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8-18 Money, Banking & Financial Institutions [CH 8

regions and headquarters for each of the Federal Reserve districts.
The Board of Governors of the Federal Reserve System consists of seven members
appointed by the President of the United States from a recommendation of the Federal

Reserve’s Board of Governors, and then confirmed by the Senate. Political pressures
are reduced by a 14-year term of office for each member, with one term expiring every
two years.
Each of the 12 Federal Reserve district banks is managed by a president and a nine-

member board of directors. Federal Reserve System member banks in a district own
stock in the district bank and elect some of the board members. The other directors, of
whom at least three must be businesspersons and another three must represent the
general public, are appointed by the Board of Governors.

The relationship between the Washington, D.C.-based Board of Governors and the
12 district banks is analogous to that of the federal government and the 50 state
governments. The Board of Governors set the general direction for the member banks,
while the district banks typically concentrate on banking issues of importance within

their district.
While all national banks are required to be members of the Federal Reserve
System, membership is optional for state-chartered banks.

Control of the Money Supply: The FED's Basic Function

The most essential function of the Federal Reserve System is to control the supply
of money and credit in order to promote a stable dollar and economic growth, both at
home and in international markets. It performs this function through the use of three
important tools: reserve requirements, open market operations, and the discount rate.
reserve requirement
Percentage of a bank's Reserve Requirements. The Federal Reserve System's most powerful tool is the
checking and savings reserve requirement—the percentage of a bank's checking and savings deposits that
accounts that must be kept
in the bank or on deposit at must be kept in the bank or on deposit at the local Federal Reserve district bank; this
the local Federal Reserve requirement is 3% to 10%. By changing the percentage of required reserves, the
district bank. Federal Reserve System can affect the amount of money available for making loans.
Should the Board of Governors choose to stimulate the economy by increasing the

amount of funds available for borrowing, it could lower the reserve requirement.
Changing the reserve requirement is a drastic means of changing the money supply.
Even a one percent variation in the reserve requirement means a potential fluctuation
of billions of dollars in the money supply. Because of this, the board of governors

would prefer to rely more often on the other two tools at its disposal—open market
operations and changes in the discount rate.
open market operations
Federal Reserve System Open Market Operations. A far more common method used by the Federal
method of controlling the Reserve System to control the money supply is open market operations— the
money supply through the technique of controlling the money supply by purchasing and selling government
purchase and sale of
government bonds. bonds. When the Board of Governors decides to increase the money supply, it buys
government bonds on the open market. The exchange of money for bonds places more
money in the economy and makes it available to member banks. A decision to sell
bonds serves to reduce the overall money supply.

The Federal Reserve Board often uses open market operations when small
adjustments in the money supply are desired. These operations do not produce the
psychological effect that often results from announcements of changes in reserve
requirements. Such announcements make newspaper headlines and are widely

interpreted by commercial banks, businesspeople, and the stock market as a signal by
the Federal Reserve System of "tighter" or "easier" money. Over the years, open
market operations have been increasingly used as a flexible means of expanding and
contracting the money supply.

The Discount Rate. The Federal Reserve System is the "banker's bank", and not a
bank for the normal citizen, business or corporations. The Federal Reserve Bank is a

bank for the banks that people use for their banking needs. When member banks need
extra money to lend, they turn to a Federal Reserve bank, presenting either IOUs

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