The US Federal reserve, usually referred to as the Fed, acts as both the central bank and one of the key regulators of the commercial banking system. The main board is based in Washington but there are also 12 regional reserve banks operating in what are referred to as Federal reserve Districts.
The main board has seven members drawn from the reserve banks in the Federal reserve Districts. The US President appoints these members with the appointments being ratified by the Senate. The members serve 14-year terms. This appointment system means that political interference is very limited and that the Fed has effective day-to-day political independence. Inevitably the board does work closely with whoever is the current incumbent of the position of secretary of the Treasur y even though they do not always see eye to eye.
The board is responsible for setting bank reserve requirements. It also shares responsibility with the regional reserve banks for establishing discount rate policy. Combined with open market operations these provide the principal tools for managing US monetary policy. It should be obvious that as the US Federal reserve is the world’s most powerful national central bank its monetary policies can have wide reaching effects in other countries, particularly those with currencies linked to the US$. The Federal Open-Market Committee (FOMC) meets on a regular basis, normally about once every six weeks, to establish a target Federal Funds rate and hence monetary policy necessary to achieve it. The Federal Funds rate is the rate that banks with surplus reserve deposits with a Federal reserve Bank charge on overnight funds to banks with a shortfall.
The Fed is able to influence the actual Federal Funds rate through open market operations by buying or selling Treasur y bills and notes in the market. Minutes of the meetings are published as are the voting records of the individual members in terms of their bias towards interest rate and monetary policy. In this context hawks favor tightening monetary policy and a bias towards higher rates and doves the opposite. The minutes and statement from the chairman are closely watched for signals on likely future Fed monetary and interest rate policies as they may have a significant impact on equity and bond markets not only in the US but around the world. The Fed is very careful of language and does not actually issue a formal bias statement but rather a “balance of risks” statement. Most people inter pret the latter as a statement of bias in any case.
The chairman of the Fed is also authorized by the FOMC to act if necessary between meetings. Such occasions are relatively rare, it is difficult to see when an emergency tightening of money supply would be necessary. There have only been three instances in recent memory when the Fed has pumped short-term liquidity into the market. One of those was flagged well in advance in the case of the Y2K switchover. The other two followed the collapse of the Long Term Credit Management group, a highly leveraged US hedge fund, which failed in dramatic style in 1998 largely due to positions it took in Russian instruments, and the reopening of US financial markets after the events of September 11th 2001.