds rate usually it's about three percent higher okay three percent higher so the banks borrow at this lower rate and then they'll lend you the money at the higher rate uh you know you can debate on on the the ethics of that perhaps but the rate at which you can borrow money is heavily influenced by that so like the example i gave we refinanced our house i'm saving 400 a month now because that lower rate it influenced the mortgage markets so here's this is a graph of bank prime loan rates historically since they've been 1950s look at that it's basically identical we're close it's just a few percentage points higher so like in the early 80s for you to borrow money it was over 20 interest okay because money would have with lending was becoming so scarce the available available money for lending was so scarce because we had to stop the inflation so compare this this is the prime rate graph to this this is a federal funds graph see how closely tied they are it's basically the same graph okay it's pretty remarkable actually so it has a huge impact a huge impact you know the federal reserve actually exercises far more power over the us economy than congress or the president it just does it just does that's the fact of the matter now i mean presidents and congresses they do make a difference tax policy regulatory policy that really does matter in the economy so i'm not saying that stuff doesn't matter but but this is this right here we're talking about just the absolute foundation of the u.s economy credit okay and uh and the federal reserve is in charge of that um one last element to federal reserve monetary policy there is also another option for member banks it's called the discount window and a discount window is if you're in need of funds and especially in an emergency the discount window is considered the last instrument sort of the last uh uh uh bulwark um in case of a financial crisis you can borrow money directly from the fed itself instead of from other member banks okay if for whatever reason you know in a time of crisis you can't do it so you could go discount window brought money directly from the fed this is called the discount rate usually the discount rate is about one percent higher than the federal funds rate so if you don't have to use it you don't and there is a stigma attached to it there's a stigma attached to it and so you generally you know banks don't like this as much but that is that is available and landing at the discount window also by the way is not audited by the government just like open market operations or fomc proceedings but that's there as well now the federal reserve considers itself independent within the government okay but but federal reserve independence you hear about a lot the independence of the federal reserve um you hear about it sometimes with or a lot of times with the judiciary you know we need an independent judiciary what does that mean judges can make decisions and not have to worry about the political consequences they can just judge and and not have to you know because concern themselves about reelection or or any or anything like that the independent judiciary well in a similar manner the fed celebrates this idea of federal reserve independence what does this mean they're independents well as i already mentioned the fomc their actions their their transactions are buying and selling of different securities and assets and their deliberations are not subject to any government audit all right i already spoke about that but i support a full audit personally i think not having an audit actually is is quite indefensible in a system like ours a democratic republic nonetheless the federal reserve defends this uh avoidance of any audit by saying well we need to guard our independence we need to be able to deliberate as a committee and to make tough decisions in the open market without having to worry about political consequences if you know a certain purchase or sale might look bad or whatever all right we need to be able to act independently without having having that in the back of our mind that's the defense of that the fed puts forward in opposing an audit the federal reserve fiercely opposes an audit of it of its actions and that is the reason that they cite but that's not the only element of fed independence monetary policy decisions do not have to be approved by the congress they do not have to be approved by the president or by any federal department or by any federal department they act completely independently now the president united states technically can remove a member of the board of governors but it's uh seen as like very very big big no-no okay even when trump toyed with the idea of maybe doing something with powell right the media was howling can't do that i need to preserve fed independence and so you know technically according to law the president can remove a member of the board of governors for cause but it's not it's ill-defined and it's not really used so monetary policy decisions do not have to be approved at all by any member of the government also the fed does not receive any funding from the congress okay so all other agencies although the military you know every part of the federal government receives funds appropriated to it by the congress the federal reserve is the exception federal reserve does not receive any funding from the congress this protects it from congress because one of the tools that congress has is the power of the purse if congress wants they can pull funding from an agency they don't like or an agency who maybe is acting up not so with the fed the fed is independent of any appropriations from the congress and then lastly members first of all well the board of directors at the 12 regional banks are not responsible at all they're elected by the the banking industry six of the nine and then three the nine by the board of governors but members of the board of governors in dc at with 14-year terms that spans multiple presidents and multiple congresses and gives them it's not a life term like a supreme court judge but it still gives them a measure of independence from partisan feeling or whatever so [Laughter] that's that and there are the notes today those are the notes today by the way the the treasury department um well the bureau of engraving and printing which is a bureau of the department of the treasury they're the ones who who design design the notes print the notes that's the only road that the the that the treasury department plays in all of this um but you know it's just it doesn't say the united states of america will pay to the bearer on demand five dollars anymore it just says this note is legal tender for all debts public and private period federal reserve note five dollar bill but you know the signature there secretary of the treasury treasurer of the united states and that's placed there because the bureau of engraving and printing are the ones who who design these notes and print them five dollar note 10 dollar note 20 the 100 note got anti counterfeit anti-counterfeiting measures placed on all these notes but especially the 100 um notes in poor condition are are destroyed and then replacements are ordered from the bureau of engraving and printing i have here at about 7 000 tons of worn currency worn out currency are destroyed every year seven thousand tons um the average length of circulation for a one dollar bill or a five dollar bill is only five to six years average uh length of circulation for a ten dollar note is uh is uh around five years twenty dollar note about eight years hundred dollar note about fifteen years so when they get old and ragged destroy the notes and replacements ordered well that's today um for the next lecture we're gonna go back all right and we'll we'll enter the world war one era and then the 1920s so this was the note in 1914 i think this is yeah series of 1914 federal reserve note united states of america will pay to the bearer on demand twenty dollars in gold and gold so we're going to go back go back to that mindset but i hope that this lecture made sense um there's the signing of the wilson signing the federal reserve act on december 23 1913. federal reserve board new york fed headed by benjamin strong jr morgan man bankers trust in new york and uh and that's where we will pick up next time so thanks for watching and i look forward to continuing onward into the 20th century see you later bye

Channel: Professor Barth

Views: 12,755

Keywords: Federal Reserve Act, 1913, Dual mandate, Alan Greenspan, Jerome Powell, chair, chairman, Ben Bernanke, Janet Yellen, New York Fed, federal funds target rate, federal funds effective rate

Id: cffutUCKU14

Length: 45min 42sec (2742 seconds)

Published: Mon Nov 16 2020