5) The Federal Reserve: The FOMC Rate Meeting
The Federal Open Market Committee (FOMC) decides whether to raise, lower or maintain its objective for the federal funds rate (FFR), as well as to determine the discount rate. As mentioned in the previous section of this guide, the FOMC only tries to influence the rate through several tools such as open-market operations. In the end, the actual rate is determined by various market factors.
A good example of the various market factors acting on the rates is during the holiday season. At this time consumers have a higher demand for cash. The banks will dip into their reserves to compensate for the increased demand. This higher demand for the reserve funds market practically increases the FFR overnight.
The FOMC usually meets eight times within the span of a year. It is during these meetings that the members decide on the changes to be made to the monetary policy. Before each meeting, FOMC members are given three different reports or “books”. The “Green Book” contains forecasts on the US economy by the Federal Reserve Board (FRB) staff. The “Blue Book” reports about the FRB staff’s monetary policy analysis. The “Beige Book” discusses the economic conditions of the different regions prepared by each of the District Feds (Reserve Banks).
If the FOMC wants to advance economic growth, all it needs to do is to decrease the target FFR. On the other hand, if it wants to tone down the economy a bit, the FOMC will only need to increase the rate. But this is not as simple as it sounds. The Fed, as a whole, tries its best to sustain a steady economic growth. Extremes are normally considered as bad for growth. If the growth is too fast the economy will have inflation, too slow and it will be in recession.
Even if the rate might seem to warrant a change, the FOMC will try to maintain rates at current levels but will warn of a possible change in policy in the near future. This warning is what is called as the bias. An easing bias is issued by the Fed if it thinks the lowering of rates is forthcoming. Oppositely, the Fed will assume a bias that leans on tightening if it feels the rates might rise soon.
Why It Works
The FOMC usually sells securities when the target FFR has been increased, and buys when the rate has been reduced.
The logic behind this is that the Fed essentially creates new money when it purchases securities, which in turn increases the supply of reserves in the market. When banks have a greater supply of reserves it doesn’t need to borrow from the reserves market. The FFR is reduced when this happens. When the Fed sells securities the opposite happens. The reserves are reduced, which will most likely cause banks to borrow from the market and increase the FFR as an effect.
Who Is Alan Greenspan?
Alan Greenspan is the former chairman of the Federal Reserve. Four US presidents have appointed him starting from Ronald Reagan up to George W. Bush. He was the one responsible for the US monetary policy from 1987 until 2006. He was a very influential man and made markets move whenever he spoke. On February 1, 2006 he was succeeded by Ben Bernanke. On February 3, 2014 Bernanke was succeeded by Janet Yellen.