Economics 304 - Winter 2013
March 12, 2013
U.S Monetary Policy: A Very Brief Tour
The objective of monetary policy in Canada is very clear. ortiaint2%aonda
band that can vary between 1 and 3 per cent. The overnight rate is the main instrument that the
Bank of Canada uses to implement monetary policy. But as we have seen in the previous lecture,
the Bank of Canada has recently used other (unconventional) tools during the ﬁnancial crisis. In
the previous lecture, we also had an overview of how monetary policy is conducted at the Bank
of Canada and some of the indicators/data that the Bank of Canada uses in the formulation of
monetary policy. We ﬁnish our description of monetary policyoiignviwofw
the Federal Reserve is organized in the United States, how it conducts monetary policy and the
inﬂuence U.S monetary policy has on Canada.
?derutcurtS evrese RlaredeFehtswiH
The Federal Reserve System (the Fed) was established by an ActofCongressin1913. Theﬁnancial
panic of 1907 led congress to consider the creation of a centr al bank. After the US civil war until
the creation of the Federal Reserve Bank, the US experienced several bank panics (1873, 1884,
1890, 1893 and 1907). The banking panics of 1893 and 1907 wereparticularly important. Many
big banks failed across the country and it was evident at the t ime that to provide stability, a lender
of the last resort with su▯cient resources to stop runs on illiquid but still solvent banks was needed.
President Wilson signed the Act and the creation of the Fed is viewed as his biggest accom-
plishment. The Federal Reserve Act of 1913 called on the Fed t o(i)actaslenderofthelastresort
and (ii) manage the gold standard to avoid sharp swings in interest rates and other macro vari-
ables. Since the abandonment of the gold standard, the secociefeFdwasagd
to “conduct monetary policy by inﬂuencing monetary and credit conditions in pursuit of maximum
employment and stable prices, and moderate long-term interest rates.”
In addition to these two objectives, the Fed is also responsible for supervising and regulating
the banking institutions (the Bank of Canada does not have a direct supervisory role), provides
ﬁnancial services to depository institutions, the U.S gove rnment and foreign ﬁnancial institutions
including playing a major role in operating and supervising the payments system.
The Congress when they created the Fed wanted to give representation to all parts of the U.S
such that the Fed in Washington would receive information about each part of the country. The
Board of Governors was established in Washington, and twelvealveiins
(Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis,
Kansas City, Dallas, San Francisco) were created.
The Congress structured the Fed to be independent within the government—that is, although
the Fed is accountable to the Congress and its goals are set by law, its conduct of monetary policy
1 is insulated from day-to-day political pressures. The FedilioheBnkofCndaihi
What makes the Fed independent? Three structural features give the Fed independence in its
conduct of monetary policy: the appointment procedure for Governors, the appointment procedure
for Reserve Bank Presidents, and funding.
2.1 Appointment procedure
The seven Governors on the Federal Reserve Board are appointed by the President of the United
States and conﬁrmed by the Senate. Independence derives fro mac olof: he
appointments are staggered to reduce the chance that a single..ritcdl kelhe
appointees; second, their terms of o▯ce are 14 years–much longer than elected o▯cials’ terms.
Appointment procedure for Reserve Bank Presidents: Each Reserve Bank President is appointed
to a ﬁve-year term by that Bank’s Board of Directors, subject to ﬁnal approval by the Board of
Governors. This procedure adds to independence because the Directors of each Reserve Bank are
not chosen by politicians but are selected to provide a cross -section of interests within the region,
including those of depository institutions, nonﬁnancial businesses, labor, and the public. This is
again very similar to the Board of Directors of the Bank of Canada.
Funding: The Fed is structured to be self-su▯cient instehteha senit meets its operating ex-
penses primarily from the interest earnings on its poroofsecurities. Anysurplusesareremitted
to the government (on average this is around $25 billion but they have been much higher recently,
around $90 billion. The Bank of Canada’s funding operates inasi lsi. hrr,ii
independent of Congressional decisions about appropriations.
Fed o▯cials report regularly to the Congress on monetic ar,ypgullatory policy, and a variety
of other issues, and they meet with senior Administration o▯cials to discuss the Federal Reserve’s
and the federal government’s economic programs. The Fed alsoreportstoCongressonitsﬁnances.
One of the most watched o▯cial meeting is the testimony of the chairman to congress.
2.2 Who makes monetary policy?
The Fed’s FOMC (Federal Open Market Committee) has primary responsibility for conducting
monetary policy. The FOMC meets in Washington eight times a year (again similar to the Bank of
Canada) and has twelve members: the seven members of the Boardo fGvrrshePdntf
the Federal Reserve Bank of New York, and four of the other Reserve Bank Presidents, who serve
in rotation. The remaining Reserve Bank Presidents contribute to the Committee’s discussions and
In addition, the Directors of each Reserve Bank contribute tomorclymaig
recommendations about the appropriate discount rate, whichareuetoﬁnlpralyte
knaevrese RlaredeFehtfos looTnas laG
The goal(s) of the Federal Reserve Bank are fairly similar to he Bank of Canada, although the
framework is not as transparent as in Canada. Monetary policy in the U.S has two basic goals:
2 to promote “maximum” sustainable output and employment andto promote “stable” prices. These
goals are prescribed in a 1977 amendment to the Federal Reserve Act.
Sustainable output would correspond to steering the econom ys hhttitn-,i
grows at the same rate at which capacity (potential output) isgrowing. eswinth