The Federal Reserve

System, Monetary Policy,

and Interest Rates
Structure of the Federal Reserve System
● Divided into 12 Federal Reserve districts, each with a main Federal
Reserve Bank
● Federal Reserve Banks operate under the general supervision of the
Board of Governors of the Federal Reserve
● The Office of the Comptroller of the Currency (OCC) charters national
banks, which are members of the Federal Reserve System (FRS)
● FRS member banks “own” the 12 Federal Reserve Banks
Board of governors of the Federal Reserve
•Seven member board headquartered in Washington, DC
•President appoints and Senate confirms members to
nonrenewable 14-year terms
•President appoints and Senate confirms Chairman and
vice-chairman to renewable 4-year terms
•Formulates and conducts monetary policy and
supervises and regulates banks
Federal Open Market Committee
•FOMC consists of 12 members
–seven members of the Board of Governors
–the president of the Federal Reserve Bank of NY
–the presidents of four other Federal Reserve Banks (on a rotating basis)
•The monetary policy-making body of the FRS
•Policies seek to promote full employment, economic growth, price
stability, and a sustainable pattern of international trade
Federal Open Market Committee
•The FOMC sets ranges for growth of monetary aggregates and the fed
funds rate, and also directs FR operations in FX markets
•Open market operations are the main policy tool used to achieve
monetary targets
–involve the purchase and sale of U.S. government and federal agency
securities
–are implemented by the Federal Reserve Board Trading Desk of the New York
Federal Reserve Bank
Functions Performed by Federal Reserve Banks
•Assist in the conduct of monetary policy
–set and change the discount rate (must be approved by the Board of Governors)
–make discount window loans to depository institutions
•Supervision and regulation
–conduct examinations and inspections of member banks
–issue warnings when banking activity is unsafe or unsound
–approve bank mergers and acquisitions
•Provide government services
–act as the commercial banks of the U.S. Treasury
Functions Performed by Federal Reserve Banks
•Issue new currency
–collect and replace currency in circulation as necessary
•Clear checks
–act as a central clearing system for U.S. banks
–clear ~25% of all checks written in the U.S.
•Provide wire transfer services
–Fedwire
–Automated Clearinghouse (ACH)
•Perform banking sector and economic research
–used in the formulation of monetary policy
Balance Sheet of the Federal Reserve
•Major assets
–Treasury securities
–Treasury currency
–gold and foreign exchange
–loans to domestic banks
•Major liabilities
–reserves
–currency in circulation
–currency in circulation + reserves = money base
MONETARY POLICY
● Increasing or
decreasing the money
supply to speed up or
slow down the overall
economy.
Monetary Policy Tools
1. Open Market Operations
2. Discount Rate Changes
3. Reserve Requirement Ratio Changes
Money Supply Targeting
● Money supply is
constant
● Money demand
decreases or
increases
● Interest rates will
fluctuate
Interest Rate Targeting
● To maintain the
interest rate at the CB’s
target rate as the
money demand
fluctuates, it conducts
monetary policy
actions to increase or
decrease money
supply
International Monetary Policies and Strategies
1. Expansion of retail deposit insurance
● Ensure continued access to deposit funding
2. Capital injections
● Improve banks’ abilities to absorb additional losses
● Strengthen protection for banks’ uninsured creditors
● Increase banks’ lending
3. Debt guarantees
● Allow banks to maintain access to reasonably priced, medium-term funding
● Reduce liquidity risk
● Lower overall borrowing costs for banks
4. Asset purchases or guarantees
● Improve bank liquidity
Bangko Sentral ng Pilipinas
Objectives:

● Maintain price stability

● Monetary stability
● Convertibility of the national currency
Bangko Sentral ng Pilipinas
Responsibilities

● Liquidity Management
● Currency issue
● Lender of last resort
● Financial Supervision
● Management of foreign currency reserves
● Determination of exchange rate policy
● Other activities
DOSRI Loans
Important Provisions:

● General Policy. Dealings of a bank with any of its Directors, Officers, Stockholders and
their Related Interests (DOSRI) should be in the regular course of business and upon
terms not less favorable to the bank than those offered to others.
● Stockholders: in person, or through an agent. Also includes juridical persons.
● Related Interest:
1. Spouse or relative of within the first degree of consanguinity of DOS
2. Partnership of which DOS or no.1 is a general partner
3. The object pledged is co-owned by no.1
4. Corporations, associations or firms where no. 1 is a director or holds at least 20% of
subscribed share capital
DOSRI Loans
Transactions Included

● The terms loans, other credit accommodations and guarantees as used herein shall refer to
transactions of the bank which involve the grant of any loan, advance or other credit accommodation
in any form whatsoever, whether renewal, extension or increase.
1. Advance by means of temporary overdraft, cash item, vale, etc.
2. Unearned salary in excess of 30 days
3. Advance through DAUDs
4. Documents indicating indebtedness
5. Increase in existing obligation
6. Sale of Assets on credit
DOSRI Loans
Transactions not included

1. Advances against accrued compensation

2. Increases in indebtedness due to the bank’s additional charges

Individual Ceiling
The total outstanding loans, other credit accommodations and guarantees to each of the bank’s directors, officers, stockholders and their related
interests shall be limited to an amount equivalent to their respective unencumbered deposits and book value of their paid-in capital contribution in the
bank: Provided, however, that unsecured loans, other credit accommodations and guarantees to each of the bank's directors, officers, stockholders
and their related interests shall not exceed thirty percent (30%) of their respective total loans, other credit accommodations and guarantees.

Exclusions

Loans, other credit accommodations and guarantees secured by assets considered as

non-risk by the Monetary Board;
Fractional Reserve Banking
● Only a fraction of bank deposits are backed by actual cash on hand and
are available for withdrawal

Reserve Requirement

● Central Bank’s tool to implement monetary policy

● Banks are paid a rate of interest on reserves
Questions
1. All else held constant, when the Central Bank purchases securities, the
reserve accounts of banks decrease.
2. Reserve requirements are requirements regarding the amount of cash a
bank must hold in reserve against deposits made by customers.
3. In money supply targeting, money supply fluctuates. The current governor
of the BSP is Amando M. Tetangco, Jr.
4. Monetary policy refers to increasing or decreasing the money supply to
speed up or slow down the overall economy.
5. Monetary policy refers to increasing or decreasing the money supply to
speed up or slow down the overall economy.
Questions
6. Selling of government bonds results to higher interest rates and therefore
result to higher inflation.
7. During a stagnant period, FOMC may conduct open market operations in
order to stimulate the economy.
8. Quantitative easing is being used by the BSP.
9. Among the tools available to the FOMC, changing the discount rate is the
most effective.
10. The BSP acts as the lender of last resort in order to prevent bank runs.
Questions
1. All else held constant, when the Central Bank purchases securities, the
reserve accounts of banks decrease. (False, reserve accounts increase)
2. Reserve requirements are requirements regarding the amount of cash a
bank must hold in reserve against deposits made by customers. True
3. In money supply targeting, money supply fluctuates. (False, interest rate
fluctuates)
4. The current governor of the BSP is Amando M. Tetangco, Jr. (True)
5. Monetary policy refers to increasing or decreasing the money supply to
speed up or slow down the overall economy. (True)