Federal Reserve Bank

The Federal Reserve System, or the “Fed”, is the U.S. central bank. The regulation of the banking system, consumer protection laws and the control of monetary policy to this quasi-government institution were mandated by Congress. The Federal Reserve is independent of the Treasury, but is the Treasury Department's personal banker. The President appoints the seven governors (designating a Chair and Vice-chair) to the Board of Governors for 14-year terms, but the Senate must confirm them. The Fed, through a system of 12 district banks, provides services to the commercial banking sector. The district banks regulate and examine commercial banks.

The Fed manages monetary policy through the Federal Open Market Committee (FOMC), which is composed of the seven governors and five of the 12 district bank presidents. A distinctive feature of the FOMC is the rotation of the 12 district bank presidents as active voting members of the FOMC. As the European Central Bank ponders what expansion will do to their already sizable policy making executive committee, one of things they are considering is mimicking the Fed’s rotation policy. The FOMC meets eight times a year to set the agenda for credit market policy based on economic conditions.

In the mid-1980s, the estimation of daily reserve needs and forecasts of M1 and M2 money supply were duties among Fed-watching economists. But since the Fed no longer directly targets monetary aggregates, following economic indicators has gained stature instead. This was especially so when Alan Greenspan, a bonafide card carrying economist was Fed chairman. His successor, Ben Bernanke, is another card carrying economist and he has continued to follow economic data closely as well.

The Fed had maintained a 1 percent Fed funds interest rate from June 2003 to May 2004 before beginning its series of 25 basis point increases. Most overseas analysts thought that the increases were long overdue. In the wake of August’s financial market unraveling, the Fed has once again started to cut interest rates despite their concerns about inflationary pressures. The interest rate spread between the U.S. and higher interest paying countries has narrowed significantly. The fed funds target rate is 4.5 percent and is 1.25 percent lower than the Bank of England’s 5.75 percent rate and 2.25 percent below the Reserve Bank of Australia’s 6.75 percent interest rate. The spread between the European Central Bank (4 percent) and the Fed has narrowed to 50 basis points.