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The district Federal Reserve banks are organized rather like private banking corporations whose shareholders consist of the private member banks in the district.

Credit Policies of the Federal Reserve System | Mises Institute

But despite their semi-private character, the district Federal Reserve banks exercise Congressionally delegated legal powers to regulate the banking industry. Each district Federal Reserve Bank is managed from day to day by its own president, who is elected to a 5-year term by his district Federal Reserve Bank's own individual board of directors.

The Federal Reserve and the Discount Rate

Two-thirds of the members of the district boards of directors are elected to their positions by the privately owned commercial banks in the district that are member banks of the Federal Reserve system. Member banks are divided on the basis of their assets into "small", "medium", and "large" banks, with each category of banks allowed to elect two directors on a "one bank, one vote" basis.

The other one- third of the directors in each district are appointed from Washington by the Fed's Board of Governors, rather as though the Board of Governers were a major creditor or minority stockholder with guaranteed representation on the district boards. The district Federal Reserve Banks act as non-profit "bankers' banks" -- that is, only commercial banking or depository institutions and certain agencies of the federal government maintain deposits at the Federal Reserve, and only member banking institutions and the US government are eligible to receive loans from it, not private citizens nor other kinds of non-bank commercial enterprises.

All banks chartered as "national banks" by Federal law must be "member banks," that as such are obligated to maintain most of their reserves as deposits in their accounts at the Federal Reserve and to submit to detailed Federal Reserve banking regulations. Many state-chartered banks and thrift institutions nowadays also choose to be members of the Federal Reserve System and submit to its regulations in order to enjoy the valuable services which the Fed provides to them.

The district Federal Reserve Banks operate clearing houses for checks and bank drafts, issue new paper currency "Federal Reserve notes" for sale to member banks on demand, withdraw worn-out currency from circulation, sit in judgment on the applications of banks that wish permission to merge with each other, extend "discount loans" to member banks with the member banks putting up their own borrowers IOUs as collateral , and perform various miscellaneous regulatory functions pertaining to the banks in their districts.

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When the Federal Reserve System was originally created back in , it was expected that the district Federal Reserve Banks would each pursue slightly different monetary policies, depending upon the economic conditions in their individual districts, so they were given the authority to collect a wide variety of information and statistical data on changes in regional business conditions to use in their decision-making. The high degree of integration of the national economy has for many years made it impractical for the district Federal Reserve Banks to maintain different levels of interest rates or pursue differing policies regarding the growth or contraction of the money stock these policy decisions are made centrally for the entire country by the Fed's Board of Governors in consultation with the district bank presidents , but the 12 district banks are still a major source of detailed economic data used by government policy-makers at both the national, state and local levels as well as by private economic forecasters and business executives.

The primary reason why the banking industry generally supported the creation of the Federal Reserve System and continues to support it today despite the inconveniences imposed by the Fed's regulations, is the valuable privilege that memberhip brings to the bankers to count on the Fed for large emergency loans of cash if they someday need it to survive a "run" on their bank.

In a bank "run," large numbers of depositors frightened by rumors that their bank is about to fail suddenly begin crowding into the bank, demanding to withdraw all their deposits in cash. This exhausts the very limited cash reserves normally kept on hand in the bank's own vaults within a few hours. Since the large majority of the depositers' dollars on deposit are always out on loan to the bank's credit customers, and since it takes days or weeks to call in any sizable fraction of the loans outstanding, the bank would have to "go bankrupt" and be liquidated by the courts unless it can raise enough cash somewhere on short notice to pay off the panicky depositers demanding their money.

Seasonal credit is extended to relatively small depository institutions that have recurring intra-year fluctuations in funding needs, such as banks in agricultural or seasonal resort communities," according to the Fed. Federal Reserve. Investopedia uses cookies to provide you with a great user experience.

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Index: Political Economy Terms

Personal Finance. Financial Advice. Popular Courses. Login Advisor Login Newsletters. Monetary Policy Federal Reserve. Each of the tools of monetary policy is really controlled by a different body within the Federal Reserve System.

What is the Federal Reserve?

So reserve requirements are controlled exclusively by the governors of the Federal Reserve System. Governors are the seven people that have broad authority over the system in general. Governors are appointed by the president of the United States, confirmed by Congress, to year nonrenewable terms. The second tool of monetary policy, the primary credit rate—that's controlled by the boards of directors of the individual Federal Reserve banks.

So there are 12 boards of directors, one for each the Federal Reserve banks, and they vote on the primary credit rate. The catch is that the primary credit rate has to be approved by the Board of Governors in Washington, D. The third tool of monetary policy, which is really what the Federal Reserve has largely become known for over the years are federal open market operations.

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And they are controlled by an organization called the Federal Open Market Committee. Congress has given the Federal Open Market Committee what is known as a dual mandate. It expects it to achieve maximum employment and price stability. So the goals of the Federal Open Market Committee are not determined independently by the committee.

Congress has given the committee its objectives, but the committee is independent to determine the policies that best achieve these two goals. And so the Federal Open Market Committee meets eight times a year to do just that, to decide what are the monetary policies that best promote price stability and maximum employment. The Federal Open Market Committee is a committee of 12 people.

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The four remaining seats on the Federal Open Market Committee are four of the remaining 11 presidents of Federal Reserve banks, who rotate in and out of the committee. Traditionally, monetary policy is conducted to the management of the overnight interest rate called the federal funds rate. How does the federal funds rate influence maximum employment and promote price stability? This is a bit of a debate in macroeconomics, and we're not going to resolve it here.

Credit Policies of the Federal Reserve System

The traditional view is that by managing the overnight interest rate, the overnight cost of funds, the Federal Reserve might be able to influence longer-term interest rates, interest rates that are important for investment decisions. And if that's true, the management of short-term interest rates is really the management, within some bounds, of longer-term interest rates, which manage investment, which affect the economy, which affect employment, and, ultimately, which affect inflation.

But of course things aren't always so easy. Changes in the overnight interest rate do not necessarily directly translate into longer-term interest rates, and it takes some time for those longer-term interest rates to affect the real economy, and it takes some time for any real effects to be felt in inflation. The lags between a policy action and a policy effect are long and variable. Policymakers have to be very forward-looking when they establish their policies.

The policies established today might not affect the rate of inflation for six months out to perhaps as long as three years from now. And so economic forecasts of how the economy is going to unfold are going to be crucial in how the FOMC discharges its responsibilities. In the implementation of monetary policy and how it affects the economy, there are some economists, many economists, who think that the dual mandate represents something of a trade-off.

That is, in the short run, policy can affect the real economy, but that has an offsetting effect on the rate of inflation—the stronger the economy, the faster the rate of inflation [and] the weaker the economy, the slower the rate of inflation.