Many times each year the economy has an increased need (demand) for money and credit.When this takes place om a regular basis, it is called a seasonal increase in demand.Typically , it occurs at Christmas,tax payment dates , and spring agricultural planting time (because farmers need money to buy seed and fertilizer).Nonregular , temporary increases in demand can occur at any time of year.Prior to creation of the Fed , these increased needs for money and credit occasionally could not be met by banks from their own reserves , and no central bank was available to which the commercial banks could turn.In severe cases financial panics ensued.

By standing ready to lend reserves to the banking system , the Fed ensures that banks can accomodate the needs of commerce under borth normal and abnormal conditions.As a result,the money supply can expand when pressure is applied and return to normal when it subsides.Providing such an elastic currency was at first the Fed's main mission , its role has expanded enormously.

Today, the federal reserve's duties fall into four general areas:

· Conducting the nation's monetary policy by influencing the money and credit conditions in the economy in pursuit of full employment and stable prices;

· Supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers;

· Maintaining the stability of the financial system and containing systematis risk that may arise in financial marcets;

· Providing certain financial services to the U.S. government, to the public, to financial institutions, and to foreign official institutions, including playing a major role in operating the nation's payment system.

Organizational Structure

The Fed consists of 12 regional Federal Reserve Banks spread throughout the country (Figure 1) and a Board of Governors based in Washington,D.C.The Board of Governors is headed by a chairman who is appointed by the President of the United States and confirmed by the Senate for a four-year term.He or she is also one of seven members of the Board of the Governors.Board members are appointed by the President and confirmed by the Senate for 14-year term.Although unusual , a Fed chairman could remain on the board , even if not reappointed by the President as chairman , to serve out his or her regular term

The Board sets major policy for the Fed,either meeting as a Board or as the majority group on the Federal Open Market Committee (FOMC).The FOMC is composed of the seven members of the Board of Governors and five Federal Reserve Bank presidents.Each of the 12 Federal Reserve Bank has its own president , all of whom rotate on and off the FOMC.The exception is the President

Figure 1:The Federal Reserve System of the Federal Reserve Bank in New York , who is a permanent member of the FOMC.The major responsibility of the FOMC is to determine monetary policy.

Figure 2.Organization of the Federal Reserve System

Membership in the Federal Reserve System and the Dual Banking System

Commercial banks that belong to the Federal Reserve System are know as member banks.Not all commercial banks are members ,but those that are hold the majority of commercial banks deposits and assets.

Whether or not a commercial bank is member of the Fed depends on a number of factors.One important variable is whether the bank has a national or state charter to operate.Because a bank can secure a charter from a federal goverment agency or the goverment of the state in which it is headquartered , we say that a dual banking system exist in the United States.The majority of commercial banks are state chartered.Those chartered by the federal goverment are known as national banks and must be members of the Fed.State- chartered banks may or may not be members at their options.In fact , the large majority of commercial banks are not members.Since national banks tend to be larger than state-chartered banks and large state-chartered banks tend to be Federal Reserve members , however , the preponderance of bank assets and deposits are held by members banks .Large state-chartered banks that voluntarily hold membership in the Fed are usually motivated by the pestige that membership confers and their ability to take advantage of member services such as direct access to the check-clearing network.

The requirements to secure a bank charter differ somewhat at the state and federal levels, but they are all stringent , requiring among other things adequate start-up capital and background checks on its officers to ensure ethical conduct.The charte for a nationale bank is issued by the Comptroller of the Currency , a division of the United States Treasury.State charter are issued by the banking authority in the state in which the bank is to operate.National banks must have their deposits insured by the Federal Deposit Insurance Corporation (FDIC),as must state banks that are members may have their deposits insured by the FDIC , and virtually all have such insurance.

The FDIC was established in 1933 to insure commercial bank deposits and help restore confidence in a banking system heavily shaken by the Great Depression and help and the resulting financial collapse of the early 1930s.Currently commercial bank deposits are insured up to $100,000 per account by the Bank Insurance Fund (BIF) of the FDIC.A non-Federal Reserve member bank insured by the FDIC is subjects to periodic examination by the FDIC to ascertain whether it is meeting requirements,including minimum levels of capital, and following appropriate lending rules.Insured banks that are members are similarly examined by the federal Reserve System.In addition, state banks are subjects to examination by state banking officials.

The previos discussion indicates that a number of agencies can be involved in chartering, insuring, examining, and setting rules for commercial banks.Numerous proposals have been made for reducing or reorganizing the regulatory structure of commercial banking.These proposals have included vesting all examination responsibility in the FDIC because virtually all commercial banks have deposits insurance, one agency could provide uniform examinations standarts.These proposals tend to encounter considerable opposition from regulators and bankers, however, and have not been enacted.IN contrast to giving the FDIC more power, the U.S.Treasure proposed in February 1991 that many bank regulatory activities be combined in a new agency, removing much regulatory responsibility from the FDIC, thought retaining considerable regulatory responsibility for the Fed.Both the FDIC and the Fed have strongly opposed this proposal.

Bank Reserves and the Fed

The Federal Reserve detemines the percentage of deposits that mast be held as reserves by member banks, nonmember banks, and other financial intermediaries offering checkable deposits, subject to persentage limits set by Congress.Such percentage is called a reserve requirement. To meet the requirement, reserves must be held in one of two ways.The first is vault cash-currency and coin held banks to apply to daily business needs.The second is in depository institution deposits at the Fed.These deposits account for the majority of bank reseves and require some explanation.

All member banks maintain deposit accounts at the Fed.These are noninterest-earning accounts that are similar to demand deposit accounts held by the public at commercial banks.Together, vault cash and depositary institution deposits are called legal reserves or total reserves.The portion of legal reserves necessary to meet the reserve requirement is known as required reserves, but banks may have legal reserves above the minimum.These are known as excess reservesLegal reserves are not included inany measure of the money supply since these money measures include only the amount of money incirculation.

Total (or legal) Required reserves reserves

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Figure 3. Composition of bank Reserves

In addition to holding reserves in depository institytion accounts at the Fed and in vault cash, nonmember banks and other financial intermediaries may maintain their reserves on a pass-throught basis at Fed member banks (which in turn deposit these with the Fed), with the Federal Home Loan Bank System (to which most savings and loan associations belong), or a special bankers' banks owned primarily by depository institutions to share the costs of various common financial services and do not do business with the general public.

Reserve requirement on transaction account in general exceed those on time deposits because these account turn over rapidly since they are used for transaction.Savings and time deposits are usually used for funds that are expected to be on deposit for some period of time.Technically, financial institutions can require notice to be given for withdrawal of funds from passbook savings account.In practice, however, passbook deposits are available for withdrawal at the time requested.The different function usually served by checking, savings, and time deposits have historically resulted in higher reserve requirements on checking accounts than on time and savings accounts.

3) The Federal Reserve and Monetary Policy

As the central bank in the United States, the Fed is responsible for fulfilling a number of functions,such as providing banking services to the Treasury and approving bank mergers.Another very important function and the one that attracts most attention is conducting monetary policy.This is the attempt by the Fed to unfluence the course of economic activity by affecting the reserves of the banking system.The reserve position of the banking system in turn affects the money supply, interest rates, and the economy.By making money and credit hard to obtain, or expensive, the Fed tries to reduce inflationary pressures in the economy.Alternative, by making money and credit plentiful and inexpensive,the Fed attempts to stimulate the economy.

Reserve Requirement Changes

When the Federal Reserve raises or lowers the reserve requirement, it changes the distribution between required and excess reserve in the banking system.An increase lowers the level of excess reserves, and a decrease increases excess reserves.Exess reserve availability influences the amount of bank lending in the economy.As most demand deposits come into existence throught bank lending, a change in reserve requirements may be translated into money supply changes.

Historically, the Fed has been reluctant to change reserve requirements because such action has a dramatic impact on the reserve positions of banks.Even relatively small changes absorb or release substantial amounts of excess reserve, which in turn may significantly affects the banking system's ability to make loans. Between 1980 and 1987 the Fed was unable to use reserve requirement changes for policy purposes even if it had wanted to.The 1980 Depositary Institutions Deregulation and Monetary Control Act mandated a phase-in of new reserve requirements.Although the Fed once again has the ability to alter the requirements within rather broad limits set by Congress, it is unlikely that it will do so frequently.Nevertheless, in December 1990, as noted previosly,it did lower reserve requirements on some categories of deposits.

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