Federal Open Market Committee
The Federal Open Market Committee (FOMC) was
created by Section 12-A of the Federal Reserve Act, as added by the BANKING
ACT OF 1933, completely revised by the BANKING ACT OF 1935, and amended
by the Act of July 7, 1942 (56 Stat. 647).
The FOMC is composed of the seven members of the board of governors
and five Federal Reserve bank officials, usually presidents.
The chairman of the Federal Reserve Board of Governors also serves
as chairman of the FOMC. Because
of the New York Fed's special role in managing the system open market
account, the bank's representative is a permanent voting member of the
FOMC and, by tradition, the committee's vice-chairman.
The other Reserve bank presidents serve on a one-year rotating
basis beginning March 1.
Each year, one president or first vice-president
is eligible to be elected to the committee by one of the boards of directors
of one of the Reserve banks in each of four groups of Reserve banks.
Group one consists of Boston, Philadelphia, and Richmond; group
two, Cleveland and Chicago; group three, Atlanta, St. Louis, and Dallas;
and group four, Minneapolis, Kansas City, and San Francisco.
The Reserve bank presidents who are not voting members of the FOMC
also attend the meetings to offer their views on economic conditions and
policy approaches. The meetings occur about 10 times a year.
Should one of the voting presidents be unable to attend a meeting,
an alternate president of a Reserve bank, designated each March from the
remaining seven, may cast a vote in the place of the absent president.
If the New York president is absent, the first vice-president of
the New York Fed attends the meeting and votes.
Traditionally, the New York Fed first vice-president is the only
such officer designated as an alternate.
Voting alternates must be from the same group as the presidents
On a daily basis, the securities portfolio
is directed by the manager of the system open market account for domestic
operations. The manager is
appointed by the FOMC and customarily is a senior officer of the New York
Fed. The account manager attends the FOMC meetings to report on
domestic operations, as well as to be fully informed of the discussions
leading to adoption of the committee's directives to him. In addition, the manager participates daily in a telephone
conference call with a designated Reserve bank president and the senior
staff of the board of governors.
The account manager proposes a plan for the day and receives comment
from the president on the call.
Each day the board's staff sends a telegram to the voting and nonvoting
members of the FOMC covering the discussion of the call.
The Federal Reserve System's open market account
is composed of the Federal Reserve System's portfolio of U.S. Treasury
and federal agency securities, and bankers acceptances, acquired in open
Open market operations involve the buying and
selling of securities in the marketplace.
The open market operations serve as one of the three basic tools
the Federal Reserve uses to conduct MONETARY POLICY - which influences
the cost and availability of money and credit.
Other things remaining equal, a purchase of government securities
in the market by the system account adds RESERVES to the commercial banking
system, enabling banks to expand their lending and investment activities.
A sale of securities by the system account withdraws reserves from
the banking system, limiting the ability of commercial banks to make loans
(The other major tools of Monetary Policy are
changes in the DISCOUNT RATE and RESERVE REQUIREMENTS.
The discount rate is the interest charge that depository institutions
(see DEPOSITORY INSTITUTIONS DEREGULATION AND MONETARY CONTROL
ACT OF 1980) must pay when they borrow from the Federal Reserve banks. Reserve requirements are the reserves that the various depository
institutions must keep in their vault or on deposit directly or indirectly
in their reserve account at the Federal Reserve bank, based on a percentage
of demand, time, and savings deposits of the institution.
A specified portion of the system's outright
holdings in the system account's portfolio is allocated to each of the
12 Federal Reserve banks, but is held by the New York Fed.
The securities trading desk of the system account at the New York
Fed is the control center of the system's market activities, which are
directed by the FOMC. The
percentage allotments of the portfolio are adjusted annually to reflect
movements of deposits among Federal Reserve banks.
The power to buy and sell government securities was granted to each Federal Reserve bank by the Federal Reserve Act. However, not until the 1920s was the monetary policy impact of changes in the portfolio generally understood. The structure of the FOMC itself, moreover, was not established in its present form until passage of the Banking Act of 1935.
The composition and value of the system account's portfolio fluctuates daily in response to the system account's operations. The interest received by the Federal Reserve on its system account's portfolio holdings constitutes virtually all of the system's earnings. However, unlike individual or private institutions, the Federal Reserve acquires or sells securities purely to implement monetary policy and not in pursuit of profit. The interest earned on the holdings is apportioned to the individual Federal Reserve banks according to the percentages of the portfolio that each Federal Reserve bank owns. A portion of the earnings is used for the salaries and other operating expenses of the Federal Reserve banks, with an amount set aside in a surplus account. In recent years these expenses have amounted to about 8.4% of the annual earnings on the portfolio of the Federal Reserve banks. After additions to surplus and dividends on Federal Reserve bank stock (owned by the member banks), the remaining earnings are paid to the U.S. Treasury on a weekly basis, as interest payments on FEDERAL RESERVE NOTES at a rate established by the Board of Governors of the Federal Reserve System.
The FOMC concentrates on controlling the supply of reserves through the government securities trading desk at the Federal Reserve Bank of New York. The New York Fed conducts open market operations on behalf of the Federal Reserve, pursuant to directives of the FOMC. The FOMC establishes operating guides for the trading desk by choosing growth objectives for various measures of money, the funds available to the public for transaction purposes, and liquid savings. The staff of the board of governors uses the monetary growth objectives as the basis for constructing growth paths for total and nonborrowed reserves which are consistent with the desired money growth.
Total reserves are assets that depository institutions may count to meet the reserve requirements. Most depository institutions must directly or indirectly maintain reserves with the Federal Reserve bank of the district. Nonborrowed reserves represent total reserves less borrowings at the district Federal Reserve bank (the discount window).
Initially, the staff decides how to divide the FOMC's two- or three-month growth objectives into monthly paths. The monthly pattern for money growth is then translated into nonseasonally adjusted weekly levels. Application of the appropriate required reserve ratios to the different categories of deposits results in an estimate of required reserves for the period between FOMC meetings, about once every four to six weeks. Addition of estimated excess reserves results in an estimate of total reserves for the period. Excess reserves are the difference between total reserves and required reserves. Deduction of the borrowing level indicated by the FOMC at its meeting produces the nonborrowed reserve average that the trading desk is expected to achieve.
Each week the trading desk has an objective for such nonborrowed reserves. The reserve objectives for the intermeeting period are reviewed by senior FOMC and trading desk staff, typically each Friday morning. The objectives may be revised to account for factors such as changes in the mix of currency and member and nonmember bank deposits in the money supply and other liabilities.
The path for nonborrowed reserves may also be revised to help speed the adjustment process if demand for total reserves is running well above or below the desired level. The nonborrowed path may be lowered if total reserves are running strong and raised if total reserves are running weak.
Comparison of the projected demand for total reserves with the nonborrowed reserve path for the interval indicates the amount of borrowing consistent with achieving the path. Borrowing needed in subsequent weeks to achieve the average is then deducted from the weekly estimates of the demand for total reserves to give the nonborrowed reserves objective consistent with attaining the desired average for the interval.
Given the week's nonborrowed reserve objective, along with an awareness of the excess and borrowed reserve expectations, the trading desk devises an operating strategy. Each day, the desk receives projections of the supply of nonborrowed reserves for the statement week, prepared by staff at the New York Fed and at the board of governors.
The projected nonborrowed reserve supply is compared with the objective to see whether reserves will need to be added or absorbed. Some factors, such as Federal Reserve FLOAT, are particularly hard to predict and often cause large projection errors. Given this uncertainty about reserves, the trading desk may also draw information about actual reserve availability from the behavior of the market for reserves. For example, a sharp rise in the federal funds rate may suggest reserves are in shorter supply than the projections indicate; a sharp decline may suggest the reverse. Pursuit of reserve objectives involves a daily judgment of when, and how much, to intervene with open market operations to achieve the weekly reserve objective.
System transactions on an outright basis typically occur through an auction process in which dealers are requested to submit bids or offers for securities of the type and maturity that the manager has elected to sell or buy that day. Once dealer tenders have been received, they are arrayed according to price. The manager then accepts amounts bid or offered in sequence, taking the highest prices bid for sales and the lowest prices offered for purchases, until the desired size of the whole transaction is reached. Not all outright transactions occur through the dealer market. Approximately three dozen dealers make up the active market in U.S. government and federal agency securities. These dealers have trading relationships with the trading desk which enables the desk to normally complete large orders promptly. Most of the system's outright transactions, whether in the dealer market or directly, take place in Treasury bills. The Federal Reserve acts as agent for a number of official agencies, such as foreign central bank, in making dollar investments.
In situations that call only for temporary additions to bank reserves, the manager engages in short-term repurchase agreements (RPs) with dealers who agree to repurchase them by a specified date at a specified price, Because the added reserves will automatically be extinguished when the RPs mature, the arrangement is a way of injecting reserves on a short-term basis. Repurchase agreements for the system account may be dated to terminate in one to fifteen business days. Most mature within seven days, and dealers usually have the option to terminate agreements before maturity. Whenever the manager arranges RPs with dealers, the distribution among dealers is determined by auction.
When the manager for domestic operations faces a temporary need to absorb rather than provide bank reserves, matched sale-purchase transactions with dealers are employed. These transactions involve a contract for immediate sale to, and a matching contract for subsequent purchase from, each participating dealer; the maturities of such arrangements usually do not exceed seven days. The initial sale causes surplus reserve to be drained from the banking system; later, when the system purchase is implemented, the flow of reserves is reversed. Such arrangements are usually in Treasury bills.
After each of its meetings, the Federal Open Market Committee issues a directive to the Federal Reserve Bank of New York to guide open market operations in the period before the next meeting. The directive adopted by the FOMC at a given meeting is made public shortly after the next meeting of the committee. It is released along with the policy record summarizing the committee's assessment of the country's economic and financial position at the time of the meeting and the discussion by the members of the appropriate course for policy during the period ahead. The votes of individual members are recorded; if any members dissent, a statement of the reasons for that dissent is also included.
In general, no one approach to the implementation of open market operations is likely to be satisfactory under all of the economic and financial circumstances that monetary policy may face. The approach to policy implementation has been adapted in light of such factors as the need to combat inflation, efforts to encourage sustainable economic growth, uncertainties related to institutional change, and evident shifts in the public's attitudes toward, and use of, money. The more that economic and financial conditions warrant emphasis on monetary aggregate objective that is closely related to the reserve base, such as M1, the greater is the emphasis that may be placed on guiding open market operations by relatively strict targeting of reserve aggregates. In other circumstances, a more flexible approach to reserve management is required.
Open market operations have their initial impact on the reserves base of the depository system - and directly on nonborrowed reserves. The major objectives for monetary policy are translated into reserve guidelines to form a basis for day-to-day decision making. Various measures of reserves are provided here: