David H Friedman I Bet You Thought

8/7/2019 David H Friedman I Bet You Thought

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IDENTIfIERSlBSTRACT

so 0" 750' t ied.an. David B.I Bet rOQ T b o a q h ~ Federal Reserye Bank of 9 ~ fork. N.r.Dec 1736p.fublic Info ~ t i o n D e p a r t l e n ~ . Pederal Beserve Bankof lew fork 3 Liberty Street . Nev York, Nev r c ~ k100115 Cfree)BF01 Plus Postage. PC Hot Available fro. EDRS.Adult E d u c a ~ i o n : .Sankinq; Concept Foraation: C r e d i ~(finance': Econa.1c Develop.ent: *Econoaic !ducation:Eoono.ics: Pederal ReqQlation: f inanc ia l poli cy :.pinancial SeryiC8$: Governaent ~ o l e : Instructionalla ter ia ls : .8oney ftenaqeaent: *soney Systeas:Purchaminq: secondary Education: Dnited StatesHistory.Federal Reserve syste.The bocklet l i s t s and di3pels 1ij economic mythsthl. "1h a d iscuss ion o f aoney. econoaic concepts, and ~ h Federal

B e ~ ~ i . . "e Systea. 'rhe objec t ive is to help secondary stadents O!: adul t sundc'":..stand tbe econoaic svstea as r e l a t e ~ to aone' and banking.Topics fOCQS cn aoney. bankinq, qo ld and s i lver , credit . qovern.entrole . financial concepts. and in teres t . For ~ h e s e topics his toricalbackQroand 1nforaatioD i s provided, teras and concepts are defined,relationships between qovernaent and the banks are pointed out,Federal Reserve functiGDS and operations l r e outlined. and varioustypes of banks are co.pared. Sa.pIe mytha inclUde "Boney is si .ply- coin and paper currency." "Gold and si lver are the only perfect.onies.- "Tbe Governaent reduces aoney's ,alue by printinq ~ o .nchcurrency." Checks are aoney." "Sanks are p a r ~ of the Govern.ent."- I l l banks are the sa.e,- Niall Street banking interests establishedthe federal Reserve and control aonetary policy," "The FederalReserve controls the a.ount uf currency in circulat.ion." and "Banksborrow aonev fro. the Federal ~ e s e r v e at the discount r a ~ e and lendthe funds at a hiqher rate tc .ake \:irofit.. f I Cartoon drav!ncrsi l lus tra te the concept.s discu3sed. (CK)


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U ' HIALTH.,auCATION &WIL''''."AT'O "AL 'NIT ITUT' OFIOUCATlON

TO THf EDUCA T'ONAl R!.50URl.t :SCENHH E f ~

DOCUMENT aEEN Ii EPIiOOuCEO I_ACTL" AS IIECEIIIEO FIlOMTHE PEIl!iON 011 ORGANIZATION ORIGINATING IT POINTSOF vIEw Oli OPINIONSSTATED DO NOT REPIIE-SfN T OFJt IC,AL NATIONAL INHIT UTE OFIDUCATION POSIT ION 011 POLICY

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'PERMISSION TO ~ L l ! ~ I MATERIAL IN M IC ROfi CHE ' ONLY

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Public Information DepartmentFederal R!serve Bank of New York33 Liberty StreetNew York. New York 10045

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P,.,.c.Most of us acqUire two types of knowledge-

" "001 knowledge" and 'fall< knowledge .' Folkknowledge IS information and "wisdom" passed fromgeneration to goneratIon or aCQuired on the streetsFor example, were often tOld that sIt ting In ad,.aft will gIve us a cold SCIence tells uS thecommon cole results frorn a V1fUS Yet. st ili wechange our seat ;0 avoid a draft We mayacknowledge that drafts only contribute tolowering our resistance to Infection but we 51111blame the tJreeza rathAr than the bugSo too most of us hold certain economicmisconceptions folk knowledge cont8lnlng agerm of truth and a plague of misconcp.pliuneconomiC myths p icked up by mlsreadlngs or t"eacceptance off ' lCls from a If lend or relativeFew of us are Immune to ( ~ c o n o m I C myths Ofmisconceptions If yuu dunt ttllTlk so I bet youthought

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T..... of ContentsBefo re reading th Is booklet. indIcate whethereach statement below IS true or false Aft e r,check your answers and rate yourself

Money IS Simply cOin amI paper currencyOnlv Calf! and currency dre rea l monIesbec


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, . . . - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - . . , --IIoMy . . 81mpl, coin Ind . . . . cunene,.Montly IS any gsnerally a c c e p r ~ j medium ofexchange, not simply COin and paper currency.Money doesn't have to be intrinsically valuable(valuable," Itself), be issued by a government orbe In any special form. In our past. Itemsranging from Iron nails and dried codfish to gunpowder and tobacco have served as moneyAnything people generally accept in exchangefor Items of value is money Money also IS astandard for measuring value and a means ofstoring purchasing power for future use AnyItem that has these three traits is moneyAmericans accept three types of money - COiniSsued by the Treasury, paper currency Issuedby Federal Reserve Banks, and checkbookbalances (demand deposits) at banksIn analyzlOg economiC activity, many economiststake a much broader view of money and InCludeother money-like Items immediately available tothe public for spending, such as passbooksavings and other funds depoSited for specifictll"\8 periodsOemarad depoSits are the nation's most commonform of money. compriSing about three-quartersOf all money 10 clfculatlon. This checkbookmoney is bOokkeeping money created malOly bytne nation's commercial banks. Americans preferusing checkbook money because It performs asa more efficient medium of exchange than COlOor currency for many transactions. Check WTltershave With one blank check the potential forspending small or large amounts. Since eachcheCk must be Signed before funds aretransferred, checkbook money cannot eaSily bestolen. In addition, cancelled checks providewritten proof of payments. Since we prizeconvenience, safety and recordkeeplng, it's nowonder that checkbook money is preferred

Checkbook money works because people areconfident in the strength, safety and prudence ofthe American banking system. Their confidencehas been bolstered by Government regUlation ofcommercial banks and Government depositinsurance. The check clearing and collectionsystem of the Federal Reserve, the nation'scentral bank. has also made checkbook moneyhighly acceptable by speeding checking accounttransfers nationwide.We've been big check users for quite awhile.The move began in the post Civil War era, whenbank deposits became the dominant form ofmoney held. Today, If all payment transactions""ere counted, including those for srock. bondand real estate purchases, the dollar volumeof check spending to coin and paper currencyspending would be enormous.Only about 3 percent of oor money IS in coms,and for every 10 cents in small change we keep.we hold about a dollar in paper money. As anation, we hold only about $80 billion of cash.compared with $230 billion of checkbook money.

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--- - -------_._---onlr COin and currency ... . rea' monl..bee........ Government uralher',. "'eg Iendet'."Com ana currency are "logal tender'" money th eGovernment says has to be accepted ,f offered tose tt le a det)' But Ih a t approval doesnl makecash any more rear th an checkbook balancesUnti l the 18605, legal tender' applle rj tocotn ye' everl Ihen we c more prIVate bii l1knotes and bank


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~ .... Gold "backing" Ilv. . . . . . do.Ia, Ita VI'u.Unt,l 1968, US currency had to be parllal lybacked by gold However. gold never gave thedollar Its value The dollar 's value always hasbeen determined by the amount of goods andservices It can buy . Its purchasing powerGold backmg was requIred through most of U Shistory as a means of restraining GovernmentoverlSSudnce of paper money and ImprovlMgpubhc confidence. and, therefore, theacceptability of paper moneyWhen the Federal Reserve was establIshed.Congress reqUIred the 12 Reserve Banks to tjackthel: currencV. known thefl a'S Federal ReserveBank notes and today as Federal Reserve notes,with 40 percent gOld and 100 percent 'el igiblepaper" (Short-term IOUs of busmesses andfarmers) The eligible paper requirement wasreduced to 60 pelcent In 1917 Gold WdS boughtfrom the Treasury Eligible paper was obtainedfrom commercial banks that pre5ented thesecuSfomer IOUs as collateral for loansEssenhally, only thoSe IDUs representtngcommerCial banI( loans made to expandmanufactuflng or farm output were deSIgnated"eligible" as collateral by the Federal ReserveThe backing reqUIrements on Federal Reservenotes were deSigned to regUlate currencyissuance automatically to the pace of theecrmomy's growth, smce only Increased bUSinessactiVity and bank lendmg could generate thecollateral necessary fOf more note IssuanceBacking requirements were Itberahzed andreduced over the years, as we gained betterinSight Into how the aconomy works and howmoney should be regulatedBy the 1930s. Congress allowed Reserve Banksto use assets other than eligible paper, such asUS Government secuntles, to back currency Bythe 19409, Congress slashed the goldrequirement to 25 percent and In 1968 eliminatedgold back1nt:, entirely

Federal Reserve notes ate stili "backed"dollar-far-dollar by the assets of the ReserveBanks About 85 percent of Ihese assets conSistof Government securities the FtJderal Reservepurchased over the years The rerr.aln:ng 15, ' rcent conSists of gold cerltf,rates representing~ I?dges against the Treasury's gold supplyHt:serve Banks no longer have to use thelf goldcertifIcates thIS way, but many sllU doCurrency backing Isn! relevant In today'seconomy Currency canno! be . redeemed," oroxcrtanged for Treasury gOld or any other assetU S f ~ ( J as backing The questIon of Just whatassets back' Federal Reserve notes has Iltllebut hookkeepmg significanceMoney's value, however IS highly relevantMaintaining the d o l l a ( ~ lIue means maintainingIts purchaSing power 11.Stng pr,ces-lMflatlon-reduce purchaSing power, stable pflces keeppurchaSing power strong,Too mUC!1 money results In excess spendingWhen consumers, bUSinesses and governmentsspend excessively, they compete for the availablesupply of goocs and services and force pflcesup When prices flse. the purchaSing power ofmoney falls To keep purchaSing power strong,then, the supply of money must not Increase toorapidly

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TIleGovwnment reducnman.,'. v.SUe byprlnUng toomuctl currency.The Bureau of Engraving an d Prinllng InWashinglon,O C , a unit of the Treasury.I! . responsible fo r printing the nahon's currencyBut its orders 10 print come from the '2Federal Reserve Banks, not the Presidentor Congress. The Reserve Banks, not IheTreasury, delermlne how much currency ISprinted. based mainly on estimates of commercialbank a nd p u bl ic cash demands Under thisarrangement. the Government can't punt moreFederal Reserve notes to pay its bIlls or debts.Since most U.S money IS checkbook money, theprinting presses have liltle 10 do with thebuying power of money. Maintaining money'svalue involves Ih e Federal Reserve's control overcommerCial banks that create most checkbookbalances.The Federal Reserve does this in three waysFlfst, the Federal Reserve Act requirescommercial banks that are members of theSystem to keep "reserves" as COin and currencyin their vaults or balances at their districtReserve Bank. By ralsmg the percentage ofreserves thaI must be held, Ihe Federal Reservereduces banks' ability to create more moneyLowering reserve requirements increases banks'money creating ability.

Second. the Federal Reserve lends money.generll fly for only a day or two, to banks thatbelong to the Federal Reserve System It chargesIhem inlerest, called the "dIscount rate ..Changes in th e Jtscounl rate have the effect ofmaking Federal Reserve loans more or lessattractive to member banks.The most important control IS open marketoperatlons-ouylnQ and selling U S Governmentsecurtties through a network of almost threedvzen privale dealer fIrms. When Ihe FederalReserve sells securities from lIs $100 billionpl'Jr!follo. dealers pay with checkbook money thatIS laken out of circulation when the checkbof)kfunds are transferred from the dealer's bank tothe Federal R e s ~ r v e . When the Federal Reservebuyt securifies. it pays with checKbook money,increasmQ money In Circulation

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,..-.---------_._._-_.._.__._-._-_._-----.--- - -CndIt card8 . . . . . , . . . form of money.Cre dIt ca rds aren 't a form of money, bu' a"de fe rred paym en t" dev ic e , a a' :lt am m ggOOds and services by prom lsm g 10 pa)' la le rCredIt ca rd tra nsactIons are sim ila r to lo ansWhen you use a cre d It card , Ihe C\tendmg yo u cred it for whIch you Will payInte rest after a short period M any peop le ,however, pay theIr cre dit ca rd bIlls with in themonth b il led and aVOId In terest chargesMany cred it ca rds carry a "credlt Im e," amaXimum am ount the Issuer WIll lend you. A$1,000 cre dIt line allows you to accum ula te$1.000 In unpaId purchases or cash advances.Cre dIt lmes are p rea rranged lo ans th at becomeeffe cti ve when used. an arrangem ent com m onlyused by la rge com panies.All bank le ndin g depends on th e availa bIl It y ofreserves whIch are de te rm ined by the FederalReserve When the supp ly of reserves.s small and cred.t card users d raw on th eircred it ltnes, banks have to reduce loans to othercustom ers Com m erc ia l banks a lo ne lent abou t$12 bIll Ion th rough credIt ca rds and simIlar p lansIn 1976, about 10 percen t of th elf loans toIndlY lduals that year

Even th ough cre dIt ca rds aren 't m oney. !h eyaffect 'he way we spend money and. in thatsense, arf3 Im port ant to understand ing people'spurchasing behav io rFor thiS reason, some econom is ts beheve lin es ofcredIt g Iven on credit cards should be countedas part of the natio n 's "m oney supply"-ate chn,ca l m easure of the funds the public hasavariabl3 for Im m ediate spending. They arg uethat many Im portant spendm g deciS ions arebased not lust on th e am ount of cash andcheckbook m uney have on hand, but onindiV iduals' ho ld Ings of financia l assets , such assavmgs depOSits, s tocks and bonds, as well asthe availabIli ty of credIt

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ca.au IIIOIMY.Checks aren't money in themselves. They are stmplyOfdel' forms instructing bank& to move checkbookdeposits, which are money, from one account toanother. Those checkbook depoSits are~ i n O entrie$, numbers on banks' ledgersand In their computers.BankS don't keep cash in "hecking accounts anddon', t ransfer currency or coin when act ing on acheck's instructions. Checkbook deposits aretransferred between accounts and banks asbookkeeplng entries only.tn 1917. the nation's 14,600 commercIal banksheld about 5230 billion of checkbook deposits forindividuals, businesses and governments.

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CIIeckbookmone, I . "created" hu currency...... -. .Commercial banks create checl


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811ftu .... pM of the GOHfftment.Manv banks carry very othclal-soundlng names,l ike "Bank of America" and 'State Bank ofAlbany," but they aren't run by, owned, or partof goverl"mentCommercIal bankS are prtv8lCly ownedb'JSlneSSes ,rYlng to earn profits prlmanlV bylending money 10 other bUSinesses and 10,"d,vlduals Don't get the wrong ImpreSSion fromthe government type sp.als on their WindowsBanks musl be Ircensed to operate The license,called a 'charter," IS gIven either by the FederalGovernment (Comptroller of Ihe Currency) or thegovernment of lhe state In which the bank wantsto operate Banks ChOOSing Federal charlers,about ona-thlrd of all commerCial banks,must have Ihe word "National" In their nr -"eor the leners'N A "(NatIonal ASSoclatlo:" afterthelf title Slate chartered banks dont have 10use the word" State" In their names. bu l many doBanks must meet government rules andregulallons Banks With Federal charters, forexample, must lOIn Ihe Federal Reserve System.the Independenl agency Congress created toregulate the nallon's flow 0' money and creditStste-chartered banks may lOin the FederalReserve, an optIon cl"osen by only 10 percent ofthe nation's 9,800 state-chartered banksSanks betongmg to the Federal Reserve maydisplay a seal on the1f rY'lQIfl wmdow md,catmQthey are a "member of the Federal ReserveSystem" Member banks are subject to manyFedsral Reserve regulatIons and can borrowmoney from Reserve SankS for short peflods tomeet unelCp.'9cted custonler Withdrawals or otherclaims exceedmg funds on hand FederalReserve membershIp doesn't make a bank a"member" ot the Federal Government

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Regardless of charter, banks can IGItl another"Federal" organ,za!:c:" the Federal DepOSItInsurance CorporatIon (FDIC) Congressestabltshed the FDIC In 1933 to Insure depositorsagainst losS when a bank lalls VIrtually all U ScommerCial banks are FDIC members Most havea seal on their main door or near tellers'WIndows mOleatlng that depOSits are Insured upto a ma)umum. which Congress sets, of $40.000~ e account But aga,n. thai "membershIp"doesn't mean the bank IS part of, run by, orowned by the GovernmentMost commercial banks ,n Ihls country are small,locally owned bUSinesses, wl1h no branches, lusta few employees, and only a few million dollarsof depOSits Relatively few commerCial banks arebIg busmesses With many branch offices andrhousands of employees These bIg banks.however, hold a relatively larger share 01 thebanking system's depOSits than the small banks,Concentraled mainly In maier Cities, these bIgbanks, like Chase Manhatlan and Chemical Bankm New York City, and Bank of America," SanFranCISco. are owned by S10ckhold1!ts Theirownership shares are bought and sold publicly onthe stock exchangesCommerCIal banks try to earn profrts forstockholders by lending money and by ,"vestingIn Federsl, state and local government secufltles.Most commercial bank loans are to businesseswhich need funds tor such purposes as buyingraw mateflals and moderniZing faclonesAlthough many of the largest banks aim most oftheir advertising at consumers. only about 52,50of eve,y $10 lenl by commercial banks are"consumer"'oans About $3,50 of every $10 lentare "commercial and Itldustrial" loans, Realestate loans take about $3, and loans to financialfirms. farmers, or others about $1 of every $10lent,

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BanIll .... 10 powerful they can flx Intareatrllt.. on loan. Ind depoaita and do Jual IboulwhaleVtll . . . . die, , . . . . . .Banks cannot do whatevor they please Theirmarketplace 'power" and their ability to " f ' ~ "mterest rales are hIghly restricted by overlappinglayers of laws and government rules andregulattons, and by a C ~ l v e competition amongbanks and other Imanctal institutionsThere are lour Federal agenClos that have bankregulatory responSibilities Federally charteredbanks are regulated by the C'Jmptrolier of theCurrency, part of the Treasury Department thatserves as the Federal Government's bankchartering agency Since all federally charteredbanks must belong to the Federal ReserveSystem, they are also sublect to the centralbank's rulesNonmember banks are regulated by both thecharterm9 stale government and the FederalDepoSit Insurance Corporallon In addllton, allbanks are sub/t"ctlO the authOrity of the JusticeDepartment. 11 the,r act,vIlles appear to Violateantitrust lawsThe hroad goal vI governmenl regulatIon ofbanks IS 10 safeguard the public's money bymaking sure banks are operahng prUdentlyFederal and state laws. for example, prohibitbanks from Investing In common stocks, and IImllthe maximum loan they can make to one borrowerFurthermore, banks cannot open new branches.merge WIth other banks. affiliate With otherbUSinesses, such as credit card companies. orchange bUSiness hours unless Ihe regUlatoryagencies say okay

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In recent years. regulators have focused on banklend109 and adverllslng practices Recentleglslallon, for example has aimed at ehminatlngraCial and seKual dlscflmmatlon In lending andrequIres that borrowers be mformed of theprecise conditions and terms of loansCommerCial banks must conform to Federal andstate laws on Interest charged on some loansand Interest paId on depOSits State 'usury" lawsset the legc.l Intere:;t rale IIlTHt on loans toIndIVIduals State governments also determInem a ) ( I f T l l H ~ rates on reSidential mortgage loansand maXimum rales Slate-chartered bankscan pay on Interest-earning (time) depOSitsIn 1933, Congress prOhibited ccrnmerclal banksfrom ~ a Y l n g Interest on checKmg account funds(demand depOSits) At the same lime, Congressgave rhe Federal Reserve power to sel ceIlingson whdt member commerCial banks could pay Inmterest on time depoSits Member banks.however, are limited to the maximum ratesestablished by the stales Since Ihe 19305. theFDIC's Interest rate ceilings have matched thoseImposed by the Federal Reserve and s,"ee 1912.so have all slate ceilings All commerCial banks.then, have the same Interest rate limitsCommerCIal banks. however. do not chargethe same rates for stmllar loans or pay the samerates for Similar depOSits. CommerCial banksactively compete against each other and against'thflft InslltutiOns" - savings banks. savings andloan aSSOCiations and credit unions-fordepOSits and many types of loans.i l lS not uncommon for banks In the same areato have different automObile, home Improvementor mortgage loan rates, diNerent rates on savingsand time depOSits and different charges forf,nanClal servlces.lSuch as money orders,personalized checks. and cheCking accounts

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AU . . . . . . .,. . tile ame."SavIngs" and "commercIal" banks dIffer In manyrespects First, they have dIfferent corporateforms Savings banks are "mutually" owned bydepositors, not stockholders They are run bynonsalaned boards of trustees, not corporatedtrectors EarnIngs aren't paId to private ownersas diVIdends but dlstnbuted to depositors asmterest on savmgsSavings banks collecllndlvlduals' savIngsand channel those funds mainly Intohome mortgd(]eS CommercIal banks lakedemand deposlls and make profIts by lendIngand investingThe ability of Ih"'t InstitutIOns to lend money formortgages IS !Inked te depoSItors' savmgsbehavior Many people depoCilt money In thnftInSlltutlons because they o11er a nood Inlerestrelurn on savings However, whe.l mterest ratesflse 10 the natIon's credIt markets. better returnsof len can be obtained by puttIng savingselsewhere Fewer depOSIts mean fewermortgages, and fewer morlgages generally leadto less home bUIlding and more unemploymenl inme construction Irades In addItIOn, manytnduSlfles that depend on a strong housmgmarket, such as furnIture and appliance makers,also suffer from reduced sales,tn the 19605, Congress established furtherdistinction between savings banks andcomm"rClal banks by allowtng thrift mslltulions topay savings depositors a rate above the cellmgffTlposed on commercial banks, ThiS small ratedifferential was designed to keep thrift depOSitinflows strong enough to buttress the mortgageand housmg markets.

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One entlcal difference between savings andcommerCial banks traditIonally has been in theway they lend money Commercial banks lend bycreating new checkbook deposits Savingsbanks and Similar thrift institutIons Simply payouteXlstmg funds lefl by depOSitors.In recent years, many states, particularly in theNor!heast, have changed thelf laws to liftreslrlctlons confining thrift ,"st,tutlon operationsmainly 10 acceptIng savtngs depOSits andgrantmg mortgages Thnfts In more than 20stales can now prOVide some form ofcheckbook-type accountMosl of these accounts, however, don't holdnewly created checkbook money. but rather thesavings that depOSitors have transferred intothem to pay bIlls. These accounts comprise onlya fracflon of the nation's total checkbook deposits.If thrift lnstitutions obtain broadj;1r powers tomake loans other than long-term mortgages, theyundoubtedly would begin creating money inmuch the same way as their commercial bankcounterparts, by adding new deposit dollars tochecking accounts. For now, most thriftinstitutions payout loans with special checksagainst funds on hand. or funds deposited at acommercial bank, not by creating new demanddeposits.

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. . . . . . . benId"l ..........tIbIJIMcI tM, ............ Mel aontrollftOftllUy poUoy.In 1913, the most vocal opposition to the FederalReserve came from the Wan Street bankingcommunity. In part. that opposition stemmed tromthe intent of Congress to establish the FederalReserve with built in "checks and balances"specIfically to insure that monetary policy-makingwould be decentraltzed and made in thebroad national interest The System's structure.organization and relationship to Congress make itimpossible for any interest group to domInatemonetary policy.The Federal Reserve System ~ o n s i s r s of rhreeinterlocking parts - a seven-member.Washington-based Board of Governors. 12regional Reserve Banks. and 5.600membercommercial banks.The Board of Governors IS a Governmentagency- Each Governor.$ appointed to a 14-yearterm by the Presidenr of the U.S. with the adviceand consent of the Senate. Terms are staggeredfor an appointment every two years. By law.Governors must come from dIfferent regions ofthe country. and "fair representation" must begiven to financial. agricultural. industrial andcommercial Interests in their selection. Only twoof the present Governors have Substantivebanking experience. Four are economists andone was a corporation presiden,.

The 12 regional Reserve Banks aren'tGovernment institutions but corporationsnominally "owned" by member commercialbanks. who must buy special. nonmarketablestock in their district Federal Reserve Bank. EachReserve Bank has nine directors, each ofwhom serves three-year staggered terms. Asstockholders, member banks elect the majority ofthe directors (six) but only three bankers canserve on a board.The Federal Reserve Act requires that threedirectors of each Reserve Bank bp appointed bythe Board of Governors. They may not bebankers. Of the six elected directors, three must,by law. be actively engaged In somecommercial. agricultural or industrial lob. TheFederal Reserve Act also prohibits the six"nonbanking" directors from being affiliatedwith a bank in any way. Thus. the nominal"owners" of the Reserve Banks, theprivate member commercial banks. have onlythree of the nine directors' seats at eachReserve Bank.Moreover. the three banking directors must berepresentative of the entire banking industry. notjust the big banks. Member commercial banksvote for their directors according to size.with small, medium and farge banks each electingone banking director. Thus, the most powerfulbanks cannot dominate the banking directors.In the 1970&. the New York Reserve Bank'sdirectors have included chairmen and presidentsof corporations and banks throughout the NewYork Federal Reserve District SUt educators.a civil r ights activist. law firm partners. and thepresident of a philanthropic organization alsohave been recent New York Reserve Bankdirectors.

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Reserve Bank directors appoint Reserve Bank FOMC decisions aren't secret. A summary of the


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presldcrll5. who serve W l t ~ l the Board ofGovernors on the Syslern's key policy-makingbody. the Federal Open Markel Commillee(FOMC) Directors' appointments of presidents.however. must be approvecj by the Board ofGovernorsTt10 FOMC, which meels monthly In Washington,DC 10 decide the course of monetary polley,consists of all seven Governors and live ReserveBank presidents, four of whom serve one-yearterms on a rotalmg basIs The president of lheNew York Reserve Bank, who traditionallyserves as FOMC vice chairman. IS !he onlyReserve Bank president who serves as apermanent Committee member

deliberations and record of policy actions aremade public about 30 days after each meeting.A record of the vote of each member of the ..Commillee appears after the formal policydecision, called the "directive." Dissenting votesare recorded with the reasons for the dissent.The 30-day delay is designed to avoid creatingexcessive reactions to policy moves that mighthinder the functioning of markets and the orderlyimplementation of policy decisions.What's more. the chairman of the FederalReserve Board of Governors formally reports toCongress every three months on the course ofmonetary policy and the Federal Reserve'slong-term objectives. In addition, SystemGovernors routinely testify on key economic andbanking issues before House and Senatecommillees.The Federal Reserve is unique among Igovernment-type institutions in that it is"independent" within the Federal Government.Congress specifically structured the FederalReserve so that monetary policy judgments andactions would be made nonpolitically. The14-year term .ur System Governors is anexample of that intent.

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TIle . . . . . . . "..... c:onIrola the I8ICMIftt of .curNllCf IncJrcuIatIoLThe Federal Reserve doesn't control the amoYntof "cuffency" in circulation. The p u ~ i c does. TheFederel Reserve. however. determines the totalamount of "money" in Circulation.When people want mors currency, they cashchecks at their banks. When banks want morecurrency, they purchase it from their ReserveBank with the checkbook money they have ondeposit as part of their required reseNes. Sincecurrency in circulation increases only whenc h e c k ~ deposits dedine, the total amount ofmoney remains unchanged. Only the compositionof the money supply changes when the p U ~ i catters the form in which it holds money balances.The pub!ic has shown, O\l&r the years. a verystrong preference tor checkbook money overcash. At particular times of the year, however,such as in December, thjs long-term preferencesmfts CS8Ctdedfy toward cash, and more than $2bitlion in currency and COlO leave the bankingsystem. In January, demand shifts back tocheckbook money. and cash returns to thebanking system.The Federal Reserve doesn', try to alter publicpreferences. but accommodates them by sellingcurrency to banks to meet public demands andaccepting currency deposits to reserve accounts.. demands slacken.

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. . 1M clllOOUftt nile and lind functe I t . . . . . . . , . . . to lUlU profit.Bantes can't borrow money 'rom the FederalReserve to lend at a higher rate, even if theywant to. The Federal Reserve. not commerCialbanks determines the rules for borrowing at thediscount rate. These rules restrict borrowing tosnortrun, temporary. seasonal or emergencyneeds, Banks that borrow too mUCh, too often,for too long, or for the wrong reasons, will soonhear from the Federal Reserve. Because banksknow the rules and understand the FederalReserve's fundamental central bank '9'e as a"lender of last resort," they rarely try to abusethe borrowing privilege.Commercial banks get the reserves that supporttheir loans and investments by attractingindividual and corporate funds with interestpayments on time deposIts, by borrowingreserves from other banks. or by selling assets,such as Government securities.When the Federal Reserve was established, theworldngs of the economy weren't as wellunderstood as today. In those days. banks couldreadily replenish the funds they lent to farmersand to buSinesses engaged in buying rawmaterials and manufacturing finished goods byborrowing from the Federal Reserve. Economictheory indicated that. since "commerCiallcans"helpt.d lncrea58 production and create morejObs, accom"'Odating banks would help feedeconomic expansion. To encourage the additionaltending and spending that would generateupansion, the discount rate would be reduced.

...To dlseourage lending, the rate would be raised.Today, the Federal Reserve no longer fOltow8 the"commercial loan theory" of discount lending.lending at the discount rate is now used as a"safety valve" that provides funds to individualbanks onty when necessary.

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