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Federal Reserve System
Purposes and functions

Board of Governors
W ashington, D.C. Septem ber 1974

F irst E ditio n — M ay 1939
S econd E ditio n — N o v e m b e r 1947
T hird E d itio n — A pril 1954
F o urth E ditio n — F ebr u a r y 1961
F if t h E d itio n — D e c e m b e r 1963
S ixth E d itio n — S e p t e m b e r 1974

Library of Congress Catalog Card Number 39-26719

P rice
Copies of this book may be obtained from Publications
Services, Division of Administrative Services, Board of
Governors of the Federal Reserve System, Washington, D.C.
20551. The price is $1.00 per copy; in quantities of 10 or
more sent to one address, 75 cents each. Remittances should
be made payable to the order of the Board of Governors
of the Federal Reserve System in a form collectible at par
in U.S. currency. (Stamps and coupons not accepted.)

“Preface

The book, The Federal Reserve System— Purposes and Functions,
has been completely rewritten for this, the sixth, edition. The revision
has attempted to present a concise, up-dated account of the responsi
bilities and operating techniques of the System in the areas of mone
tary policy, banking and financial regulation, and international finance.
While primarily a handbook of operations, the revision also in
cludes some description of economic relationships, market structure,
and the theoretical underpinnings of central banking, so as to provide
the general reader with a better understanding of the role of the
Federal Reserve in the Nation’s economic and financial system. Many
economic and financial texts, of course, are available to the student
requiring a more elaborate economic background.
Stephen H. Axilrod, Adviser to the Board in the Office of Man
aging Director for Research and Economic Policy, was primarily
responsible for the planning and preparation of the text. The actual
writing was a collaborative effort of many members of the staff.
In the area of domestic monetary policy and regulation, Peter M.
Keir, Adviser, Division of Research and Statistics, was the principal
author, and Richard Puckett, Senior Economist in the Banking Sec
tion in the Division of Research and Statistics made a major contri
bution. The discussion of the Federal Reserve balance sheet and bank
reserves was the principal responsibility of Helmut F. Wendel,
Assistant Adviser, and Raymond Lombra, Economist, Government
Finance Section, in the Division of Research and Statistics.
Principal contributors to the chapter on the Federal Reserve in the
international sphere were Arthur B. Hersey, formerly Senior Adviser,
Division of International Finance, and Ralph C. Bryant, Director of
that Division.

The chapter on banking supervision and regulation was authored
mainly by Samuel Talley, Senior Economist, Financial Structure Sec
tion, Division of Research and Statistics. Brenton C. Leavitt, Direc
tor, Division of Banking Supervision and Regulation, and Robert J.
Lawrence, Associate Adviser, Division of Research and Statistics,
carefully reviewed the draft of that chapter. Discussion of the orga
nization of the Federal Reserve System was mainly the responsibility
of Normand R. V. Bernard, Assistant Secretary, Office of the Secre
tary.
Ralph A. Young served as consultant to the Board to help provide
substantive editing of text in the preparation of the first draft. Eliza
beth B. Sette, Chief of the Economic Editing Unit, Division of Re
search and Statistics edited the final manuscript and coordinated all
phases of the publication process. Barry Huber was primarily respon
sible for the graphic design.

J. Charles Partee,
Managing Director,
Office of Managing Director
for Research and Economic Policy

Table of Gontents

QTapter Oije
MONETARY POLICY AND THE ECONOMY

ROLE OF THE FEDERAL RESERVE IN
GOVERNMENT

MONETARY POLICY AND THE ECONOMY

Financial effects of policy actions ___

Impacts on economic a c t i v i t y __________________________

Financial guides for monetary policy _______

QTapter TWd
STRUCTURE OF THE FEDERAL RESERVE
SYSTEM

BOARD OF GOVERNORS

FEDERAL OPEN MARKET COMMITTEE

FEDERAL RESERVE BANKS

FEDERAL ADVISORY COUNCIL

OTHER AD VISOR Y COM MI T TEES

MEMBER BANKS

Obligations ___________________________________________ 20
Benefits of membership ________________________________ 20
FISCAL AGENCY FUNCTIONS

QTapter Three
FEDERAL RESERVE OPERATIONS AND
COMMERCIAL BANK RESERVES

CONSOLIDATED BALANCE SHEET OF THE
RESERVE BANKS

Major asset accounts ___________________________________27
Major liability accounts ________________________________ 32
Capital accounts _______________________________________ 34
BANK RESERVE EQUATION

Major factors in the equation ___________________________ 38
Sources s i d e ____________________________________

Uses s i d e _____________________________________________ 42

QTapter T o u t'
INSTRUMENTS OF MONETARY POLICY:
OPEN MARKET OPERATIONS

ROLE OF SECURITIES MARKETS

CONDUCT OF OPEN MARKET OPERATIONS

Organizational arrangements ____________

Policy process ______________

Materials for policy-making _______ ___________________ 58
Manager's operating techniques ________

OPEN MARKET OPERATIONS AND TREASURY
FINANCINGS

Qtapter^Five
OTHER INSTRUMENTS OF MONETARY
POLICY

OPERATION OF RESERVE BANK DISCOUNT
WINDOW

Mechanics of borrowing ______________________________ _ 70
Adjustment c r e d it _____________________________________ 71
Seasonal borrowing privilege ______ ________ ___________ 73
Emergency c r e d it ______________________________________ 74
Discount r a t e _________________________________________ 75
Coordination of discount and open market operations ___ 77
CHANGES IN RESERVE REQUIREMENTS

Use as a policy instrument _____________________________ 79
Structure of reserve requirements ____________

CEILING INTEREST RATES ON TIME DEPOSITS

MARGIN REQUIREMENTS

SELECTIVE CREDIT CONTROLS

Q ia p terS ix
THE FEDERAL RESERVE IN THE
INTERNATIONAL SPHERE

MONETARY POLICY AND INTERNATIONAL
ECONOMIC DEVELOPMENTS
INTERNATIONAL RESERVE TRANSACTIONS

92
94

Ownership and management of international
reserve assets _______________________________________ 95
Reserve transactions with foreign central b a n k s ___

Qjiapter S ix -Continued
FOREIGN CURRENCY OPERATIONS

100

“Swap” n e tw o rk ______________________________________ 100
Drawings by foreign central banks ____________________ 102
Drawings by the Federal Reserve _____________________ 103
REGULATION OF FOREIGN OPERATIONS OF
U.S. BANKS

104

Special reserve requirements against foreign borrowing
by member b a n k s ______________________________ _ _ 105
Voluntary Foreign Credit Restraint (VFCR) __________ 106

Qiapter Severi
BANK REGULATORY AND SUPERVISORY
FUNCTIONS
BANK REGULATION AND SUPERVISION

107
107

Federal supervisory structure __________________________ 108
Scope of Federal Reserve supervisory functions ________ 109
BANK HOLDING COMPANY RESPONSIBILITIES

110

Bank acquisitions _____________________________________ 112
Nonbanking acquisitions ______________
BANK MERGER RESPONSIBILITIES

113
115

RESPONSIBILITIES FOR MEMBER BANKS’
IN TERN A TIONAL OPERA TIONS

116

RESPONSIBILITIES FOR TRUTH IN CONSUMER
LENDING

118

illustrative N{atefials

Page
Measures of Money Stock— December 1973 ________________ 10
The Federal Reserve System— Organization __________ _ _ _

Checks Handled by Reserve B a n k s ________________________21
Disposition of Federal Reserve Bank Earnings _____________

Bank Reserve Equation:
Annual Averages, 1940-73 _______________

Weekly Averages, January-June, 1973 _______________

Currency in Circulation— Weekly ____________ _____________

The Federal Reserve System— Relation to Instruments
of Credit P o lic y ________________________________________50
Selected Interest Rates, and Member Bank Borrowings _______

Deposit Growth at Thrift Institutions, and Selected
Interest Rates __________________________________________ 84
Margin Requirements and Related I te m s _____________________ 88
U.S. Balance of P aym ents_________________________________ 93
U.S. Reserve Assets ____________________________________

Foreign Reserve Assets in the United States _________ _______

Exchange Rates _________________________ ______________ _ 101

Tables
Statement of Condition of the Federal Reserve Banks,
Wednesday, May 16, 1973 _____________________ ______
Bank Reserve E q u a tio n _________________________________ 37

Tables - Continued
A Simplified Example of Balance-Sheet Changes Induced
by Open Market O perations_____________________________ 44
Transactions of the System Open Market Account,
1972 and 1973 ____________________

Reserve Requirements on Deposits of Member Banks,
June 30, 1974 _________

Maximum Interest Rates Payable on Time and Savings Deposits
at Commercial Banks, June 30, 1974 ___________________

Number and Deposits of Registered Bank Holding Companies,
Selected Y e a r s ________________________________________ 111

Other
Map of the Federal Reserve System ______________________

Federal Open Market Committee (photograph) ____________

Trading Desk at the Federal Reserve Bank of New York
(photograph) __________________________________________ 56

oM onetary
^Policy and the
cEcon6hiy

The aim of this book is to explain briefly how the Federal Reserve
System fulfills its responsibilities in helping to achieve the Nation’s
economic and financial objectives. The System was established on
December 23, 1913, when President Woodrow Wilson signed the
Federal Reserve Act. As expressed by its founders, the original pur
poses of the System were to give the country an elastic currency, to
provide facilities for discounting commercial paper, and to improve
the supervision of banking.
From the outset, it was recognized that the original purposes of the
System were in fact aspects of broader U.S. economic and financial
objectives. Over the years, economic stability and growth, a high level
of employment, stability in the purchasing power of the dollar, and
reasonable balance in transactions with foreign countries have come
to be recognized as primary objectives of governmental economic
policy.
Such objectives have been articulated in many acts of Congress,
including particularly the Employment Act of 1946. And the structure
and functioning of the Federal Reserve System has been modified
over the years by amendments to the original Federal Reserve Act,
perhaps the most important of which were those set forth in the
Banking Act of 1935.

Purposes and Functions
The Federal Reserve contributes to attainment of the Nation’s eco
nomic and financial goals through its ability to influence the availabil
ity and the cost of money and credit in the economy. As the Nation’s
central bank, it attempts to ensure that money and credit growth over
the longer run is sufficient to provide a rising standard of living for
all of our people. In the short run the Federal Reserve seeks to adapt
its policies in an effort to combat deflationary or inflationary pressures
as they may arise. And as a lender of last resort, it has the responsi
bility for utilizing policy instruments available to it in an attempt to
forestall national liquidity crises and financial panics.
A sound financial structure is one essential ingredient of a growing
and prosperous economy. This being so, the Federal Reserve has also
been entrusted with many supervisory and regulatory functions. Among
others, it has responsibility for the amount of credit that may be used
for purchasing or carrying equity securities; it establishes the maxi
mum interest rates that commercial banks that are members of the
System may pay on savings and time deposits; it supervises Statechartered member banks, and regulates the foreign activities of all
U.S. banks; it is responsible for administering the laws that regulate
activities of bank holding companies; and it establishes the rules of
disclosure as to credit charges and repayment terms ( “truth in lend
ing” ) to which all lenders of consumer credit must adhere.

ROLE OF THE FEDERAL RESERVE IN
GOVERNMENT
Today most countries have institutions, commonly called central
banks, to perform functions broadly similar to those of the Federal
Reserve System. In England, for example, it is the Bank of England,
which has been in existence since the end of the 17th century; in
France, it is the Bank of France, established in 1800 by Napoleon I;
in Canada, it is the Bank of Canada, which began operations in 1935.
Central banks throughout the world have varying degrees of inde
pendence within their governments, depending on the economic, po
litical, and historical circumstances surrounding their establishment
and subsequent development.
Often it is said that the United States has an independent central
bank. This is true in the sense that decisions of the Federal Reserve

Monetary Policy and the Economy
do not have to be ratified by the President or one of his appointees in
the executive branch of the Government. But the Federal Reserve
must report to Congress, and thereby to the people as a whole, on its
policies. All appointments to the Board that governs the Federal Re
serve System are made by the President by and with the consent of
the Senate, and the President designates two members of the Board
to be the Chairman and Vice-Chairman, respectively. In view of these
circumstances and of the fact that the Federal Reserve works within
the framework of the over-all objectives of economic and financial
policy established by the Government, a more accurate description of
the System’s role is to characterize it as “independent within Govern
ment.”
In modern economies it is understood that central banks and other
instrumentalities of the Government will work together to encourage
economic growth and well-being and to combat inflationary and re
cessionary tendencies as they emerge. Inflation is a form of taxation
that falls on those least able to cope with it. Because the rising prices
of goods and services that characterize inflation mean that dollars can
buy less, the real value of savings held and of income earned by the
mass of our people is reduced. Moreover, in an inflation, speculative
excesses are encouraged; these excesses can divert resources away
from uses most productive to society and can lead to economic im
balances and recession.
Recessions, in contrast, result in extensive waste of both human
and economic resources because those who wish to work cannot find
gainful employment in a reasonable period of time. Standards of living
are depressed. In general, the Nation produces below its potential.
As it carries out its responsibilities, the Federal Reserve is in con
tinuous contact with other policy-making bodies of the Government.
The Chairman pf the Board of Governors represents the Federal
Reserve in policy discussions within the Government. He appears be
fore Congress— particularly before the Senate and House committees
dealing with banking and related matters, and the Joint Economic
Committee— to report on Federal Reserve policies, the System’s view
about the state of the economy, and other matters. He meets fre
quently with the President of the United States, and he often confers
with the Secretary of the Treasury. In addition, he participates, with
the Secretary of the Treasury, the Chairman of the Council of Eco
nomic Advisers, and the Director of the Office of Management and
Budget, in evaluations of economic conditions and objectives. The

Purposes and Functions
Chairman has also been called upon from time to time to serve on a
number of Government-wide policy bodies, including the Committee
on Interest and Dividends (as Chairman), the Cost of Living Council
(as Adviser), and the Emergency Loan Guarantee Board.
In addition to serving in areas of largely domestic operations, the
Chairman of the Board of Governors is a member of the National
Advisory Council on International Monetary and Financial Problems
of the U.S. Government, which includes the heads of other U.S. agen
cies that make foreign loans or engage in foreign financial transactions.
As a member of the U.S. delegation in key international conferences,
he sets forth the central bank’s view on matters of international finan
cial and economic policy. And in late 1972 he was appointed an
alternate governor of the International Monetary Fund.
Other members of the Board of Governors also participate actively
in governmental discussions. These include domestic and international
matters that cover issues ranging from the coordination of policies
with respect to ceiling rates of interest on time and savings deposits
as they affect banks and other thrift institutions to the formulation of
U.S. positions in international negotiations on such matters as reform
of the international monetary system. At scheduled intervals, the
Board as a whole meets with the Council of Economic Advisers.
Members of the Board’s staff, too, are in close touch with their
counterparts in the Government. A luncheon meeting with senior staff
of the Treasury is generally held each week; these luncheons are some
times attended by the Chairman of the Board of Governors or perhaps
another Board member and by the Under Secretary of the Treasury
for Monetary Affairs. There is also continuous, informal contact with
staffs of such agencies as the Office of Management and Budget and
the Council of Economic Advisers on relevant economic matters, and
with those of the Comptroller of the Currency, the Federal Deposit
Insurance Corporation, and the Federal Home Loan Bank Board on
relevant regulatory and legal matters.
The Federal Reserve has found that its continuing contacts within
the Government contribute to its ability to undertake monetary and
regulatory policies in the light of as accurate an assessment as possible
of the likely course of the many governmental and private policies
that affect the economy. For instance, governmental tax and expend
iture policies bear critically on economic performance, as does also
the Government’s policy regarding the exchange value of the dollar
internationally. Government credit policies that affect housing, small

Monetary Policy and the Economy
business, agriculture, or exports also influence the economy generally.
The wage and price policies of business enterprise clearly affect the
Nation’s economic well-being. And finally, economic activity depends
importantly on a multitude of other private and public decisions,
many of which are, in varying degrees, independent of monetary and
fiscal policies— related as they often are to such factors as the timing
of technological innovations, wars and other emergencies, and the
public’s mood and state of confidence. As this indicates, monetary
policy is only one of many influences affecting the economy.

MONETARY POLICY AND THE ECONOMY
The Federal Reserve System necessarily operates within the general
framework of national goals and objectives established within the
legislative and executive branches of Government. In the econom
ic sphere, the Federal Reserve helps to achieve the Nation’s economic
goals through its influence on the availability and cost of bank re
serves, bank credit, and money. As will be explained later, the central
bank can affect the availability of reserves to support bank deposits.
This is done through its open market operations— purchases and sales
for its own account of securities, mainly securities issued by the U.S.
Government— and by its authority to vary reserve requirements. In
addition, the discount rate set by Federal Reserve Banks, after review
and determination by the Board of Governors, directly affects the cost
of reserves borrowed by member banks from their Federal Reserve
Bank; and this cost, together with administrative rules governing
member bank access to Reserve Bank credit, affects the total amount
of such borrowing.

FINANCIAL EFFECTS OF POLICY ACTIONS
Changes in bank reserves influence, first, the ability of banks to
expand loans and investments, and as effects spread, conditions in
financial markets generally. For example, if the Federal Reserve adds
to member banks’ monetary reserves, the banks will generally seek to

Purposes and Functions
acquire new loans and investments, which will tend to exert downward
pressure on interest rates. At the same time that banks are buying
securities or making loans, they will be adding to the deposits of the
public. The public’s willingness to hold the deposits is, in turn,
influenced by the level of interest rates that is emerging in the market.
Monetary policy actions also affect financial institutions other than
banks, for as rates of interest on market instruments change, the pub
lic may seek to hold more or less of its savings at depositary institu
tions such as mutual savings banks and savings and loan associations.
At the same time mortgage and other long-term markets will be
affected as lenders and borrowers adjust to changes in the level of,
and outlook for, interest rates.
Monetary policy, however, is not the only influence on credit mar
kets. If the economy is expanding vigorously and demands for credit
are strong, interest rates will tend to rise, even though monetary policy
actions may be adding substantially to bank reserves. Under such
circumstances, the existing demands for credit, money, and bank
reserves will be exceeding the supply; and demands will be brought
into balance with supply through changes in the price of credit and
money— that is, through changes in the levels of interest rates.
Interest rates are also influenced by expectational factors. Attitudes
of investors and borrowers may be shaped by a variety of influences,
including the outlook for future business activity, the pace of techno
logical change, and interest rate developments in major markets abroad.
One of the most important expectational influences in recent years
has been attitudes toward inflation. In periods when the public has
expected significant future price increases, interest rates have gen
erally remained relatively high, or have risen. One reason for this is
that investors have demanded an inflation premium for making their
funds available in assets that carry a fixed rate of return. Another is
that borrowers have been willing to pay an interest rate premium for
the use of money if they believed that prices, incomes, and the costs
of real investments would continue to rise.

IMPACTS ON ECONOMIC ACTIVITY
Spending by various economic sectors and the levels of economic
activity are influenced by changes in credit conditions and financial

Monetary Policy and the Economy
liquidity induced in part by monetary policy. Businessmen’s decisions
to expand their investment in plant and equipment depend to a de
gree on interest rates. While prospective sales, profits, and wage costs
are key factors in such decisions, some businesses will postpone some
investment programs when interest costs for financing long-lived assets
rise relative to the prospective return on plant and equipment. Finan
cial conditions— the extent of business liquidity, the availability of
credit from banks and other sources, and short- and medium-term
interest rates— also affect the spending of businesses for working capi
tal assets, particularly for inventories.
Another sector that is highly sensitive to changes in credit condi
tions is the mortgage market, and through it, private spending for
construction purposes. For example, at times over the last decade or
so, homebuilding has appeared to bear an undue share of the burden
of credit restraint. Because borrowing costs are an important part of
the total ongoing costs of housing investment, changes in interest
rates and other mortgage terms naturally can be expected to have a
significant impact on the demand for housing. Since the mid-1960’s,
however, several episodes of credit restraint appear to have had a dis
proportionate influence on housing because of sharp declines in the
volume of funds available to prospective mortgage borrowers.
The availability of mortgage credit is strongly influenced by inflows
of funds to banks and other savings institutions, and these inflows are
very sensitive to the relationship between interest rates on market
instruments and interest rates offered on time and savings deposits.
Rates offered on such deposits tend to move sluggishly. On the up
side they are constrained by regulatory ceilings; the extent to which
these ceilings can be raised has been constrained because the interest
income on earning assets that these institutions hold changes relatively
slowly. As a result, inflows of savings to these institutions tend to
accelerate as market rates of interest fall and to decelerate as such
rates rise. Over time, however, institutional changes are reducing to
some degree the sensitivity of the supply of mortgage credit to changes
in monetary policy. These institutional changes include enhanced
Federal support to the mortgage market through the credit-supplying
activities of various housing agencies and increased marketings by sav
ings institutions of time certificates with relatively long maturities.
Spending on consumer goods, particularly durable goods bought
on credit, is also influenced by changing monetary and credit condi
tions. Instalment credit terms have an impact on decisions to buy

Purposes and Functions
autos, furniture, and other long-lasting products. The liquidity posi
tion of consumers also at times appears to influence their spending.
And there are indications that changes in the total value of financial
asset holdings— common stocks and bonds being the most volatile
elements— have an impact on the willingness of consumers to spend
for goods and services.
Thus, spending by private sectors of the economy— and to a de
gree also the capital expenditures of State and local governments—
is influenced by shifts in monetary policy. However, impacts on spend
ing occur only with some lag. It takes time for businesses to alter
their spending plans, and even more time for changes in plans to
affect actual outlays. In the housing market, to give another example,
changing credit and monetary conditions have an impact first on the
mortgage commitment policies of lending institutions, then on housing
starts, and ultimately on residential construction expenditures.
The length of these lags varies with economic conditions and with
the particular type of spending involved, but experience suggests that
a change in monetary policy ordinarily cannot be expected to begin
to affect economic activity significantly for about 6 months, with the
total cumulative effect spread over many more months. Sometimes
announcement and expectational effects may accelerate the impact of
such a change.
Experience also indicates that monetary policy affects the real out
put of goods and services sooner than it affects the average level of
wage rates and prices. The economy seems to adjust initially to
changes in monetary and credit conditions through changes in pro
duction and in buying plans. Effects on prices develop more slowly,
as wage negotiations and business pricing policies are adjusted be
latedly to changes in the level of resource utilization, to past changes
in costs and prices, and to other factors.

FINANCIAL GUIDES FOR MONETARY POLICY
Since the instruments of monetary policy affect conditions in a
wide range of financial markets, and since the impact of policy is felt
more rapidly and directly in financial markets than in over-all mar
kets for goods and services, it is important to decide which aspects
of financial conditions should be taken as principal guides in judging

Monetary Policy and the Economy
whether monetary policy at any moment is correctly attuned to its
ultimate objectives. There has been a continuing debate about this for
a number of years both inside and outside the Federal Reserve System.
Some have advocated interest rates as the principal guide for mone
tary policy in the belief that an interest rate guide can be related
more dependably to current and prospective expenditures by key
sectors of the economy, and hence to the ultimate economic objectives
of full employment, reasonable price stability, and international com
petitiveness. Others have advocated growth in one or more measures
of the money stock, since they believe that control of the money stock
will more surely and predictably lead to the over-all economic effects
that are desired. Still others have taken an eclectic position; they be
lieve that no one financial variable can or should be taken as a unique
guide to monetary policy in view of the complexity of the economy,
the wide variety of financial influences on spending, and the changing
— sometimes rapidly changing— attitudes of businessmen, investors,
and consumers toward spending and liquidity.
In recent years the Federal Reserve has been placing somewhat
more emphasis than it did earlier on monetary aggregates, including
the money stock, as a guide in its monetary policy actions. But the
Federal Reserve has recognized— in line with the eclectic view taken
by most people who have had to deal with monetary problems around
the world— that judgments must continuously be made as to the
appropriateness of over-all financial conditions, including interest
rates, the liquidity positions of institutions and the public, and the
psychological factors affecting the flow of credit. In addition, as the
Nation’s central bank, the Federal Reserve must be well aware of its
role as lender of last resort, because it is of critical importance to the
health of the economy that financial panics and disorders be averted.
An emphasis on monetary aggregates— for example, an effort
to maintain a generally moderate growth in the money stock— has
the advantage of providing a built-in adjustment for unexpected and
undesired shifts in the demand for goods and services. If the money
stock were kept growing at a predetermined pace, interest rates would
rise if demands for goods and services turned out to be excessive
relative to the available supply of real resources. This rise in interest
rates would, in turn, tend to dampen excessive demands. Conversely,
with a given rate of monetary growth, interest rates would decline if
demands for goods and services proved to be weak relative to eco
nomic objectives.

Purposes and Functions
An approach that places heavy emphasis on desired and actual
rates of growth of the money stock as a policy guide, nevertheless,
poses a number of problems— some practical and some theoretical.
For one thing, it is not clear how best to define money. For another,
past experience fails to give clear guidance as to optimal rates of
growth of money.
Economists have not been able to agree on the best definition of
money. The Federal Reserve publishes three definitions, and it takes
all of them into account in evaluating policy. The three measures
are: (a) money narrowly defined (A/,) encompassing only currency
and demand deposits held by the nonbank public; (b) money more
broadly defined (AT.) including also time and savings deposits at
banks, other than large negotiable time certificates of deposit (CD’s);
CHART 1
MEASURES OF MONEY STOCK - December 1973
Billions of dollars 1000

M x: Averages of daily figures for (1) demand deposits of commercial banks other than
domestic interbank and U.S. Govt., less cash items in process of collection and F.R. float;
(2) foreign demand balances at F.R. Banks; and (3) currency outside the Treasury, F.R.
Banks, and vaults of commercial banks.
M „: Averages of daily figures for M, plus savings deposits, time deposits open account,
and time certificates other than negotiable CD’s of $100,000 of large weekly reporting banks.
M 3: M„ plus the average of the beginning- and end-of-month figures for deposits of mutual
savings banks and for savings capital of savings and loan associations.

Monetary Policy and the Economy
and (c) a broader definition (M 3), including as well savings deposits
at mutual savings banks and savings and loan associations. Clearly, a
still broader definition that has economic meaning would encompass
other liquid assets, such as large negotiable time CD’s, U.S. savings
bonds and Treasury bills, and prime commercial paper.
The important point is that there are many assets closely related to
cash, and that the public can readily switch between cash and these
other liquid assets. Much of the time, switches are in response to
changing interest rate differentials. At other times though, the switches
may reflect a growing awareness of ways to increase current income,
or they may simply reflect shifting attitudes of the public. For exam
ple, over the post-World-War-II period corporations have become
increasingly aggressive in managing their cash positions, with a view
to maximizing interest earnings. Shifting preferences for money
as variously defined and between money and other financial assets,
however prompted, have at times complicated the already difficult
task of determining how much of an increase in money would most
likely be consistent with maintenance of high employment and rea
sonable price stability.
Those who advocate the behavior of interest rates as a principal
guide to policy do so partly because changes in interest rates can have
more clearly definable economic results and partly on the grounds that
no one can be certain just how strong demands for cash and near-cash
liquidity will be relative to income. With interest rates as a guide,
any sudden shift toward greater demands for liquidity for a given
level of income— because of either domestic or international uncer
tainties— would lead the Federal Reserve to provide more bank re
serves. If the System did not provide the reserves, interest rates would
rise as the public sold marketable assets in an effort to obtain cash.
And in that event the rise in interest rates would tend to hold eco
nomic activity below desired levels.
Monetary policy decisions inevitably involve a joint consideration
of conditions affecting demands for goods and services and those
influencing demands for cash and liquidity. How the instruments of
monetary policy are used, adapted, and coordinated in light of these
decisions and to achieve policy objectives is discussed in Chapters
4 and 5.
Before that discussion, however, there are two chapters describing
first, the organization of the Federal Reserve System and the services

Purposes and Functions
it provides to the member banks, and second, the statement of con
dition of the Federal Reserve Banks and the variety of factors
(including System actions) that influence bank reserves. The sixth
chapter discusses the operations of the Federal Reserve in the inter
national sphere. The final chapter deals with the Federal Reserve’s
regulatory and supervisory functions.
□

Structure of the
T ederal Reserve
System
QTapter Twd

The Federal Reserve System is a relatively complex organization.
Its principal components, in addition to the roughly 5,800 banks that
were members in mid-1974, are three bodies that have responsibility
for making and executing monetary policy. These three are the Board
of Governors, the Federal Open Market Committee, and the Federal
Reserve Banks. Their main responsibility is to regulate the flow of
credit and money, but they also perform important supervisory and
service functions for the public, the U.S. Treasury, and the commer
cial banks.

BOARD OF GOVERNORS
The apex of the Federal Reserve’s organization is the Board of
Governors in Washington. The Board’s prime function involves the
formulation of monetary policy. In addition the Board has broad
supervisory and regulatory responsibilities over the activities of com
mercial banks and the operations of the Federal Reserve Banks.

Purposes and Functions
As noted below, the members of the Board constitute a majority
of the Federal Open Market Committee, which is the most important
policy-making body in the monetary area. In addition to functioning
as a part of the Open Market Committee, the Board establishes the
reserve requirements for member banks, reviews and approves dis
count rate actions of the Federal Reserve Banks, issues regulations
governing the administration of the discount window at those Banks,
establishes ceiling rates of interest that member banks may pay on
time and savings deposits, and sets margin requirements on credit
purchases in the stock market.
The Board also has broad supervisory and regulatory responsibil
ities over the activities of member banks, including their foreign
activities, and the operations of the Federal Reserve Banks. It also
administers the law that regulates activities of bank holding companies.
The Board is an agency of the Federal Government. It consists of
seven members appointed by the President of the United States and
confirmed by the U.S. Senate. Board members are appointed for terms
of 14 years, and their terms are so arranged that one expires every 2
years. A member may not be reappointed after having served a full
term. The Chairman and Vice Chairman of the Board are named by
the President of the United States from among the Board members
for 4-year terms and may be redesignated.
The Board submits an annual report to the Congress, and it makes
available detailed statistics and other information relating to the Sys
tem’s activities through a variety of publications such as the monthly
Federal Reserve Bulletin. Expenses incurred by the Board in carrying
out its duties are not defrayed out of appropriated funds but are paid
out of assessments upon the Reserve Banks. Each year a public ac
counting firm of national prominence audits the Board’s accounts.

FEDERAL OPEN MARKET COMMITTEE
Open market operations are the principal instrument used by the
Federal Reserve to implement national monetary policy. According
to statute the Federal Open Market Committee (FOM C) is respon
sible for determining what transactions the Federal Reserve will con
duct in the open market. Through frequent buying and selling of U.S.

Structure of the System
Government securities, the securities of Federal agencies, or bankers
acceptances, the Manager of the System Open Market Account pro
vides or absorbs bank reserves in keeping with the instructions and
directives issued by the Committee. In addition to operations in the
domestic securities market, the FOMC authorizes and directs opera
tions in foreign exchange markets for major convertible currencies.
The membership of the FOMC comprises the seven members of
the Board of Governors and five Reserve Bank presidents, one of
whom is the president of the Federal Reserve Bank of New York.
The other Bank presidents serve 1-year terms on a rotating basis.
By statute, the Committee determines its own organization, and by
tradition it elects the Chairman of the Board of Governors to serve
as its Chairman and the president of the Federal Reserve Bank of
New York as its Vice Chairman. The Committee meets in the Board’s
offices in Washington every 4 or 5 weeks throughout the year.

FEDERAL RESERVE BANKS
The operations of the Federal Reserve System are conducted through
a nationwide network of 12 Federal Reserve Banks located in Boston,
New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago,
St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.
Branches of Reserve Banks have been established in 24 additional
cities, and the Federal Reserve also has other facilities around the
country, mainly for the purpose of clearing checks. The Board’s
offices in Washington are a headquarters-type facility, and no opera
tions are conducted from those offices. The boundaries of the 12
Federal Reserve districts and the locations of the various Reserve
Bank and branch offices are shown on the accompanying map.
Each Reserve Bank is an incorporated institution with its own
board of directors, consisting of nine members. As provided by law,
the Class A directors, who represent member banks, and the Class B
directors, who are engaged in pursuits other than banking, are elected
by the member banks in each Federal Reserve district. The Board
of Governors appoints the three Class C directors, and it designates
one of the three as Chairman and another as Deputy Chairman of
the Bank’s board. No Class B or Class C director may be an officer,

Purposes and Functions

Structure of the System
director, or employee of a bank; in addition, Class C directors are
prohibited from being stockholders of a bank. Each branch of a
Reserve Bank has its own board of directors of five or seven mem
bers. A majority (three or four, as the case may be) is appointed by
the head-office directors, and the others by the Board of Governors.
The directors of each Reserve Bank oversee the operations of their
Bank under the over-all supervision of the Board of Governors, and
they establish, subject to approval by the Board, the interest rates that
the Bank charges on short-term collateral loans to member banks and
on any loans that may be extended to nonmember institutions. The
directors appoint, and recommend the salaries of, the Bank’s president
and first vice president, subject to final approval by the Board.
Earnings of the Federal Reserve Banks are derived primarily from
interest received on their holdings of securities acquired through open
market operations and on their loans to member banks. Such earnings
go first to the payment of expenses (including assessments by the
Board of Governors to defray its expenses), the statutory 6 per cent
dividend on Federal Reserve stock required to be purchased by mem
ber banks, and any additions to surplus necessary to maintain each
Reserve Bank’s surplus equal to its paid-in capital stock. Remaining
earnings are then paid into the U.S. Treasury. More than 80 per cent
of the Reserve Banks’ earnings have been paid into the Treasury since
the Federal Reserve System was established. Should a Reserve Bank
be liquidated, its surplus— after all obligations had been met—would
become the property of the U.S. Government.

FEDERAL ADVISORY COUNCIL
The Federal Reserve Act provides for a Federal Advisory Council
consisting of one member from each Federal Reserve district. The
board of directors of each Bank annually selects one Council mem
ber, usually a prominent banker of the district. The Council is re
quired by law to meet in Washington at least four times a year. It
confers with the Board of Governors on economic and banking mat
ters and makes recommendations regarding the affairs of the Federal
Reserve System.

CHART 2
THE FEDERAL RESERVE SYSTEM - Organization

BOARD

FEDERAL RESERVE

BANKS

GOVERNORS

(12 Banks Operating
24 Branches)

(About 5,800)

FEDERAL
SEVEN MEMBERS
APPOINTED BY

OPEN MARKET
COMMITTEE

UNITED STATES
AND

MEMBERS
OF THE
BOARD OF
GOVERNORS

REPRESENTATIVES
OF F.R.BANKS

(7)

(5)

CONFIRMED BY
THE SENATE

Each Group Elects
One Class A and

3 Class A - Banking

THE PRESIDENT
OF THE

EACH BANK WITH
9 DIRECTORS

MEMBER

3 Class B - Business
► - 3 Class C - Public

One Class B
D irector in Each
F.R. District

DIRECTORS
Eaeh F.R. Bank

Approves Appointments and Salaries

Appoint
Approves Salaries

FEDERAL
ADVISORY

President
First Vice President
and
Other O fficers
and Employees

Large
About 600
Medium
About 2,100

COUNCIL
(12 Members)

Small
About 3,100

Purposes and Functions

Structure of the System

OTHER ADVISORY COMMITTEES
In dealing with many policy and operating problems that call
for a coordinated approach within a decentralized organization,
the System makes use of a number of conferences and commit
tees that help to reach an understanding on common problems.
Of these the most important are the Conferences of (1) the Chairmen,
(2) the Presidents, and (3) the First Vice Presidents of the Federal
Reserve Banks. The first of these Conferences meets at the Board’s
offices in Washington once or twice a year. The other Conferences
hold some of their meetings at other Federal Reserve offices; they
usually meet at least four times each year. Another important group
is the Advisory Committee on Truth in Lending; this Committee meets
from time to time, at the call of the Board. In addition, various
staff-level committees have been established that draw upon specialists
from around the System.

MEMBER BANKS
In mid-1974 about 5,800 commercial banks— out of a total of
some 14,000 in the country— were members of the Federal Reserve
System. These members accounted for 79 per cent of all bank de
posits, a proportion that has been declining since the late 1950’s.
National banks, which are chartered by the Comptroller of the
Currency, an official of the Department of the Treasury, are re
quired by law to be members of the System. Banks chartered by any
of the 50 States may elect to become members if they meet the re
quirements laid down by the Board of Governors. The member banks
own all of the stock of the Reserve Banks. However, ownership of
that stock, which is a legal requirement of membership, does not carry
with it the usual attributes of control and financial interest.
When banks join the Federal Reserve System, they become eligible
to use all of the System’s facilities. At the same time they undertake
to abide by certain rules, prescribed by law or developed by regula
tion in accordance with the law, for the protection of the public interest.

Purposes and Functions
OBLIGATIONS
Banks that become members of the Federal Reserve System must
assume several important obligations: They must maintain sufficient
monetary reserves to meet the requirements established by the Board
of Governors under the law; such reserves may be either deposits
at their Reserve Bank (such deposits do not draw interest) or cash
in their own vaults. They must remit at par for checks drawn against
them when presented by a Reserve Bank for payment. And they must
comply with various Federal laws, regulations, and conditions of
membership regarding the adequacy of capital, mergers with other
banking institutions, establishment of branches, relations with bank
holding companies, interlocking directorates, loan and investment
limitations, and other matters. If the member bank is chartered by a
State, it is subject to general supervision and examination by the
Federal Reserve System.

BENEFITS OF MEMBERSHIP
The privileges of membership in the System are several. For exam
ple, member banks may ( 1) borrow from the Federal Reserve Banks
when temporarily in need of additional funds, subject to criteria for
such borrowing (customarily called discounting) set by statute and
regulation; (2) use Federal Reserve facilities for collecting checks,
settling clearing balances, and transferring funds by wire to other
cities; (3) obtain currency as needed; (4) share in the informational
facilities provided by the System; and (5) participate in the election
of six of the nine directors of the Federal Reserve Bank for their
district. The terms and circumstances under which a member bank
may borrow from its Federal Reserve Bank are described in Chapter
5. Other Federal Reserve services provided for member banks are
described below.
The volume of checks handled by Federal Reserve Banks has grown
rapidly in recent years. In 1973 the Reserve Banks cleared about
10 billion of the estimated 26 billion checks drawn on banks in the
United States. Those checks not handled by the Federal Reserve are
cleared by local clearinghouse associations, by large correspondent

Structure of the System
CHART 3
CHECKS HANDLED BY RESERVE BANKS
Billions

NUMBER

Trillions

DOLLAR AMOUNT
10

Figures exclude checks of the U.S. Govt, and postal money orders.

banks, or by direct local exchange. Settlement among banks for these
check exchanges is often effected through the reserve accounts of
member banks.
To reduce the time required to clear checks through the check
collection system, the Federal Reserve has implemented a Regional
Check Processing Centers program. This program has resulted in the
establishment of Federal Reserve check-clearing offices in seven addi
tional locations, and in a sharp increase in the number of checks
cleared on an immediate-credit basis— from 19 per cent prior to the
program to 56 per cent by the end of 1973.
The expense and complexity of processing and transporting the
enormous volume of paper checks has prompted the banking indus
try to begin the establishment of a paperless electronic means of trans
ferring funds. The formation of automated clearing houses (ACH’s)
is one method that is being used to transfer funds without requiring
paper checks. These ACH’s make possible the exchange of payments
— such as for payrolls and dividends— through electronically processable media. The ACH computer processes the transfers, and these

Purposes and Functions
are delivered to recipient banks for posting to customer accounts. In
1973 the Federal Reserve operated three ACH’s.
The Federal Reserve also makes available to member banks a
computer-based communications system that can be used to transfer
funds from one part of the country to another swiftly and efficiently.
All such transfers are made through debits or credits to member
bank reserve accounts held at the Reserve Banks. Funds transferred
on this network are immediately available to the receiving member
bank upon receipt of an advice. Member banks may also use the com
munications system to transfer funds to and from specific customer
accounts by providing the necessary information in the transfer
request. The System’s communications facilities permit member banks
to lend their excess reserves to banks that are experiencing temporary
reserve deficiencies. The market that brings banks together in such
transactions is called the Federal funds market.
The System’s communications facilities may also be used to trans
fer marketable Government securities. Trading in these issues is very
active, and transfer of ownership typically involves large-denomina
tion certificates payable to bearer; in many instances such securities
are held in the Reserve Banks for safekeeping. Serious problems
may be encountered from time to time in the physical transfer of such
securities between banks and dealers and between dealers and other
investors and in the storage of these securities. To help resolve such
problems, the Federal Reserve Banks and the Treasury have instituted
a computerized book-entry system by which ownership of U.S. Treas
ury and certain Federal agency securities is recorded on the books of
the Federal Reserve Banks, and transfers may be effected without the
necessity of transporting the securities. Use of the Federal Reserve’s
communications system in combination with the book-entry system
provides an efficient and secure method of transferring owner
ship of Government and agency securities and for making interest
payments.
In addition, the Reserve Banks provide facilities in which member
banks may deposit certain noncash items for collection, such as notes,
drafts, warrants, coupons, and bonds.
Virtually all paper currency and coin moves into and out of circu
lation through the Federal Reserve Banks. Sometimes (for example,
before a major holiday), banks are called on to pay out more cash
than they receive; at other times (for example, after such a holiday),
they receive more cash than they pay out. When member banks have

Structure of the System
to replenish their cash supply, they order currency and coin from
their Reserve Bank and have their reserve accounts charged. On the
other hand, when currency on hand exceeds prospective needs, the
member banks forward such excess to their Reserve Bank for credit
to their reserve accounts. Generally, the larger member banks service
the needs of nonmember banks for currency.
Nearly all of the Nation’s circulating currency— some 90 per cent
of it— is issued by the Federal Reserve Banks in the form of Federal
Reserve notes. All such notes are obligations of the U.S. Government
as well as of the Federal Reserve Banks and must be fully collateral
ized by Federal Reserve holdings of Government securities, gold
certificates, Special Drawing Rights certificates,1 or certain other types
of assets. Paper currency, including Federal Reserve notes, is pro
duced by the U.S. Treasury’s Bureau of Engraving and Printing in
Washington, D.C. New coins are struck at the Treasury’s Bureau of
the Mint facilities in Philadelphia, Denver, and San Francisco.
In addition to these services, the Federal Reserve provides— to
member banks and the public at large— a variety of informational
services, such as publications covering a wide range of local and
national financial and economic statistics and descriptive and analyti
cal materials relating to the Nation’s economy and the System’s activ
ities.

FISCAL AGENCY FUNCTIONS
In addition to their role in carrying out monetary and regulatory
policy and in providing services to ensure a smooth flow of money
and credit in the economy, the 12 Federal Reserve Banks act as the
Government’s principal fiscal agents. They hold Treasury checking
accounts, receive applications from the public for the purchase of
securities being sold by the U.S. Treasury, allot the securities among
bidders, deliver securities, collect payment from the buyers, redeem
securities, make wire-transfers of securities to other cities, make de
nominational exchanges of securities, pay interest coupons, and con
1For description see p. 29.

Purposes and Functions
duct transactions in the market for various Treasury accounts. Most
of these activities are under the general supervision of the Treasury,
which reimburses the Reserve Banks for most fiscal agency functions.
In addition, the Reserve Banks perform fiscal agency services in
connection with the financial activities of various Federal or Federally
sponsored credit agencies. They are reimbursed by the Treasury or
other Government agencies for much of the expense incurred. The
Federal Reserve Bank of New York also performs some fiscal agency
functions for foreign central banks and other foreign official and
international accounts, such as handling and safekeeping their invest
ments in Treasury and similar securities and holding part of their
gold stock under earmark custody for their account.

Operations and
Commercial g a n k
E^ser\€s
QTapter Three

Federal Reserve operations, as stated in Chapter 1, directly affect
member bank reserve positions, and this effect initiates a series of
financial responses through which policy influences the economy.
Thus, bank reserves can be said to be a fulcrum for the operation of
monetary policy.
This chapter explains the basic factors affecting member bank
reserves. Some factors, such as changes in the System’s holdings of
securities, are under the control of the Federal Reserve and they
reflect monetary policy actions, whereas others, such as changes in
the System’s gold certificate holdings or currency in circulation, re
spond to decisions made outside the Federal Reserve and thus do not
directly reflect monetary policy actions. A brief explanation of the
consolidated balance sheet of the Federal Reserve Banks and of what
is known as the “bank reserve equation” will illustrate how the vari
ous factors interact to determine the reserve position of the member
banks.

Purposes and Functions

CONSOLIDATED BALANCE SHEET
OF THE RESERVE BANKS
The consolidated balance sheet of the 12 Federal Reserve Banks
reflects a broad range of functions that these Banks perform. This
balance sheet, known as the statement of condition of the Federal
Reserve Banks, is one of the most complete statements of its
kind, and it is released every Thursday to show the condition of the
TABLE 1
STATEMENT OF CONDITION OF THE FEDERAL RESERVE BANKS
Wednesday, May 16, 1973*1

Millions of
dollars
1.
2.
3.
4.
5.

ASSETS
GOLD CERTIFICATE ACCOUNT
SPECIAL DRAWING RIGHTS CERTIFICATE ACCOUNT
Cash
LOANS
SECURITIES:
a. Bought outright
b. Held under repurchase agreement

6. CASH ITEMS IN PROCESS OF COLLECTION
7. Bank premises and other assets
Total assets

LIABILITIES
8. FEDERAL RESERVE NOTES
9. DEPOSITS:
a. Member bank reserves
b. U.S. Treasurer—General account
c. Foreign
d. Other
10. DEFERRED AVAILABILITY CASH ITEMS
11. Other liabilities, including accrued dividends
Total liabilities

10,303
400
316
2,445
76,386
1,467

10,530
739
102,586

59,156
27,631
4,925
333
644
7,189
894
100,772

CAPITAL ACCOUNTS
12. Capital paid in
13. Surplus
14. Other capital accounts
Total liabilities and capital accounts

815
793
206
102,586

Operations and Bank Reserves
Reserve Banks at the end of the preceding day.1 The statement then
appears in the Friday issue of principal daily newspapers of the
country, usually accompanied by explanatory comment.
The purpose of the consolidated balance sheet of the Federal
Reserve Banks is to provide an accounting summary of all phases of
Federal Reserve operations and to record in some detail the primary
uses of Federal Reserve credit. Inasmuch as the Nation’s demand
for money converges on commercial banks, especially the member
banks, and through them on the Reserve Banks, much can be learned
about current banking and financial trends by following changes in
the principal items of the statement from week to week.
The balance sheet in Table 1 is a condensed form of the state
ment for May 16, 1973.12 The most important items on it are printed
in capital letters. Explanation of the components provides both an
introduction to many important points made in other chapters and an
opportunity to mention some technical aspects of Federal Reserve
operations not otherwise dealt with.

MAJOR ASSET ACCOUNTS

1. Gold Certificate Account

The monetary gold stock of the United States consists of gold
held by the U.S. Treasury and gold in the Exchange Stabilization
Fund maintained by the Treasury. Most changes in the gold stock
result from purchases of gold from, or sales to, foreign monetary
authorities. Recently, however, the dollar value of the gold stock was
1 The Wednesday reporting date for the consolidated balance sheet ties in
with the accounting period of commercial banks that belong to the Federal Re
serve System. These banks operate on what is commonly referred to as a state
ment-week ending Wednesday—that is, one for the period Thursday through
Wednesday. The member banks use this accounting period to determine their
reserve position under the Federal Reserve regulations.
2As the purpose here is a general explanation of the balance sheet, some of
the less important components are not discussed. For a detailed review of all
items in the balance sheet readers may consult: G lo s s a r y : W e e k ly F e d e r a l
R e s e r v e S ta te m e n ts , Federal Reserve Bank of New York, September 1972,
23 pp.

Purposes and Functions
increased as a result of changes in the par value of the dollar, which
were legislated in 1972 and 1973. The result of these two changes was
an increase of $2.0 billion in the value of the U.S. gold stock. Major
changes in the country’s monetary gold stock are usually reflected, as
will be brought out below, in the Federal Reserve GOLD CERTIFI
CATE ACCOUNT.
Since 1934 the laws of the United States have prohibited the pub
lic circulation of either gold coin or gold certificates— paper money
that represents a claim on gold held by the Treasury. Nevertheless,
the Federal Reserve Banks may still own gold certificates. As of
May 16, 1973, the date in Table 1, their holdings amounted to $10.3
billion, and on June 30, 1974, they were $11.5 billion.3
The System’s gold certificate assets are increased whenever the
Treasury monetizes gold that it has purchased from foreign monetary
authorities or issues new gold certificates following an increase in
the par value of gold and thus in the value of the outstanding gold
stock. To see how changes in the gold certificate account affect the
consolidated balance sheet, assume that the Treasury buys $100
million of gold from a foreign monetary authority. The Treasury
will pay for the gold by drawing a check on its balance at the Reserve
Banks (item 9.b). Suppose the foreign government deposits this
check in a U.S. commercial bank. When the commercial bank collects
this check, there will be a $100 million increase in member bank
reserve deposits (9.a). In order to replenish its cash balance, the
Treasury issues $100 million of gold certificates to the Reserve Banks,
which in turn credit $100 million to the Treasury’s balance with them
(9.b). This pair of transactions will result in an increase of $100 mil
lion on both the assets side and the liabilities side of the Reserve
Banks’ balance sheet.
If $100 million of gold certificates are issued by the Treasury to
the Reserve Banks in consequence of an increase in the official price

3 Gold certificate holdings serve as reserve assets for inter-district settlements.
Inter-regional payments involve shifts in deposit accounts of member banks and
of the Treasury at individual Reserve Banks, and final settlements are accom
plished by the transfer of gold certificate credits from one Reserve Bank to
another.
On Aug. 15, 1974, the President signed a bill that amends the Par Value
Modification Act and that authorizes U.S. citizens to own, buy, or sell gold as
of Dec. 31, 1974 (or at any time prior to that date if the President finds and
reports to Congress that the private ownership of gold would not adversely
affect the U.S. international monetary position).

Operations and Bank Reserves
of gold, the gold certificate account will be increased by that amount
and the Treasury’s balance at Reserve Banks will be credited initially.
However, member bank reserves will subsequently increase by $100
million as the Treasury, in the normal course of fiscal operations,
draws down its balance to pay for the goods and services the Govern
ment buys from the public.
At present, there are no legal minimum ratios for the gold certifi
cate holdings of Federal Reserve Banks in relation to either their
deposit or their note liabilities; none have existed, in fact, since March
1968.4 Long before that time, however, the gold reserve ratio had
lost whatever significance it once may have had as a regulator of
national monetary policy.
2. SDR Certificate Account

A Federal Reserve asset item closely related to the gold certificate
account is the SPECIAL DRAWING RIGHTS CERTIFICATE
ACCOUNT. SDR’s (Special Drawing Rights in the International
Monetary Fund) are created by the Fund on agreed occasions and
are allocated to members of the Fund in accordance with an accepted
formula— but without any payment by them— to serve as a supple
ment to the international monetary reserves of the members of the
Fund. They may then be transferred, somewhat like gold, from one
national monetary authority to another.
SDR’s received by the U.S. Government are first placed in the Ex
change Stabilization Fund by the Treasury. From time to time the
Treasury may monetize SDR’s by issuing SDR certificates to the
Reserve Banks. When this occurs, the SDR certificates thus acquired
by the Banks are credited to the SDR certificate account. Since the
first SDR’s were created in 1970, the Federal Reserve Banks’ reserve
assets have included small amounts of SDR certificate credits.
Transfers of SDR’s to and from the monetary authorities of other
countries, against payment in dollars, have up to now been made
only in small volume. These transfers have utilized unmonetized
SDR’s, or have added to the Stabilization Fund’s holdings, without
4 Although statutory minimum gold reserve requirements against Federal
Reserve Bank liabilities and Federal Reserve notes (the so-called gold cover)
were abolished on Mar. 3, 1965, and Mar. 18, 1968, respectively, it is still
true that each Reserve Bank must maintain collateral equal to the amount of
its Federal Reserve notes outstanding. Eligible collateral includes gold certifi
cates, SDR certificates, U.S. Government securities, and collateral received in
making loans.

Purposes and Functions
effect on the Federal Reserve Banks’ holdings of SDR certificate
claims, which have remained unchanged at $400 million from April
1970 to the time of this writing.5
3. Cash

Cash represents only the amounts of currency issued by the Treas
ury that the Reserve Banks hold; most of these holdings are in the form
of coin. Although each Reserve Bank may hold Federal Reserve notes
issued by other Reserve Banks, such notes cancel out in a consoli
dated statement of condition for the System as a whole.
4. Loans

LOANS represent the amount of Federal Reserve credit that mem
ber banks and others obtain at their own initiative— secured by U.S.
Government or Federal agency obligations, by eligible commercial,
agricultural, or industrial paper, or by other assets— and for which
they incur a repayment obligation. As is explained in Chapter 4, about
one-half of these borrowings from Federal Reserve Banks represent
short-term advances secured by U.S. Government and Federal agency
securities. This reflects in part the large role of such securities among
bank assets, and in part the great convenience of using them as col
lateral. All borrowing by member banks against such securities or
against eligible paper is done at the established discount rate. Mem
bers may also borrow against any other assets satisfactory to their
Reserve Bank by incurring an additional charge of Vi percentage point
above the Reserve Bank’s regular discount rate. Federal Reserve Bank
loans to member banks are governed by the Board’s Regulation A.
The Reserve Banks may also make other types of loans; these too
must conform to regulations prescribed by the Board of Governors.
One type is loans to individuals, partnerships, and corporations (in
cluding nonmember banks) secured by U.S. Government and Federal
agency obligations. Another type involves discounting of eligible
=Total Treasury holdings of SDR’s by the Treasury’s Exchange Stabilization
Fund on May 16, 1973, the date used in Table 1, amounted to $1,949 million,
of which $400 million was obligated to the SDR certificate account held by
the Reserve Banks. On that same date the total U.S. gold stock was $10,487
million, of which $10,303 was obligated to the gold certificate account; the
remainder—unmonetized—was held by the U.S. Treasury ($107 million) and
by the Exchange Stabilization Fund ($77 million).

Operations and Bank Reserves
paper for individuals, partnerships, and corporations in unusual and
exigent circumstances. Both types bear an interest charge higher than
the basic discount rate. Yet another form represents loans to foreign
monetary authorities secured by gold; such loans are made at the
prevailing discount rate.

5. Securities

The System’s portfolio comprises mainly U.S. Government secu
rities (Treasury bills, notes, and bonds) and obligations of Federal
agencies. Federal Reserve transactions in these securities, commonly
referred to as open market operations, are conducted by the Federal
Reserve Bank of New York on behalf of the FOMC for the joint
account of the 12 Reserve Banks. The securities portfolio of the
Reserve Banks is distributed among the individual Reserve Banks
according to a formula. In addition, the Federal Reserve Bank of
New York conducts for its own account operations in bankers ac
ceptances and operations in the form of repurchase agreements,
in both Treasury and Federal agency issues; these operations, too,
are under the direction of the FOMC.
Since Reserve Bank purchases and sales of authorized securities
are the principal means by which the Federal Reserve can affect the
volume of Reserve Bank credit and member bank reserves at its own
initiative, changes in Reserve Bank holdings of these securities are
watched closely by observers in the credit markets. A breakdown of
holdings, by type of security, is shown each week in the published
statement. (Repurchase agreements are described on page 64.)

6. Cash Items in Process of Collection

CASH ITEMS IN PROCESS OF COLLECTION are checks and
other cash items (for example, U.S. postal money orders and Feder
al food stamp coupons) that have been deposited with the Federal
Reserve Banks as of the date of the statement for collection by the
Banks on behalf of commercial banks— either members or nonmem
bers. The item has a counterpart in an account— Item 10, deferred
availability cash items— on the liability side of the statement. Items
in process of collection always exceed the amount of deferred avail
ability items, because many checks that the Reserve Banks present
for collection are not actually collected within the time schedule for

Purposes and Functions
crediting member bank reserve accounts to which the Reserve Banks
must adhere by regulation— at present a 2-day maximum time sched
ule. The difference between these two accounts yields a measure of
a type of Federal Reserve credit called “float,” which the Reserve
Banks generate in rendering collection services to member banks;
float is further explained on pages 33 and 34.

7. Bank Premises and Other Assets
The item “Bank premises and other assets” includes— in addition
to bank premises— interest accrued, and various other items of minor
importance. At times it has included substantial holdings of converti
ble foreign currencies acquired under “swap” agreements with foreign
central banks, as is brought out in Chapter 6.

MAJOR LIABILITY ACCOUNTS

8. Federal Reserve Notes

FEDERAL RESERVE NOTES, which are liabilities of the Re
serve Banks, are the principal type of U.S. currency in circulation. As
noted in Chapter 2, they constitute about 90 per cent of the total.
Changes in the amount of Federal Reserve notes in circulation
occur seasonally and cyclically in accordance with changing demands
of the public for currency and of member banks for vault cash. The
public meets its immediate needs for currency by cashing checks at
commercial banks. The member banks in turn require vault cash to
accommodate the needs of their own customers and also the vault cash
and customer needs of nonmember banks. They obtain the currency
for these purposes by drawing down their reserve balances at Reserve
Banks; when their needs decline, they dispose of any excess currency
by depositing it in their reserve accounts.

9. Deposits
The major portion of the DEPOSITS in Federal Reserve Banks rep
resent the reserve accounts of member banks. The aggregate of mem52

Operations and Bank Reserves
ber banks’ deposit balances at Federal Reserve Banks and of their
vault cash constitutes the reserve base of the banking system.
The second most important category of Reserve Bank deposit
liabilities comprises the deposit accounts of the U.S. Treasury. The
Treasury draws on these accounts to make payments by check for
all major types of Government spending. The Treasury also main
tains deposit accounts— commonly known as tax and loan accounts
—with approved commercial banks for receiving taxes and the pro
ceeds of securities sold to the public. The Treasury’s established
practice is to maintain large enough balances in its checking accounts
at the Reserve Banks to meet all near-term payment obligations.
Hence, it transfers funds from its accounts in commercial banks into
its Reserve Bank accounts in accordance with anticipated payments.
Also, whenever the Treasury’s total account at the Reserve Banks
exceeds desired working levels, the excess may be redeposited in its
tax and loan accounts at commercial banks.
By allowing the bulk of the changes in its total cash balance to
occur in tax and loan accounts, the Treasury moderates the effect on
bank reserves of fluctuations in its receipts and payments. If the
Treasury were to permit its deposits at the Federal Reserve to fluctu
ate widely, this would cause large swings in the banks’ reserves; net
payments out of the accounts would provide deposits— and simultane
ously, reserve funds— to member banks, while net receipts in the
accounts would represent funds drained from member banks.
Deposits of foreign central banks and governments are the third
category of deposit liabilities at the Reserve Banks. These deposits are
maintained with the Federal Reserve Bank of New York, but all
Reserve Banks share in the deposit liability. They represent working
balances held by foreign authorities for purposes of international
settlement. Such deposits are usually small, but they may fluctuate in
the very short run at times when foreign central banks are buying or
selling dollars in their exchange markets.
The fourth category, “other” deposit liabilities, includes deposits
of some Government agencies and of international organizations of
which the United States is a member, and miscellaneous deposits.

10. Deferred Availability Cash Items
As mentioned on page 31, DEFERRED AVAILABILITY CASH
ITEMS are the counterpart of the asset account Item 6— cash items

Purposes and Functions
in process of collection. Deferred availability items arise because the
Federal Reserve Banks do not give immediate credit to the deposit
account of the collecting bank for all checks deposited with them for
collection. The credit is deferred according to a schedule that allows
time for out-of-town checks to go through the mail or by other trans
fer media to the banks on which they are drawn. As stated in the
explanation of Item 6, the maximum period for deferral of credit is
presently two business days. After such period, the member bank’s
reserve account is automatically credited.
Since the time actually taken to collect a check may be longer than
that allowed in the schedule, this crediting often occurs before the
account of the bank on which the check is drawn is debited. The
difference between the asset account (cash items in process of collec
tion) and the liability account (deferred availability cash items)
represents checks that— although not yet collected by the Reserve
Banks— have previously been credited to the reserve accounts of the
banks that deposited them.
As already noted, this difference, which is sometimes sizable, is
called “float.” It measures the amount of Federal Reserve credit
generated by the national check-collection process and available to
the member banks. The application by Reserve Banks of electronic
technology to check clearance at regionally located check-processing
centers is now working to speed up check settlement. This will
gradually reduce the volume of both the asset and liability items and
also of Federal Reserve float.
11. Other Liabilities, Including Accrued Dividends

The item “Other liabilities, including accrued dividends” includes
unearned discount, discount on securities, and miscellaneous accounts
payable.

CAPITAL ACCOUNTS

12. Capital Paid In
When a bank is admitted to membership in the Federal Reserve
System, it must subscribe to capital stock of the Reserve Bank

Operations and Bank Reserves
of its district an amount equal to 6 per cent of its own capital
stock and surplus. Of this amount, 3 per cent must be paid in, and 3
per cent is subject to call by the Board of Governors. The shares
do not carry the same power through voting to control the manage
ment of the Reserve Bank as does ordinary stock in private banks
or corporations. Member banks are entitled by statute to a cumula
tive dividend of 6 per cent per annum on the value of their paid-in
stock. Ownership of Reserve Bank stock may not be transferred, nor
may the owning bank hypothecate its shares.
13. an d 14. Surplus, and Other Capital Accounts

The surplus account represents retained net earnings of the Reserve
Banks, while the other capital accounts represent the unallocated net
earnings for the current year to the date of the statement. The Re
serve Banks may draw on their surplus to meet deficits and to pay
dividends in years when operations result in loss, but they may not
distribute it otherwise to the stockholding member banks. As pre
viously noted, and as Chart 4 shows, by far the major part of all
CHART 4
DISPOSITION OF FEDERAL RESERVE BANK EARNINGS

EARNINGS 1914-73 = $41,971 MILLION

Purposes and Functions
Federal Reserve Bank earnings over the years have been paid into
the U.S. Treasury. Net earnings of the Federal Reserve Banks in 1973
amounted to $4,441 million. Of this total, $4,341 million was paid to
the Treasury.

BANK RESERVE EQUATION
Since the Federal Reserve Banks are not operated for profit, profit
considerations have no effect on the amount of credit they extend.
The amount of Federal Reserve credit is determined primarily by the
monetary policy pursued by the Federal Reserve authorities in the
public interest. Actions to implement Federal Reserve monetary
policy increase or decrease the availability, and also the cost, of
bank reserves— and thereby influence the supply and cost of bank
credit and money in the economy.
In order to promote its monetary policy objectives, the Federal
Reserve conducts operations, such as purchases of securities, partly
in response to movements in other factors that cause increases or
decreases in bank reserves. Unless there is some offsetting action,
these other factors can affect the ability of banks to lend or invest
and to expand the money stock and bank credit in a manner not
consistent with the prevailing objectives of monetary policy. How
Federal Reserve credit varies with changes in these other factors
affecting bank reserves is analyzed most easily by combining all of
these factors in a bank reserve equation. Items in the equation reflect
the numerous forces in the country’s economic life that affect the
activities of the banking system.*123
NOTES TO TABLE 2:
1 U.S. Govt, securities, Federal agency obligations, and bankers acceptances.
2 Line 4 does not give the exact June figure for quantity of currency held outside the
Federal Reserve and member banks, because it includes a timing discrepancy. In meeting
their weekly reserve requirements, member banks use vault cash holdings as of 2 weeks
earlier. Hence, currency in vault (line 8b) is timed to show data on this lagged basis. To
preserve the balance in the reserve equation, these lagged vault cash figures were subtracted
from total currency in circulation to arrive at line 4.
3 Ordinarily, the sum of required reserves and excess reserves would equal member bank
reserves as shown on line 8. For the periods chosen, however, a transitory reserve deficiency
allowance was in effect under which Federal Reserve Banks waived penalties on reserve
deficiencies for a transition period beginning with changes in Regulation J, effective Nov. 9,
1972. These waivers amounted to $166 million in June 1973 and $428 million in December
1972; these amounts are included in excess reserves as shown above.
N o te .— Details may not add to totals because of rounding.

Operations and Bank Reserves
Most of the factors in the equation come from the consolidated
balance sheet of the Federal Reserve Banks, reviewed in the first part
of this chapter; but some represent Treasury monetary accounts, such
as the gold stock and an account that reflects the issuance of currency
TA B LE 2

BANK RESERVE EQUATION
Averages of daily figures, in millions of dollars

Amounts,
June 1973
I. SOURCES (Factors
supplying reserve funds):
1. Reserve Bank credit
outstanding
a. Security holdings1
b. Loans
c. Float
d. Other assets
2. Monetary reserves
a. Gold stock
b. Special Drawing
Rights certificates
3. Treasury currency
outstanding
TOTAL SOURCES

80,547

3,696

75,446
1,788
2,371
942

4,261
739
-1,108
- 196
10,810

10,410
400
225
3,921

8,518
99,875

II. USES (Factors absorbing
reserve funds):
4. Currency in circulation
outside Federal Reserve
and member banks
261,523
Treasury holdings of
currency
386
Deposits (other than
member bank) held by
Federal Reserve Banks
3,372
a. Treasury deposits
2,408
b. Foreign deposits
266
c. Other deposits
698
7. Miscellaneous accounts.
liabilities, and capital
2,732
Member bank reserves
31,863
a. Deposits at Federal
Reserve B an k s................. 25,777
b. Currency in vault
26,086
TOTAL USES
99,875
III. DISTRIBUTION OF MEMBER
BANK RESERVES:3
Required ...........................
Excess3 ..............................

Change from
December 1972

31,970
59

1,558
36
1,019
-

959
6
67
370
938

947
9
3,921

836
160

For notes see opposite page.

Purposes and Functions
and coin by the Treasury. As a result of this consolidation of Federal
Reserve and Treasury monetary accounts, the reserve equation re
cords the gold stock directly rather than the amounts of gold certifi
cates shown in the condition statement of the Reserve Banks. A
convenient rule of thumb for translating between the System’s com
bined balance sheet and the bank reserve equation is that items from
the asset side of the balance sheet enter the equation as sources (that
is, as supplying reserve funds), and that liabilities enter as uses (or
absorbing reserve funds). Similarly, asset items from Treasury mone
tary accounts would enter the equation on the sources side, and
liabilities on the uses side.
Table 2 shows two sets of data for the items in the reserve equa
tion: (1) daily-average amounts outstanding for June 1973 and (2)
changes in such amounts over the 6-month period ending June
1973. One can usefully view items (1) through (3) as the sources
side of the equation, and items (4) through (8) as the uses side.
One of the factors using reserve funds is member bank reserves.
The source items supply reserve funds when they increase. For
example, if other things remain unchanged, an increase in Reserve
Bank credit will add to member bank reserves. On the other hand, a
decrease in Reserve Bank credit or any other source item would re
duce reserve funds and member bank reserves if other things were
unchanged.
An increase in the use items absorbs reserve funds. For example,
if other items are unchanged, a rise in currency in circulation would
be accompanied by a decline in member bank reserves.
Thus, factors affecting both the supply of and demand for reserve
funds have to be considered in order to understand the interaction
between Federal Reserve operations (a source of reserve funds) and
member bank reserves (a use of reserve funds).

MAJOR FACTORS IN THE EQUATION
Over the longer run, the major factors affecting member bank
reserves are Federal Reserve credit, holdings of international mone
tary reserves, and currency in circulation. Other factors, which do not
change greatly over the longer run, include: Treasury currency out
standing; Treasury deposits; and foreign and other nonmember bank
deposits at the Reserve Banks. Levels of the major factors and of

Operations and Bank Reserves
CHART 5A
BANK RESERVE EQUATION — Annual Averages
Billions of dollars 100

MAJOR FACTORS SUPPLYING RESERVE FUNDS

’40

'45

’50

'60

'65

Annual averages of monthly figures. Beginning 1959, currency in circulation excludes
amounts of currency and coin held as bank reserves.

Purposes and Functions
member bank reserves over the period of 1940-73 are depicted in
Chart 5A (with abrupt changes in the level of member bank reserves
usually indicating action by the Board to change reserve requirement
percentages of member banks).
The interaction of changes that occur among major factors affect
ing reserve funds is considered in the discussion that follows, in order
to put into perspective the linkage between Federal Reserve monetary
actions and commercial banking.

SOURCES SIDE
As Table 2 shows, Federal Reserve credit is the major factor on
the sources, or supply, side of the bank reserve equation. The com
ponents of Federal Reserve credit consist of the System’s security
holdings, Reserve Bank loans, float, and other assets.
Most of the loans of the Reserve Banks represent temporary bor
rowings by member banks as they adjust to unexpected changes in
their reserve positions. Although individual commercial banks take
the initiative in seeking credit, the frequency and duration of borrow
ing is limited under Federal Reserve regulation. In addition, the
Federal Reserve can influence the relative attractiveness of such
credit by the interest rate that it charges on these loans (the “discount
rate” ). Increases in borrowing added $739 million to Reserve Bank
credit in the first half of 1973.
Another component of Federal Reserve credit is float— the differ
ence between cash items in process of collection and deferred avail
ability cash items. The importance of float hinges not so much on the
total amount of reserves it supplies— because that volume is rela
tively small compared with the volume supplied by other components
of Federal Reserve credit— but rather on the volume and frequency
of changes in its level. From one week to another float may vary
sharply and sometimes quite erratically. During one week in January
1973, for example, it declined by $1.2 billion on a daily-average basis.
Therefore, it is very difficult to predict the extent to which float will
affect week-to-week changes in bank reserves. During the first half of
1973 the highest daily-average level of float for any week was $4.5
billion, and the lowest was $1.7 billion. Meanwhile, over the half
year the level of float declined by $1.1 billion on balance, reducing
the supply of reserve funds by a similar amount.

Operations and Bank Reserves
CHART 5B
BANK RESERVE EQUATION - Weekly Averages
Billions of dollars 84

MAJOR FACTORS
SUPPLYING
RESERVE FUNDS

Billions of dollars 70

MAJOR FACTORS
ABSORBING
RESERVE FUNDS

, 30

1973
Weekly averages of daily figures.

Purposes and Functions
By far the most important component of Federal Reserve credit
is the System’s portfolio of securities. As a result of purchases and
sales in the open market during the first half of 1973, the Federal
Reserve increased its holdings by $4.3 billion, thus providing a similar
amount of reserve funds. These open market operations, the essential
features of which are described in Chapter 4, are a key element in
the linkage betwen monetary policy actions and bank reserves.
To illustrate the impact of an open market transaction on member
bank reserves, assume that the Federal Reserve Banks purchase $100
million of Treasury bills for the Open Market Account. The Federal
Reserve pays for these bills by issuing checks drawn on the Reserve
Banks. As the sellers of the securities— typically a group of Govern
ment securities dealers— utilize the funds to repay bank loans or to
build up their own deposit balances, they deposit these checks in
member banks. The banks send the checks to the Reserve Bank where
they are credited to the member bank’s deposit account.
This illustration has traced a Federal Reserve open market opera
tion in slow motion to show how the process works. In actual practice,
the transaction does not require a check, since the process is acceler
ated by a computer-hook-up between the Reserve Banks and the
banks that act as clearing agents for the dealers. Payments to the
dealers and credits to member bank reserve accounts are thus made
simultaneously, and the transaction is fully cleared during the day
specified for delivery, which is often the same as the day of purchase.
The result of the above transaction then is an increase of $100
million in the Federal Reserve’s holdings of securities and an equal
increase in member banks’ reserve balances at the Federal Reserve.
Although the direct effect of the operation is to increase the reserves
available to certain commercial banks, indirectly the action initiates
a series of portfolio adjustments by banks and the public by which
the reserves are quickly diffused through the banking system. These
adjustments will be described more fully in the discussion of member
bank reserves on the uses side of the equation.

USES SIDE
Member bank reserves are one of the several uses into which the
supply of reserve funds may be absorbed. In general, the uses of
reserve funds can be thought of as jointly determined by the individ-

Operations and Bank Reserves
ual demands of the public, the Treasury, and member banks. De
mands by each of these sectors absorb reserve funds. For example,
when the member banks make payments to the Federal Reserve to
obtain additional currency for their customers or to make remittances
to the Treasury account at the Federal Reserve, these actions— by
draining member bank reserve balances— absorb reserve funds gen
erated by the sources described above. However, member bank re
serves are pivotal in Federal Reserve operations since they influence
the Nation’s bank credit and bank deposits (which are the principal
component of the Nation’s money stock).
To understand the role of member bank reserve balances, a dis
tinction should be made between the two major components of these
balances— required reserves and excess reserves. Federal Reserve
regulations require that each member bank keep a certain fraction
of its deposits as cash reserves held either with its Federal Reserve
Bank or in its own vault. The level of required reserves depends in
part on the type of deposit and in part on the volume, as explained
in Chapter 5. In mid-1974 required reserves of member banks aver
aged about 8 per cent of their total deposits subject to reserves.
Reserves held by member banks that exceed required reserves are
called excess reserves. Member banks try to keep a small amount
of such reserves in order to avoid incurring penalties on reserve
deficiencies. However, since excess reserves do not earn any income,
member banks try to put to use quickly any accumulation of such
reserves above minimal levels. For instance, if excess reserves increase
by $100 million above minimal levels as a result of a change in
another reserve factor— say, a purchase of securities by the Federal
Reserve—the banks that receive these excess reserves are likely to
use them to expand loans and investments.
The relationship between reserves (required and excess) on the
one hand, and bank credit (that is, loans and investments) and de
posits on the other is illustrated by the simplified presentation in
Table 3. In this example, it is assumed that the Federal Reserve pur
chases $100 of securities from the nonbank public and that the seller
of the securities deposits the check (issued by the System to pay for
the securities) in his deposit account at a member commercial bank.
Thus, the initial impact on banks of the open market operation of
$100 is a simultaneous increase of $100 in both reserves and deposits.
However, if it is assumed that banks are required by Federal Reserve
regulations to maintain “required” reserves equal to 10 per cent of
deposits, the functional composition of the $100 addition to bank

Purposes and Functions
TABLE 3
A SIMPLIFIED EXAMPLE OF BALANCE-SHEET CHANGES INDUCED
BY OPEN MARKET OPERATIONS'

Member banks

Federal Reserve
Item
Assets

Liabil
ities

Assets

Liabil
ities

Nonbank public
Assets

Liabil
ities

Initial impact of operations
(in the amount of $100)
Securities
Reserves

-1 0 0

+ 100
+ 100

+ 100
of which:
(required, + 1 0 )
(excess, + 9 0 )

Demand
deposits
Total

+ 100
+ 100

+ 100

Ultimate impact of operations
(in the amount of $100)
Securities
and loans
Reserves .

+ 100
+ 100

Deposits
Total

+ 100

+ 900
+ 100
of which:
(required, + 100)
(excess, .. .)
+ 1,000
+ 1,000

+ 1,000

2—500

2+ 500

+ 1,000
+

500

+ 500

1 This example assumes a uniform reserve requirement of 10 per cent on all deposits.
2 In this illustration it is assumed that the nonbank public reduces its security holdings by
$500 and increases its debt to banks by $500. Given this assumption together with an
assumption of a 10 per cent reserve requirement against such deposits, commercial banks
would hold $400 more in securities and $500 more in bank loan assets. This distribution
has been assumed for illustrative purposes only; the actual composition as between holdings
of securities and bank loans would depend on a number of economic factors.

reserves will be $10 of required and $90 of excess, as shown in the
top panel of Table 3.
The bank will normally seek to employ these unneeded funds profit
ably by extending loans to or acquiring securities from the nonbank
public. Those members of the nonbank public who receive the pro
ceeds of the loans or sell securities will acquire more deposits. A large
part of these deposits will be used to make payments, and in the
process the deposits will be redistributed to many banks. The expan
sion in deposits at banks will increase the quantity of required reserves
and will lower the quantity of excess reserves by identical amounts

Operations and Bank Reserves
for member banks as a group. Thus, there is a change in the com
position of bank reserves but not in the level.
It is possible for the expansion of bank credit and the simultaneous
expansion of bank deposits to continue until the entire $100 of re
serves originally supplied to the banking system by the Federal Re
serve open market operation become required reserves. If so, at the
end of the expansion process the aggregate deposit holdings of the
nonbank public (which are bank liabilities) will have increased by
$1,000 (bottom panel of Table 3). Commercial bank assets, on the
other hand, will also have risen by $1,000— $100 in reserves and
$900 in loans to, and/or securities purchased from, the public.
In reality, the relationship between increases in reserves on the one
hand and in bank credit and deposits on the other is more complex
and less stereotyped than this description would make it. For one
thing, if member banks have borrowings outstanding at the Federal
Reserve Banks, they may use some of the excess reserves to repay
those borrowings. Or if their excess reserves are low, they may wish
to hold part of the increment in that form. In addition, we have as
sumed a uniform (10 per cent) reserve requirement ratio, but since
reserve requirements in practice are not the same for all types of
deposits, the volume of reserves needed to meet requirements will
depend on the distribution of deposits by type. And how the public
decides to divide its deposits among demand deposits, savings de
posits, and time CD’s will depend in large measure on the levels of
interest rates and economic activity. Thus, a given injection of re
serves will be absorbed to a greater or lesser extent in demand
deposits or time deposits, depending on economic circumstances.
Furthermore, it may be that the public will decide to increase its
holdings of currency during this process of expansion; if so, reserve
funds would be absorbed.
As Table 2 has shown, currency in circulation is the largest single
use of reserve funds. The public’s demand for currency depends
principally on income, and it is responsive to both long-run growth
and cyclical movements of the economy. However, there are also large
seasonal swings in demand for currency, especially around major
holiday periods. During the last 2 months of a year the increase in
currency in circulation may absorb as much as $3 billion of reserves.
Then in the following 2 months much of this increase returns from
circulation. One of the original reasons for creating the Federal Re
serve System was to provide a means of accommodating, at least in

Purposes and Functions
part, such seasonal increases in the public’s demand for currency (by
supplying reserve funds) and to avoid the often undesirable contrac
tion of bank reserves and deposits that would otherwise occur.
CHART 6
CURRENCY IN CIRCULATION - Weekly
Billions of dollars 70

Weekly averages of daily figures.

In its efforts to influence money and credit, the Federal Reserve
System is much more concerned about the total quantity of privately
held currency and demand deposits (M x) than about the composition
of the total as between currency and demand deposits. Hence shifts
from demand deposits to currency are usually accommodated by
increasing the amount of Federal Reserve credit, so as to offset the
net contractionary effect on the total of Mx that is caused by a shift
toward currency. This net contractionary effect arises because cur
rency in circulation absorbs reserve funds on a one-for-one basis
whereas demand deposits absorb the fraction of reserves indicated by
reserve requirement percentages. As a result, absorption of a given
amount of reserve funds in currency will cause deposits to decline by
a multiple of that amount if additional reserves are not provided.

Operations and Bank Reserves
The foregoing pages have described how the major factors in the
bank reserve equation interact jointly to affect the total volume of
member bank reserves— including currency as absorbing reserves, and
other factors, such as Federal Reserve credit, as supplying reserves.6
It has been shown that some of these factors are under the Federal
Reserve’s control and that others are not. But movements in the fac
tors that are not controllable can be either offset or accommodated by
System operations, depending on the monetary policy being pursued
by the Federal Reserve at the time. Thus the quantity of reserves
available to the banking system is ultimately controllable by Federal
Reserve policy. However, the various factors supplying and absorbing
bank reserves are very volatile, and to a great extent unpredictable on
a week-to-week basis. This tends to limit the precision with which
such reserves can be controlled in the short run.
In summary, when there is a change in member bank reserves, it is
accompanied by a series of adjustments in the portfolios of both com
mercial banks and the public. On the one hand, banks change their
loans and investments. On the other hand, the public changes its loan
indebtedness to the banks or alters its holdings of securities—with
consequent changes in deposits. The changes in holdings of securities
take place in a national market and thus affect portfolios throughout
the country. Moreover, the adjustment process is accompanied by
movements in interest rates as the demand for, and supplies of, finan
cial instruments in the various markets are brought into balance.
The following two chapters explain how the Federal Reserve uses
its available instruments to implement monetary decisions.

0 It may be noted that many financial analysts employ a measure known
as the monetary base in analyzing the thrust of monetary policy and its effect
on the flow of money and credit in the economy. The base is defined as the
sum of member banks’ reserves and currency in circulation, and it is easy to
see that this measure accounts for almost all of the uses side of the bank re
serve equation over the longer run.

instrum ents of
i
»

Open IVjarket
Operations
QTapter ^ o u f

Regulation of the Nation’s supply of money and credit, as ex
plained in Chapter 1, encompasses both efforts to ensure that the
growth in money and credit will be adequate to meet the longer-run
needs of a steadily expanding economy, and actions in the shorter
run to slow or accelerate such growth in order to dampen inflationary
or deflationary pressures.
The initial impact of Federal Reserve actions is on the availability
and cost of bank reserves. But the effects of changes in these soon
spread more widely— to the supply of money and credit, interest rates
in financial markets, and the liquidity of financial institutions, busi
nesses, and the public generally. Ultimately, after time lags of varying
length, changes in financial conditions affect current expenditures,
output, employment, and prices.
The thrust of general monetary policy is made effective through
the coordinated use of open market operations, the regulation of
member bank discounting with Federal Reserve Banks, and changes
in member bank reserve requirements. The three instruments should
be considered more as a set of complementary instruments than as
alternatives that substitute for one another. Of these three policy
instruments, the open market instrument is the most flexible, and it is
in continuous use as monetary policy adapts to ever-changing market
and economic conditions. Because of the leading role played by open
market operations in U.S. monetary policy, it is useful to begin by
setting out briefly the general features of such operations.

Purposes and Functions

CHART 7
THE FEDERAL RESERVE SYSTEM - Relation to Instruments of Credit Policy

Key instruments

Other instruments

Open Market Operations
Federal Reserve purchases and sales of securities in the open
market are transacted mainly in U.S. Government securities. Opera
tions are also conducted in Federal agency securities and bankers
acceptances, but these are on a considerably smaller scale. When
the Federal Reserve buys securities, the supply of bank reserve funds
is expanded, and when it sells, reserve availability contracts. Open
market operations of the scale and frequency needed to carry out
U.S. monetary policy could not be undertaken without a large and
active market for securities.

ROLE OF SECURITIES MARKETS
A central bank might conceivably provide or absorb bank reserves
through market transactions in any type of asset. Whatever the asset,
a purchase would be paid for by a check drawn on the central bank.
The seller of the asset would deposit this check in his commercial
bank, and once the check had cleared, central bank funds would be
added to the banking system. When the central bank sold an asset,
the buyer would draw a check on his commercial bank, and once this
check had cleared, funds would be transferred from the banking sys
tem to the central bank.
In practice, however, most types of assets cannot be traded easily
enough to be well suited to open market operations. For the open
market instrument to work effectively, the central bank must be able
either to buy or to sell assets on a timely basis at its own convenience
and in whatever volume may be needed to keep the supply of bank
reserves in line with prevailing policy objectives.
The Federal Reserve carries out by far the greatest part of its
open market operations in the U.S. Government securities market.
This market, in which aggregate trading generally averages several
billion dollars a day, is the broadest and most active of U.S. financial
markets. Transactions in that market are handled “over the counter.”
The great bulk of the sizable volume of buy or sell orders are placed
with specialized dealer firms that make regular markets. Although
most dealer firms are located physically in New York City, dealers
and customers— regardless of where they are located— are linked

Purposes and Functions
together by a network of telephone and wire services that makes
the boundaries of the market nationwide.
The large volume of secondary trading in Government securities
is a reflection in part of the sheer size of the outstanding marketable
Federal debt— about $265 billion on June 30, 1974— and in part of
the widespread use of these securities as liquid assets in the portfolios
of many types of investors. This use is encouraged by the heavy con
centration of Treasury issues in relatively short maturities; roughly
half of them mature within 1 year, and slightly more than four-fifths
within 5 years. Moreover, because the Federal Government’s broad
power to tax assures that servicing charges on its debt will be paid.
Treasury securities are free of default risk. The combination of large
over-all debt availability, of heavy concentration in relatively shortdated maturities, and of the lack of default risk has encouraged the
development in this market of a highly specialized and intensely com
petitive group of dealer intermediaries.
These special advantages of U.S. Government securities have en
couraged economic units of virtually all types to hold some such
issues in their investment portfolios. Business corporations— both
financial and nonfinancial—State and local government units, Fed
eral agencies, charitable institutions, foreign official institutions and
foreign banks, trust accounts, and even many individual investors are
interested in owning some marketable Treasury securities.
In recent years there has also been a substantial growth in both
the outstanding amount of Federal agency securities and the volume
of trading in these issues.1 Inasmuch as such issues are considered
fairly close substitutes for Treasury issues, Government securities
dealers have generally extended their market-making to the Federal
agency sector. The growth of the Federal agency market has made it
possible for the Federal Reserve to execute some open market trans1 The bulk of Federal agency debt, about $66 billion in mid-1974, con
sists of securities of Federally sponsored housing and farm credit agencies. These
agencies, while privately owned, were organized by acts of Congress, and they
operate in close collaboration with the Federal Government. The Federal home
loan banks, the Federal National Mortgage Association, and the various agen
cies of the Farm Credit Administration fall in this category.
Another $17 billion of Federal agency debt has been issued by Federally
owned corporations, such as the Tennessee Valley Authority, the United States
Postal Service, the Farmers Home Administration, the Export-Import Bank,
and the Government National Mortgage Association. The B u d g e t o f th e U n ite d
S ta te s G o v e r n m e n t records the borrowing activities of these agencies.

Open Market Operations
actions in this sector, although the volume still represents a relatively
small share of the System’s total market transactions.
Short-term Treasury and Federal agency securities, of course, are
not the only types of short-term market instruments available to
large investors seeking interest-earning, liquid assets. Competitive
alternatives include bankers acceptances, large negotiable CD’s, highgrade commercial paper, and short-term securities issued by State
and local governments with high credit ratings. Among these forms
the Federal Reserve does conduct some operations in bankers accept
ances, but such operations represent only a small fraction of all
Federal Reserve operations.
The other competing debt forms mentioned are also traded in open
markets. For the most part, however, markets for these securities are
not well suited to open market operations; secondary trading in
individual issues is considerably less active than in Treasury issues—
and in some is discontinuous. Furthermore, except for certain State
and local government securities, the Federal Reserve is not authorized
by law to conduct operations in any of these other securities.

CONDUCT OF OPEN MARKET OPERATIONS
The following exposition of the conduct of open market operations
begins with a description of the organizational arrangements the Sys
tem has developed for administering open market policy. After that
there is a discussion of the process through which policy actions are
decided, along with the types of information on which these actions
are based. And finally there is a description of the operating tech
niques used by the Trading Desk for carrying out open market
transactions.

ORGANIZATIONAL ARRANGEMENTS
By law, all open market operations of the Federal Reserve System
must be directed and regulated by the System’s Federal Open Market

Purposes and Functions

Open Market Operations
Committee, whose functions and composition were noted in Chapter
2.2 The Committee meets approximately once a month to decide on
its policy stance and objectives. It expresses these, for operating
purposes, in the form of a directive issued to the Federal Reserve
Bank of New York.
The Committee regularly designates the New York Bank to serve
as its agent in executing whatever open market transactions the
Committee authorizes. The Committee selects a Manager of the
System Open Market Account, who is also a senior officer of that
Bank and who has the immediate responsibility for carrying out open
market operations. The System Account is participated in jointly by
all 12 of the Federal Reserve Banks.
Coordination of the day-to-day operations with the directive is
maintained by telephone through the medium of a daily conference
call. Regular participants in this call are the System Account Man
agement, senior staff at the Board of Governors, and a Reserve
Bank president currently serving as a voting member of the Com
mittee. Following this call, a memorandum is sent to all Committee
members— by wire to all Reserve Bank presidents— informing them
of action that the System Account Manager expects to take during
the day in light of developing conditions and Committee objectives.
The staff at the Federal Reserve Bank of New York that assists
the Account Manager in carrying out the FOMC’s domestic policy
directive operates through a “Trading Desk,” which maintains direct
telephone communication with about two dozen dealers located in
New York City or outside. All of the Manager’s purchase and sale
orders for the Committee are executed through this Desk.
When the Account Manager seeks to execute an open market trans
action, his staff contacts dealers in Treasury and Federal agency secu
rities just as other investors do. In fulfilling their obligation to make
regular markets, the dealers stand ready, when asked, to quote firm
bid and offer prices on such securities and to do business at these
prices on whichever side of the market the customer wishes. Since
nearly two dozen dealers are now making markets in U.S. Government
and Federal agency securities and are actively competing with one an2 The Committee's responsibility also encompasses operations in foreign cur
rencies. The purposes and characteristics of such operations are discussed in
Chapter 6. This entire chapter is concerned with open market operations in
domestic securities carried out in accordance with the domestic policy directives
issued by the FOMC.

Purposes and Functions

Open Market Operations
other for some share of the available business, the Trading Desk en
counters no difficulty in completing its orders promptly. When its
orders are large, as they usually are for the System’s Account, the
Trading Desk utilizes the auction method in distributing its orders
among competing dealers.3

POLICY PROCESS
The process of formulating open market policy is a continuum that
carries through successive meetings of the FOMC. It is a complex
process because the quantity and the flow of money and credit not
only affect all aspects of the economy’s production and consumption
activities but also are affected by them.
Discussion of policy at Committee meetings typically covers three
general areas. First, there is a general expression of member judg
ments as to the state of the economy and the prospects for the future
performance of such key economic variables as output, employment,
prices, and the balance of payments, in relation to desired goals.
Second, there is a more explicit statement of member recommenda
tions as to what the thrust of open market policy should be— both for
the longer run and in the inter-meeting period just ahead. Finally, the
Committee engages in give-and-take discussion to synthesize its in
dividual views into a consensus that can be expressed in sufficiently
specific terms to provide meaningful guidance to the Manager in the
conduct of day-to-day open market operations in the interim between
Committee meetings.
Operating targets in recent years have included rates of growth in
bank reserves and the monetary aggregates and associated ranges of
tolerable changes in money market conditions. The key element in the

3 Of those firms that were active as Government securities dealers in mid1974, roughly half were special departments of major money market banks.
Among the nonbank dealers, several were large, integrated brokerage houses
that operate as investment bankers and traders in a number of different sectors
of the securities markets—including equity as well as fixed-income securities.
Other firms specialize mainly in the more active sectors of the Treasury and
Federal agency markets. But most dealer houses participate in more than one
market sector, and their close attention to changing yield relationships in the
total structure of market rates helps to link developments in one sector to those
in others.

Purposes and Functions
latter is a permissible range of fluctuation in the Federal funds rate.
This rate— essentially that at which banks are willing to lend or
borrow immediately available reserves on an overnight basis— is a
very sensitive indicator of tightness or of ease in bank reserves.
Individual members of the Committee may stress different operat
ing targets as having key importance in the existing financial setting—
depending in part on differences in their interpretation of recent and
prospective developments and in part on their interpretation of the
lessons of experience and economic theory. For this reason an ex
tended discussion is sometimes needed to arrive at a consensus.
When a consensus has crystallized, the Committee formulates an
instruction in the form of a domestic policy directive. The Committee
also reaches an understanding with regard to the specific targets and
ranges that will serve as guides to the Manager in implementing the
directive.
By law, the Board of Governors is required to keep a record of
the policy actions taken by the FOMC at each meeting and of the
reasons underlying these actions, and to publish that record in its
Annual Report to the Congress. In view of the strong emphasis that
the Congress places on keeping the public informed about the activ
ities of all Federal agencies and of the special interest that the finan
cial community takes in the FOMC’s policy process, the Board and
the Committee regularly make the policy record for each meeting
available to the public about 90 days after a meeting. The record sum
marizes the Committee’s assessment of the country’s economic and
financial position at the time of the meeting as well as the Committee’s
views regarding the appropriate course for policy during the period
ahead. Finally, it includes the policy directive adopted by the Com
mittee at the meeting in question, together with a record of the votes;
if there were any dissents, statements of the reasons for the dissents
are also included.

MATERIALS FOR POLICY-MAKING
In carrying out their decision-making responsibility, policy-makers
need a wide variety of background information. They must seek to
make judgments as objectively as possible in the light of movements
and interrelations in a wide array of statistical data that show how

Open Market Operations
the economy is performing. Furthermore, they must assess such per
formance in relation to the national goals of sustained high employ
ment, avoidance of marked inflationary or deflationary tendencies,
and a balanced flow of U.S. payments with foreign countries. This
need to consider current developments in relation to ultimate goals
forces the Committee to look into the future with great care since
actions to affect bank reserves today produce their ultimate impact on
final spending, prices, and employment only after sizable time lags.
To meet the Committee’s needs for an adequate factual foundation
for diagnosing the recent performance of the economy and to provide
an analytical framework for projecting how the economy is likely to
perform in the future, a considerable amount of intensive and system
atic staff preparation must precede each meeting of the FOMC. The
results of this work are presented to Committee members in various
forms, of which the following are most important:
1. Roughly three times a year, or more frequently if unusual de
velopments require it, the staff provides the Committee with a fullscale projection of the domestic economic outlook. This presentation
lays out expected levels and quarterly changes in all of the key sectors
of the gross national product accounts— both in current and in con
stant dollars— for the next 12 to 18 months. It also provides projec
tions of associated changes in key sectors of the Federal Reserve flow
of funds accounts, plus a full review of expected developments in for
eign trade and the balance of payments.
The projection is based on specific assumptions as to monetary, fis
cal, and other Governmental policies. A monetary strategy is
assumed that seems likely to come closest to achieving the Com
mittee’s policy goals during the period under consideration. To pro
vide Committee members with a rough idea of trade-offs among
policy goals that might result from alternative policy strategies,
projections of key economic variables for alternative strategies are
also provided. The particular estimates included in the projection
are based on a blending of judgments reached by economic analysts
experienced in making projections and of results from a large-scale
econometric model of the U.S. economy.
2. Before each monthly meeting, Committee members receive
a comprehensive staff document that reviews the facts and impli
cations of recent domestic and foreign economic and financial devel
opments, including the extent to which actual events seem to be
confirming, or deviating from, the most recent economic projection.
When significant deviations from the projection become evident, their

Purposes and Functions
implications for the longer run are evaluated and needed adjustments
are made in the forecast.
3. To assist the Committee in formulating the short-run operat
ing targets that lie behind its policy directive, the staff provides at each
meeting a special document that serves as a basis for discussion of
this subject. The document lays out several alternative sets of inter
meeting operating targets. One set indicates what might be expected
or required for key financial variables if the prevailing longer-run policy
strategy continues about unchanged; the others show what might de
velop if the policy strategy is revised. Each set of targets documents
relationships among bank reserves, the monetary aggregates, and in
terest rates that would be expected to result from the particular strat
egy assumed.
4. The Account Manager provides detailed written reports, and
also reports orally during the meeting, on his transactions since the
Committee’s last meeting; these reports include comments on any spe
cial problems that he has encountered in carrying out the Committee’s
instructions or in achieving the operational targets that the Committee
specified for his guidance.4
5. Finally, Committee discussions at the monthly meetings are
preceded by oral reports from the senior staff. These reports not only
capsulize the highlights of the more comprehensive written materials
the Committee has already received but also evaluate those aspects of
the outlook, including the implications of alternative monetary policy
strategies, that are believed to be of special significance to the Com
mittee’s current policy decision.

MANAGER’S OPERATING TECHNIQUES
During the period between meetings, the System Account Manager
is concerned with executing the Committee’s latest domestic policy
directive. His time horizon thus breaks down into the days and weeks
in which he will be transacting operations, and he is constantly watch
ing to see how the latest facts on bank reserves, the monetary aggre
4 The Special Manager for foreign currency operations provides similar
reports on foreign exchange markets and on actions he has taken under the
Committee’s directive to him.

Open Market Operations
gates, and interest rates seem to be relating to the Committee’s opera
tional targets.
The Federal Reserve engages in open market operations virtually
every business day. The purpose of most of these operations, how
ever, is to keep various technical (market) factors from introducing
independent shifts in bank reserve positions that are inconsistent with
the current aims of Federal Reserve policy or that may lead to larger
and potentially destabilizing day-to-day fluctuations in money market
conditions. As noted in Chapter 3, such technical market factors as
changes in currency in public circulation, in Federal Reserve float,
and in the Treasury’s balance at the Federal Reserve can cause large
day-to-day changes in bank reserve positions. Some of these changes
are seasonal; others are unpredictable. The System’s well-known prac
tice of frequent open market transactions to offset the play of tech
nical factors makes for a smoother day-to-day flow of money and
credit to finance the Nation’s business.
The Manager receives information continuously during the day on
conditions in both the money and securities markets. In addition he
receives information daily— with a 1-day lag— on bank reserve posi
tions, and his staff provides him with both daily projections for sev
eral weeks ahead of all of the technical factors expected to influence
the supply of reserves and weekly projections of the money and credit
aggregates. Data on the money stock and the bank credit proxy
are made available to the public weekly with a 1-week lag, although
very rough preliminary data are available internally before that.
The Manager’s operating techniques must be sufficiently adaptable
for him to adjust to rapidy changing market forces and reverse the
flow of reserves when the reserve effects of his transactions in preced
ing market days prove to have been too great or too little. Reflecting
this need for adaptability, the Account Manager uses two general
approaches to the execution of his operations. The approach that he
selects depends on the expected duration of the particular reserve
situation.
When projections of reserve factors indicate a net need to supply
or to withdraw reserves for the banking system as a whole and this
situation seems likely to persist for more than the current bankstatement-week, the Manager will generally buy or sell securities on
an outright basis for prompt delivery. If the need is to withdraw
reserves, he may also allow maturing securities to run off without re
placement.

Purposes and Functions
In situations where the need to provide (or withdraw) reserves
seems only temporary— either because the projections suggest that
reserves provided today will soon need to be withdrawn to offset
expected seasonal movements in technical reserve factors, or because
there is marked uncertainty about the near-term reserve outlook— the
Manager will use special methods that have only a temporary effect on
the aggregate supply of reserves. Thus, when the need is for tempo
rary provision of reserves, he makes “repurchase agreements” with
dealers; when it is for temporary withdrawal, he makes “matched salepurchase transactions.”

Outright Purchases and Sales
System transactions on an outright basis are typically made through
an auction process in which all 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.5 Once dealer tenders have been re
ceived, they are arrayed according to price. The Account Manager then
accepts amounts bid or offered in sequence until his order is covered.
Not all “outright” transactions occur through the dealer market. If,
on a day when the Manager sees a need to supply or absorb reserves,
he has an order from a customer who uses the Federal Reserve as
agent for transactions— say from a foreign account— that matches up
with the System need, he may simply execute the order directly
through the System Account. Since the staff of the Trading Desk
keeps an hourly record of bid and offer prices being quoted by dealers
for the full list of Treasury securities, foreign orders can be readily
executed directly with the System’s portfolio at the “best” market
prices.
The great bulk of the System’s outright transactions— whether in
the dealer market or directly with official accounts— occur in Treas
ury bills since the Treasury bill sector is by far the most active part
of the U.S. Government securities and Federal agency markets. From
time to time the System extends its purchases beyond the Treasury bill

5 The System is prepared to do business with any dealer with adequate capi
tal that demonstrates—through regular daily reports to the Federal Reserve
Bank of New York on its positions and transactions—that it is regularly mak
ing markets in U.S. Government and Federal agency securities. Each dealer is
also expected to submit at intervals financial statements certified by qualified
public accounting firms.

Open Market Operations
TABLE 4
TRANSACTIONS OF THE SYSTEM OPEN MARKET ACCOUNT
In millions of dollars

1972
U.S. Government securities:
Outright transactions:
Treasury bills:
Gross purchases
Gross sales
Redemptions
Others within 1 year:
Gross purchases
Gross s a le s ................................................................
Exchanges, maturity shifts,or redemptions
1-5 years:
Gross purchases
Gross s a le s ................................................................
Exchanges, or maturity sh ifts ................................
5-10 years:
Gross purchases.......................................................
Gross s a le s ................................................................
Exchanges, or maturity sh ifts................................

1973

8,522
6,467
2,545

15,517
4,880
3,405

125

1,396

2,933

—140

789

579

—1,405

—2,028

539

500

—2,094

895

167

129

250

10,142
6,467
2,862

18,121
4,880
4,592

23,319
23,319

45,780
45,780

31,103
32,228
—312

74,755
74,795
8,610

Federal agency obligations:
Outright:
Gross purchases
Sales or redemptions
Repurchase agreements, n e t ......................................

1,197
370
—88

865
239
29

Bankers acceptances, net:
Outright ............................................................................
Repurchase agreements .................................................
Net change in total System holdings

—9
—145
272

—2
—36
9,227

Over 10 years:
Gross purchases
Gross sales .............................................................
Exchanges, or maturity shifts
Total outright transactions:
Gross purchases
Gross sales
Redemptions
Matched sale-purchase transactions:
Gross purchases...........................................................
Gross sales
Repurchase agreements:
Gross purchases
Gross sales
Net change

Purposes and Functions
market to include intermediate- and long-term Government and
agency issues. In recent years it has not had occasion to sell longerterm coupon issues, but it has sold short-term issues (those maturing
in less than a year).
Buying of longer-term coupon issues is typically undertaken when
the immediate market supply of Treasury bills is temporarily depleted
and a supply of longer-term issues is available. Sometimes, the FOMC
directs that longer maturities be purchased to help implement a par
ticular interest rate strategy. But the impact of such transactions, in
and of themselves, on yield spreads between short- and long-term
issues tends to be quite marginal because the term structure of market
yields is very strongly influenced by the consensus or interest rate ex
pectations of market participants as a group. Nevertheless, at times
when interest rates are already on the verge of a general decline— say,
because of a threatened downturn in economic activity— System buy
ing of longer-term maturities for the System account may influence
the timing and sharpness of the decline in long-term rates.

Repurchase Agreements
In situations that call for only temporary additions to bank reserves,
the Manager of the System Account engages in short-term repurchase
agreements (R p’s) with dealers— that is, the System buys securities
from the dealers, who agree to repurchase them by a specified date.
This arrangement permits an injection of reserves on a short string, so
that the reserves will automatically be drawn back when the R p’s
mature.
Rp’s for the System’s Account are dated to terminate in from 1 to
15 business days. However, most of them mature in less than 7 days,
and dealers have the option to terminate agreements before maturity
if they so desire. Pre-maturity withdrawals of dealer Rp’s may also suit
the needs of the System. Such withdrawals absorb reserves, and they
often occur because a greater than anticipated availability of re
serves to the banks is either reducing dealer borrowing costs elsewhere
or is leading to large sales of securities by dealers.
Whenever the Account Manager offers Rp’s to dealers, the distri
bution among dealers is determined by means of an auction. All deal
ers are advised of the auction, but because banks have access to the
Federal funds market— and under certain circumstances, to the Federal

Open Market Operations
Reserve discount window— only nonbank dealers are asked to submit
tenders. Individual dealers may enter more than one bid at various
rates. The Manager arrays bids from all dealers in descending order
and then accepts the amount needed to meet his reserve objectives.
Because System Rp’s are initiated to suit the needs of the Federal
Reserve and not those of dealers, the Account Manager may find pro
vision of reserves through Rp’s difficult on days when dealer financing
needs are minimal. At such times he may encourage dealers to seek
collateral for Rp’s from customer sources in addition to whatever
limited amounts the dealers may have in their own inventories.

Sale—Purchase Transactions
In situations where the Account Manager faces a temporary need to
absorb, rather than provide, bank reserves, he may employ matched
sale-purchase transactions with dealers, including bank dealers as well
as nonbank firms. 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 7 days. The initial sale causes surplus reserves to flow from
banks through the dealers to the System. Later, when the System pur
chase is implemented, the flow of reserves is reversed.
On the sale side of the transaction, the Account Manager offers to
all dealers immediate delivery of a given bundle of securities at stated
prices. Simultaneously, he requests all dealers to make offerings in an
auction indicating the amounts and prices at which they would be pre
pared to resell these same securities to the System after one or a few
days. Since dealers must borrow the funds they will use to enter into
matched sale-purchase arrangements, the dealers check with money
market banks to determine the present availability and cost of funds
on ordinary bank Rp’s (whereby the bank will provide the dealer with
funds by purchasing the security from the dealer under an agreement
to sell it back).
Once they know what these rates are, dealers make their tender
offers in the Manager’s auction so that the yield they receive on the
matched sale-purchase operation produces a small spread over the cost
of funds borrowed through bank Rp’s. The Account Manager then
arrays the tenders by price and allots his sales along this price scale
until the desired volume of transactions is covered.

Purposes and Functions

OPEN MARKET OPERATIONS AND
TREASURY FINANCINGS
Because the bulk of the System’s open market operations are car
ried out in the market for U.S. Government securities, question is
often raised as to how these operations relate to market borrowing by
the Treasury. Treasury financings are of two types— (1) cash borrow
ings, which raise new money and expand the size of the outstanding
public debt, and (2) refinancings, which roll over outstanding debt, as
it matures, into new issues. The Treasury must undertake its financ
ings in the open market. In the United States only a very limited
amount of direct lending to the Treasury by the central bank is per
mitted since such direct lending would expand the supply of bank
reserves and thus be potentially inflationary.0 This insulates the Fed
eral Reserve from any official pressure to assist in financing of Govern
ment deficits.
In Treasury refinancing operations, the Federal Reserve limits its
participation to the amount needed to roll over System holdings of the
maturing issue. If the System did not undertake to roll over such debt,
its holdings of maturing debt would have to be redeemed, and this
would cause a commensurate contraction in bank reserves. This could
greatly complicate the Federal Reserve’s task of managing bank re
serves because of the very large size of System holdings of maturing
Treasury debt; for example, holdings of maturing coupon issues at
times may amount to as much as $6 billion. The sheer size makes
simultaneous redemptions and concurrent market purchases to avoid
unwanted reserve absorption impracticable.
The Account Manager may elect to redeem a small part of the
System’s holdings of a particular issue of maturing debt as a means
of absorbing redundant reserves being otherwise generated at the
time. These run-offs seldom exceed a few hundred million dollars,
°The law has usually permitted the Treasury to borrow up to $5 billion di
rectly from the Federal Reserve. On the few occasions when such borrowing has
occurred, it has taken the form of special Treasury certificates to be repaid
within a few days. The purpose of such borrowing is to permit the Treasury to
borrow for very short periods when its cash balance may be running low for
technical reasons, such as at times just before large inflows of income tax re
ceipts around quarterly tax-payment dates. The temporary borrowing privilege
was suspended in the fall of 1973 and as of mid-1974 was awaiting congres
sional renewal.

Open Market Operations
and they occur chiefly in connection with weekly Treasury bill auc
tions rather than in refinancings of Treasury coupon issues.
The net effect of these Federal Reserve practices is to require the
Treasury to cover its financing needs in competition with other bor
rowers in the public securities market. To attract funds from the
general public, the Treasury is obliged to pay the “going” rate of in
terest in the market.
The thrust of monetary policy is thus unaffected by Treasury
financing operations. However, there are short periods from time to
time when the Federal Reserve does take account of large-scale
Treasury debt financing— particularly those involving issuance of in
termediate- and longer-term debt— in the day-to-day conduct of pol
icy. The term “even keel” is the shorthand expression that the market
uses to describe such periods.7
The length of an even-keel period may vary from 1 to 3 weeks,
depending on market conditions and attitudes at the time. Sometimes
it may be only the very brief period between the announcement and
the auction or subscription date. In others it may be the somewhat
longer period until the date for payment. In a very few it may run
somewhat beyond the payment date.
During an even-keel period, the Federal Reserve does not give up
completely its freedom of maneuver in carrying out monetary policy.
But it does not undertake any actions that, by themselves, would
severely jolt market attitudes while a large U.S. Government financing
is in process and thereby risk great unsettlement in securities markets
generally. Nevertheless, swings in market rates of interest have some
times been quite sizable during periods of even keel as well as outside
of such periods. Thus, in no way does even keel provide a guarantee
that the Federal Reserve will stabilize securities markets for Treasury
financings at the expense of reserve objectives.

7The concept of even keel does not apply to regular, repetitive auction
financings such as those for weekly and monthly bills.

Other
instrum ents of
Qiapter ^Five

Changes in the Federal Reserve discount rate and in member bank
reserve requirements are the key instruments that the Federal Re
serve uses along with open market operations to implement national
monetary policy. All three affect the availability of bank reserves
and money and the cost of credit generally.
In addition to these tools of general monetary policy, the Federal
Reserve manages two other instruments, each of which has a more
selective impact on deposits and credit flows. One is the setting of
ceilings on the interest rates that member banks may pay to customers
on their savings and time deposits; the other is the fixing of the initial
margin requirement (downpayment in cash or collateral) on creditfinanced purchases of corporate stocks and convertible bonds. The
interest rate ceilings limit the expansion of member bank savings and
time deposits only when interest rates in the credit market are high
relative to the ceilings. Margin requirements, in contrast, limit expan
sion of stock market credit at all times, although they are much more
of a limitation the higher the required margin, which has been 50 per
cent or higher throughout the postwar period.

Purposes and Functions

OPERATION OF RESERVE BANK DISCOUNT
WINDOW
The Federal Reserve lending mechanism, originally conceived as
being the heart of the U.S. central banking operation, has long since
been displaced in this role by open market operations. For some time
it has served mainly as a complement to open market operations in
the implementation of monetary policy.
The provision of Federal Reserve credit to member banks— at the
initiative of the borrowing bank but subject to administrative con
straints— serves essentially as (1) a source of temporary funds to
help with large, unexpected deposit or portfolio adjustments that in
dividual banks sometimes encounter and (2) a safety valve for mem
ber banks as a group during periods of monetary restraint. In addi
tion, through lending operations the Federal Reserve provides
somewhat longer-term credit to member banks that lack ready access
to national money markets when these banks need help in covering
recurring seasonal needs for funds. On rare occasions of emergency,
when members confront urgent needs for liquefying their assets (such
as needs arising from, say, unexpected developments in the local,
regional, or national economy), they may obtain credit on a longer
than temporary basis. Finally, nonmembers may borrow from the
Federal Reserve under unusual and exigent circumstances in the
financial markets, but at an interest rate that is above the discount
rate available to member banks.

MECHANICS OF BORROWING
Technically, a member bank has two ways of borrowing funds
from its Reserve Bank— by a discount or by an advance. Although
the two methods are quite different, it has become customary to refer
to both as “discounting.”
A discount, in a technical sense, entails the sale of “eligible paper”
to the Reserve Bank; all such paper carries the member bank’s en
dorsement. An advance is a loan evidenced by a promissory note of
the borrowing bank and secured by adequate collateral. At one time
discounts were much the more important means of access to Federal

Other Policy Instruments
Reserve credit, but today virtually all funds flow through the dis
count window by means of advances.
The law identifies three types of collateral for ordinary use in
securing a member’s borrowing— U.S. Government or Federal agency
obligations (or other debt fully guaranteed by the U.S. Government
or a Federal agency); “eligible commercial, industrial, and agricul
tural paper” ; and other security deemed satisfactory by the Reserve
Bank. The major part of all borrowings are backed by U.S. Govern
ment obligations. Since many member banks leave their holdings of
U.S. Government securities at Reserve Banks for safekeeping, it is a
fairly simple matter to use such obligations as collateral.
Employing “eligible paper” is somewhat more complicated because
such paper must be sent to the Federal Reserve Bank along with in
formation that will permit the Reserve Bank to make a judgment con
cerning the eligibility and acceptability of the paper. Today, most
private obligations held in bank portfolios are considered to be “eligi
ble” for discount with a Reserve Bank if the remaining time to maturity
is 90 days or less. Bankers acceptances and municipal warrants, how
ever, may have a remaining maturity of up to 6 months, and agricultural
loans may have as long as 9 months to maturity. Loans made for spec
ulative purposes and bank finance bills (working capital acceptances)
are not eligible.
Loans “secured to the satisfaction” of the Reserve Bank— that is,
by other than U.S. Government or agency obligations or by eligible
paper— are more common today than a decade or so ago. By law, the
rate charged for such loans must be Vi of a percentage point higher
than the rate on borrowing against collateral authorized by statute.

ADJUSTMENT CREDIT
Access to a Reserve Bank discount window is treated as a privi
lege of membership rather than as a right. An important reason for
administrative restraint by the Federal Reserve on member bank bor
rowings is to maintain reasonable control over the volume of such
borrowings and thus avoid excessive and unexpected fluctuations in
the over-all volume of reserves being supplied by this means.
From the standpoint of an individual member bank, borrowing
from the Federal Reserve can be an alternative to obtaining funds in
the broad U.S. money market by borrowing overnight funds from

Purposes and Functions
other banks (so-called Federal funds), by selling securities from its
asset portfolio, or (in the case of larger banks) by issuing large nego
tiable time CD’s. For the banking system as a whole, however, there
is an important difference between borrowing from the Federal Re
serve and making adjustments through the market. Borrowing from
the Federal Reserve increases the total reserves of banks and— if not
offset by open market operations— provides the basis for an expansion
of money and credit. Market adjustments, on the other hand, merely
redistribute presently available reserve funds among banks.
Since membership in the Federal Reserve System in mid-1974
numbered about 5,800 banks with assets of more than $600 billion,
it is apparent that the volume of borrowed reserves could vary widely
if each member were free to tap its Federal Reserve Bank discount
window without restriction. A pattern of large and volatile borrow
ing by the member banks would run the risk of eroding the System’s
ability to control bank reserves and thereby to influence growth of
money and credit in line with the Nation’s economic objectives. For
these reasons administrative constraints on member bank borrowing
have been developed.
As already indicated, most of the borrowing by member banks
from the Reserve Banks is for quite short periods— usually no more
than a few days— as banks seek funds to make temporary adjust
ments in their reserves. Such borrowing can be termed adjustment
credit. Reasons for such borrowing that are considered appropriate
generally include unexpected increases in loan demand, sudden de
posit losses, or temporary and unexpected difficulties in obtaining
funds through the facilities of the money market. Borrowing for the
following purposes would be considered inappropriate: to finance
speculative loans and investments, to substitute Federal Reserve
credit for member bank capital, to finance lending in the Federal
funds market, to acquire securities or other money market paper at
a profit, or to refinance existing indebtedness to private lenders at
the lower discount rate.
In judging whether a member bank is relying unduly on borrow
ing at the discount window, the Reserve Bank discount officer takes
into account the amount of a member’s indebtedness in relation to its
required reserves, the frequency of the bank’s borrowing, any need
for funds that is attributable to computer breakdowns in transfers of
funds, and any special circumstances affecting the current position of
the bank.

Other Policy Instruments
As a general rule, larger member banks borrow to the next busi
ness day or for only a few days at a time since they manage their
positions on a daily basis. Smaller banks usually borrow to the end
of the reserve week, or for two reserve weeks. Even though requests
for credit extensions are seldom denied, requests for renewals or
too frequent requests for short-term discounting are closely scruti
nized and under some circumstances are discouraged or even refused.
If a particular member bank shows a pattern of borrowing that is
characterized by frequent or continuing indebtedness over an ex
tended period, the Reserve Bank lending officer will intervene and
press the offending bank to repay its debt to the System, even though
this may require the bank to reduce its assets and modify its loan and
investment policies.
System guidelines for lending are interpreted by the Reserve Banks
acting individually through their lending officers and credit commit
tees. Policies with regard to such interpretations are coordinated by
the System Conference of Lending Officers, which meets periodically
and holds telephone conferences as needed. Through this type of
coordination regional differences of interpretation are minimized.
Since administration of the discount window is not normally intended
to serve as an instrument of counter-cyclical monetary policy, lend
ing guidelines are applied uniformly throughout the credit cycle—
that is, during both periods of tight money and periods of easy
money. However, since member bank borrowings are largest and
most widespread during periods of credit restraint, more banks
ordinarily become subject to administrative constraints at such
times.

SEASONAL BORROWING PRIVILEGE
In 1973 the Board of Governors, in consultation with the Reserve
Banks, decided to formalize arrangements allowing for the extension
of seasonal credit to member banks that lack effective access to na
tional money markets. This decision was an outgrowth of the studies
reappraising the discount mechanism undertaken by a special Fed
eral Reserve committee in the late 1960’s.
In its report this special committee noted that without an assured
source of seasonal credit, smaller banks typically accumulated short

Purposes and Functions
term securities as a pool of liquidity on which they could draw to
meet peak seasonal needs for funds. To the extent that bank re
sources were tied up in this v/ay during the off-peak season there
was a danger that some local credit needs for desirable projects would
not be adequately accommodated. As a result of the 1973 changes in
the regulation, which permit the Reserve Banks to supply credit to
smaller banks to tide them over periods of peak seasonal need, banks
are now able to use resources that they had previously placed in
liquid assets to meet local needs.
To be eligible for the new seasonal borrowing privilege, a member
bank must satisfy certain conditions:
1. Lack reasonably reliable access to national money markets;
2. Have a seasonal need that arises from a recurring pat
tern of movement in deposits and loans that persists for at
least 8 weeks;
3. Meet from its own resources that part of the seasonal
need equal to at least 5 per cent of its average deposits over
the preceding calendar year;
4. Arrange with its Reserve Bank for seasonal credit in
advance of the actual need for funds.
Smaller banks that do a substantial volume of loan business in farm
or resort areas are examples of institutions that may need to use the
seasonal borrowing privilege, but they by no means exhaust the pos
sibilities. For some banks, seasonal credits may remain outstanding
for a number of months.

EMERGENCY CREDIT
Emergency credit is made available to individual banks or groups
of banks facing financial stringency caused by adverse local, regional,
or national financial developments. In such operations the Federal
Reserve serves its traditional role as the ultimate provider of liquidity
— “lender of last resort”— to the economy.
A good example of this function is the action taken by the Fed
eral Reserve in the summer of 1970 following insolvency proceed
ings by a major railroad corporation. When that corporation defaulted
on its outstanding commercial paper, investors became generally con
cerned about the liquidity of a number of other large issuers of com

Other Policy Instruments
mercial paper, and as a result they cut back on their acquisitions of
such paper. This forced issuers of maturing commercial paper to turn
suddenly, and in volume, to their back-up credit lines at banks,
thereby exerting a substantial squeeze on the resources and reserve
positions of the banks involved. Since the problem was one of meet
ing a general demand for liquidity without adverse repercussions on
business confidence and since the demands of the commercial paper
issuers on banks did not represent a net expansion in the total de
mand for credit, the banks involved were allowed to cover some of
their added needs for funds through special borrowings at Reserve
Bank discount windows. Interest rate ceilings under Regulation Q
on large CD’s with relatively short maturities, which were below
market rates of interest at the time, were also suspended, thus permiting banks to bid competitively for needed deposit funds in the
market.
In its role as ultimate provider of liquidity the Federal Reserve
also stands ready to provide credits to nonmember institutions under
emergency conditions. Atlhough no credits of the latter type have
actually been provided in recent years, on several occasions— when
it appeared that net deposit drains on nonmember banks, savings
banks, or savings and loan associations might create general
liquidity problems— the machinery for emergency lending was put
in place on a contingency basis. Emergency lending to nonmember
institutions is provided at a higher interest rate than to members and
only after special authorization by the Board of Governors.

DISCOUNT RATE
The cost of member bank borrowing is set by each Reserve Bank’s
discount rate— the rate of interest established by its board of direc
tors, subject to review and determination by the Board of Governors.
As envisioned in the original Federal Reserve Act, each Reserve
Bank would set a discount rate in accord with its regional banking
and credit conditions. In the early years of the System it was as
sumed that in its review process the Board would look particularly
to regional banking conditions; but over the years, the progressive in
tegration of regional credit markets into a fluid national market grad
ually produced a national perspective for discount rate determina
tion. Establishment by Congress of national economic goals in the

Purposes and Functions
Employment Act of 1946 further enhanced the role of national con
siderations in proposals for changes in Reserve Bank rates and in
the Board’s determinations with respect to proposed changes.
Because the discount rate establishes the cost to members of re
serves borrowed from Reserve Banks, it plays a significant role in
the decisions that a bank makes about whether to borrow at the
Federal Reserve discount window. Although bankers may be reluc
tant to borrow from the Federal Reserve and may do so only to cover
temporary adjustment needs, a low discount rate in relation to other
rates on money market claims makes it more likely that a bank will
seek funds at the discount window instead of using alternative sources.
CHART 8
SELECTED INTEREST RATES, AND MEMBER BANK BORROWINGS
Per cent per annum

Monthly averages of daily figures.

Other Policy Instruments
For example, if the rate on short-term Treasury bills is high
in relation to the discount rate, a member bank may prefer to borrow
from the Federal Reserve rather than sell Teasury bills from its port
folio. Similarly, if the rate charged for reserves obtained through the
Federal funds market is high, a bank has an incentive to use the
discount window. Or if rates are high on large time CD’s, which may
be sold in some volume and relatively impersonally in the money
market, the demand for borrowing from the Federal Reserve is stimu
lated. Consequently, when spreads in these various market rates over
the discount rate make it profitable, and particularly if economic ac
tivity is buoyant and credit demands on banks are strong, member
banks in need of funds tend to make increasing use of the discount
window.
To help control the volume and profitability of borrowings at the
discount window, the Federal Reserve adjusts the discount rate from
time to time to relate it more closely to other money market rates.
On occasion, however, changes in the discount rate may signal Fed
eral Reserve concern over unfolding economic developments and a
possible intent to alter current and future policy accordingly. Reac
tions of the financial community to such signals— “announcement
effects”— may exert a significant impact on securities markets be
cause market participants will tend to adjust their investment strat
egies in anticipation of coordinated System actions via other policy
instruments. Changes in the discount rate, therefore, must be inter
preted in terms of how they complement, or are likely to be comple
mented by, other policy actions.

COORDINATION OF DISCOUNT AND
OPEN MARKET OPERATIONS
In gauging what volume of reserves to supply through open mar
ket operations to achieve monetary policy objectives, the FOMC must
take account of the extent to which member banks may wish to bor
row reserve funds from the Reserve Banks, or to repay outstanding
borrowings. Member bank borrowings generally rise during periods
of monetary stringency and fall during periods of monetary ease.

Purposes and Functions
These tendencies have to be taken into account in formulating open
market strategy.
In periods of monetary restraint for example, if open market op
erations provide a smaller increase in nonborrowed reserves than
the banks would like to have, given prevailing market conditions, the
banks may offset this shortfall in desired reserves to a substantial
extent, at least initially, by increasing their borrowing from the Re
serve Banks. But because Federal Reserve credit is available only on
a temporary basis, the upswing in such borrowing could moderate
only temporarily the restraint being exerted on the availability of
credit and money through open market operations. Rather, banks
would soon need to obtain other funds to repay their debt to the
System— by bidding more aggressively for funds in the money
market, by liquidating assets such as Treasury bills, or by restricting
the expansion of their loan portfolios. Efforts by banks to obtain
funds through alternative money market transactions or by modifying
loan policies would put upward pressure on short-term market rates,
transmit reserve shortages to other banks, set in motion upward inter
est rate adjustments throughout credit markets, and lead in time to a
slowing of expansion in the money stock.

CHANGES IN RESERVE REQUIREMENTS
Legislation enacted in 1935, with subsequent amendments, gives
the Board of Governors authority, within prescribed limits, to set
minimum ratios for the reserves that member banks must hold against
their demand and time deposits.1 These limits range from 7 to 22
per cent for demand deposits and from 3 to 10 per cent for time de
posits, depending on the size of bank. As explained in Chapter 3,
1 As banks have diversified their liabilities in recent years, the Federal Re
serve has broadened the definition of deposits to cover such liabilities and bankrelated claims as commercial paper issued by bank holding companies or non
bank subsidiaries to finance credit expansion by the affiliated bank or banks,
liabilities of banks to their foreign branches (so-called Euro-dollar borrow
ings), and finance bills (working capital acceptances) issued by banks.

Other Policy Instruments
member bank reserves consist of cash held in member banks’ vaults
and of deposit balances held at Federal Reserve Banks.
Actions by the Federal Reserve to change reserve requirements do
not affect the total amount of reserve funds held by the member
banks as a whole. Instead, they change the volume of deposits and the
volume of loans and investments that member banks can support with
the volume of reserves on hand. When required reserve ratios are
raised, the amount of deposits a given supply of reserves can support
is reduced. Correspondingly, when ratios are lowered, the volume of
liabilities and credit the banking system can support on a given
reserve supply is increased. Thus, an increase in reserve requirements
is a restrictive action and a decrease an expansive action.

USE AS A POLICY INSTRUMENT
As an instrument of monetary management, adjustments in re
quired reserve ratios are less flexible than open market operations
or changes in the discount rate. There are two reasons for this. One
is that changes in the ratio affect all member banks in a given class at
once. The second is that for each member bank the required reserve
ratio is the basis for current and forward decisions by the bank’s man
agement concerning the composition and maturity of liabilities and of
loans and investments. Frequent changes in that ratio complicate in
some degree the task of. forward planning by the management.
Furthermore, even fairly small changes in reserve requirements,
such as V2 of a percentage point, may result in relatively large
changes in the margin between total reserves and required reserves.
Thus even a small change in the required reserve ratio may have a
rather large potential impact on deposits and bank credit.
Changes in reserve requirements are normally undertaken as part
of a monetary policy strategy that is designed to help moderate in
flationary or recessive tendencies in the economy. Reserve require
ment actions have an immediate impact on banking liquidity and on
costs in all parts of the country. In contrast, if the same amount of
reserve changes were effected through open market operations, there
would be no announcement effect; instead, the impact would tend
to be concentrated at first on banks at money market centers, filter-

Purposes and Functions
ing subsequently to smaller and more remotely located banks after
some lag.
Some reserve requirement actions, however, are not designed to
affect stabilization policy. For example, a cut in reserve requirements
for member banks was implemented late in 1972 to realign reserve
requirements among member banks on a more equitable basis and
to compensate for a large, once-and-for-all reduction in bank reserve
availability incident to a reform of the System’s check-collection pro
cedures. When changes in reserve requirements are made for purely
structural reasons, the potential impact on credit market conditions
and money growth can be offset by open market operations.
Regardless of the purpose of a particular change in reserve re
quirements— whether it be to support the thrust of monetary policy
or to restructure requirements— it is always necessary to coordinate
the reserve requirement changes closely with open market and dis
count operations. For instance, changes in reserve requirements may
be timed to coincide with seasonal needs to supply or absorb reserves,
thus replacing a certain amount of open market operations that other
wise would have been needed at the time. More generally though,
the fact that the Federal Reserve can use offsetting open market ac
tions and lending operations to adjust the net amount of reserves
absorbed or provided by changes in reserve requirement ratios pro
vides a cushioning mechanism that enables the banking system to
make a smooth adjustment to a change in reserve requirements.
Additional flexibility may be provided by the reserve requirement
instrument through selective changes in the structure of requirements.
For example, in the new system of graduated requirements established
in late 1972 for demand deposits, future changes may be limited to
one or a few deposit-size categories or be made larger for some cate
gories than for others. For other deposits, requirements have typically
been different for savings and time accounts and have often been
changed independently of one another. Similarly, for time deposits
alone, requirements have been lower for small deposits, and additional
size differentiations could, of course, be introduced.
Finally, the Federal Reserve established (effective in June 1973)
a marginal reserve requirement on large time CD’s of banks. This
requirement applied to the marginal amount by which a bank’s large
CD’s and related money-market-type liabilities issued to the public
exceed the total that the bank had outstanding on a given base date.
Earlier in 1973 major banks had been promoting large CD’s ag

Other Policy Instruments
gressively as a source of funds to finance rapidly expanding loans to
business. The marginal reserve requirement was introduced in an
effort to dampen growth of business loans by raising the cost of CD
funds being used to finance such loans.

STRUCTURE OF RESERVE REQUIREMENTS
The reserve requirement percentages that were in effect on
June 30, 1974, for demand and time deposits are shown in Table 5.
For both classes of deposits the percentages are graduated, but for
demand deposits the graduation involves more steps. The demand
deposit ratios apply to “net demand deposits” (as defined in footnote
1 to Table 5). A bank with net demand deposits of $100 million, for
instance, would have reserve requirements of 8 per cent on the first
$2 million, IOV2 per cent on the next $8 million, and \2Vi per cent
on the remaining $90 million— or $12,250,000 ($160,000 + $840,000 + $11,250,000).
As of June 30, 1974, all savings deposits were subject to a straight
3 per cent requirement. These deposits are held by individuals or non
profit organizations, are ordinarily evidenced by a “passbook,” and
in practice seldom require a notice for withdrawal.2 “Other time
deposits” consist of accounts with at least 30 days to initial maturity
or with a requirement that there be 30 days’ notice before with
drawal; these include time CD’s and “time open accounts.” On these
deposits the requirement ratios were graduated a little. On deposits
of $5 million or less, the ratio was 3 per cent. Amounts in excess of
$5 million were subject to two ratios: one that may be considered
regular; the other temporary. As Table 5 shows, the regular require
ment was 5 per cent, and the marginal one was 3 per cent. Require
ments of this temporary type, referred to as marginal, may be re
moved as inflation is brought under control.
For any given bank, the total of its vault cash and of its deposits
at the Federal Reserve must be sufficient to satisfy requirements.

2 Special deposits such as Christmas and vacation club accounts held by in
dividuals are treated as savings accounts for reserve requirement purposes.
Technically, a bank may require a wait of 30 days before permitting with
drawals from savings accounts.

Purposes and Functions
TABLE 5
RESERVE REQUIREMENTS ON DEPOSITS OF MEMBER
BANKS, June 30, 1974

Type of deposits, and portion
(in millions of dollars)

Per cent of deposits

Net demand deposits:1
2 or less ....................................
2 - 1 0 ...............................................
10-100
100-400 ........................................
Over 400

8
101/2
121/2
13/2
18

Time and savings deposits:
Savings ........................................
Other time:
5 or less ..................................
Over 5:
Regular requirement
Marginal requirement . .

3
3
, 35 [S
Legal requirement range
Minimum | Maximum

Net demand deposits:
Reserve city b an k s.....................
Other banks
Time deposits ........................................

10
7
3

22
14
10

1Demand deposits subject to reserve requirements: gross demand de
posits (including interbank) less (1) cash items in the process of collec
tion and (2) demand balances due from domestic banks other than U.S.
branches of foreign banks.
-This temporary marginal reserve requirement—which was last adjusted
in December 1973—applies to the amounts by which increases in bank
issues of time deposits of large size ($100,000 or more), finance bills, and
bank-related commercial paper exceed a base. The base—set as the sum
of large time deposits ($100,000 and over), finance bills, and bank-related
commercial paper—is $10 million or the amount outstanding as of the
week ending May 16, 1973, whichever was larger. On amounts of these
instruments in excess of the base, a required reserve ratio of 8 per cent
(the 5 per cent plus an additional 3 per cent) is levied.

Since 1968 the requirements for a particular week have been com
puted on liabilities 2 weeks before.3 Consequently, the volume and
composition of liabilities in the current statement week can have no
impact on current reserve requirements; they can only affect require
ments 2 weeks hence.
“Also since 1968, vault cash used to satisfy reserve requirements is the daily
average of such cash for the week 2 weeks earlier.

Other Policy Instruments
In any week, excess reserves up to 2 per cent above requirements
may be carried into the following week to help satisfy that week’s
requirements. And any deficiency, up to 2 per cent, may be carried
into the next week. A penalty rate equal to 2 percentage points above
the discount rate is levied against deficiencies beyond the 2 per cent
carry-forward. Such deficiencies occur rarely. In the event that they
occur too often, the Board of Governors is empowered to take further
penalizing action against the offending bank.

CEILING INTEREST RATES ON TIME DEPOSITS
The Board of Governors has responsibility for establishing maxi
mum interest rates that member banks may pay for savings and time
deposits. Similar responsibility for setting ceiling rates payable by
nonmember commercial and savings banks and by insured savings
and loan associations, respectively, rests with the Federal Deposit
Insurance Corporation and the Federal Home Loan Bank Board. All
actions as to rate ceilings are taken only after consultation among
these agencies. The structure of ceiling rates so established contrib
utes to equitable competition among banks and thrift institutions for
interest-bearing deposits of the public.
Because of the structure of their assets, nonbank thrift institutions
in recent years have been at some disadvantage in competing for
funds, particularly during periods of monetary stringency. The prin
cipal assets of these institutions are home mortgages, which are long
term and illiquid assets. Assets of banks, on the other hand, generally
have a shorter average maturity and they are much more widely dis
tributed as to type— including securities, business loans, and consumer
loans, among others, as well as mortgages.
Because portfolios of mortgage loans turn over slowly, a rise in
their average yield tends to lag well behind a general advance in
market interest rates. Thus, when interest rates on market securities
rise rapidly, the returns from the assets of nonbank thrift institutions
do not keep pace. The deposit liabilities of such institutions, on the
other hand, are short-term. Hence, during periods of generally ris
ing rates, competitive pressures tend to develop for across-the-board
increases in the rates paid on deposits. In the absence of ceilings,

Purposes and Functions
these pressures could lead to unduly sharp increases in rates and con
sequently to operating losses, which might impair the solvency of
some institutions.
While helping to preserve equity among banks and thrift institu
tions, ceilings on rates for savings and time deposits may also limit
the ability of both groups of institutions to compete with issuers of
market securities for savings at times when rates of interest in both
the money and bond markets have become high relative to the ceil
ings. In this way, the existence of rate ceilings can affect flows of

CHART 9
DEPOSIT GROWTH AT THRIFT INSTITUTIONS,
AND SELECTED INTEREST RATES
Per cent 20

I________ I________ I________ I________ I________ I________ L
1967

1969

1971

1973

Interest rates: Quarterly data. Treasury bills, averages of daily rates. Thrift institutions,
averages of highest ceiling rates payable on consumer-type deposits at mutual savings banks
and savings and loan associations. During the period July 1—Oct. 31, 1973, when the rate
ceiling on 4-year, $1,000 minimum-denomination consumer-type certificates of deposit was
suspended, most institutions offered rates no higher than IV 2 per cent on these deposits.
Deposit growth: Quarterly changes, at seasonally adjusted annual rates, in total deposits
at mutual savings banks and in savings capital at savings and loan associations.

Other Policy Instruments
funds through banks and related institutions and thereby influence
the availability of credit to particular types of borrowers, such as
businesses and home buyers. During periods of restrictive monetary
policy, therefore, unless ceilings are reasonably adjusted to levels of
market rates, the administration of rate ceilings may adversely affect
borrowers who rely heavily on either banks or thrift institutions to
meet their credit needs, as compared with borrowers who have access
to the open market.
Many proposals have been advanced in recent years to remove or
to limit the application of ceilings on interest rates for time and sav
ings deposits. Since May 1973 ceiling rates on large time deposits—
$100,000 or more— have been suspended. Most of these deposits are
sold by banks to corporations, State and local governments, and other
large, active investors; and the bulk of them take the form of nego
tiable time CD’s. Ceiling rates remain, however, on smaller consumertype time and savings deposits, which are the focal point of competi
tion among banks and nonbank thrift institutions. Proposals to remove
ceiling rates on consumer-type time deposits have often been accom
panied by proposals to widen the services and the lending powers
of nonbank thrift institutions so that these institutions will have a
broader and more flexible earnings base.
The ceiling rates of interest applicable to time and savings deposits
at commercial banks as of June 30, 1974, are shown in Table 6. These
ceilings are moderately lower than those for nonbank thrift institutions.
During periods of economic expansion, commercial banks that are
particularly aggressive in extending credit to large businesses often
obtain funds to finance those loans by issuing large CD’s. Sales of
these instruments, when not constrained by rate ceilings, are an effec
tive means of attracting a large volume of funds in a short period of
time. Because these large CD’s are usually sold to investors that are
highly sensitive to rate differentials, a small change in offering rates
may induce large swings in the amounts of CD’s sold. For that rea
son, when ceilings on such deposits are below rates available on com
petitive market instruments, large net run-offs tend to occur as holders
switch to higher-yielding money market securities.
That is what happened in the tight money episodes of 1966 and
1969-70. In those periods ceiling rates on CD’s were not raised to
remain competitive with market rates— in an attempt to exert pressure
on the banks that were most responsible for making loans to large

Purposes and Functions
TABLE 6
MAXIMUM INTEREST RATES PAYABLE ON TIME AND
SAVINGS DEPOSITS AT COMMERCIAL BANKS
June 30, 1974

Type, and maturity

Per cent per annum

Savings deposits
Other time deposits: 1
Less than $100,000:
30-89 days
90 days-1 year
1 -2 V i years
2 V i years and over
4 years and over 2
$ 1 0 0 ,0 0 0 and over

5
51/2
6
61/2
7 1 /4

No ceiling

1 Multiple- and single-maturity.
2 Minimum denomination for deposits of this maturity is $1,000.

corporate businesses. As a result, businesses began to place increasing
reliance on obtaining funds in the commercial paper and bond mar
kets, sources of funds that are not readily available to such borrowers
as small businesses and consumers. The result of these developments
was a great deal of churning in financial markets, a loss to some degree
of the stability in financial flows and risk-taking associated with finan
cial intermediation, and perhaps a disporportionate credit squeeze on
those bank customers unable to shift to open market sources of funds.
In June 1970, following the bankruptcy of a major railroad, ceil
ing rates on short-maturity (30- to 89-day) time CD’s were sus
pended to permit banks to bid freely for the funds needed to cover
large, unexpected calls on bank credit lines by businesses that were
being forced out of the commercial paper market at that time. There
after, short-term market rates dropped below rate ceilings on longer
maturity bank CD’s, so the ceilings on those instruments, which were
still in effect, were no longer a deterrent to bank issuance of such
instruments. In May 1973, when advances in market interest rates
above ceilings again began to make longer maturity CD’s noncom
petitive, ceilings on longer maturity CD’s were also suspended, and as
of mid-1974 they had not been reinstated. The intent of the continuing
suspension has been to permit smoother and more equitable adjust
ments, by both banks and borrowers to changing market conditions.

Other Policy Instruments

MARGIN REQUIREMENTS
The Securities Exchange Act of 1934, with amendments, author
izes the Board of Governors to regulate the use of credit for pur
chasing or carrying securities. In exercising this responsibility the
Board imposes limitations on the amount of such credit that may be
provided by brokers and dealers (Regulation T ), banks (Regulation
U ), and other lenders (Regulation G ). In order to prevent borrowers
from obtaining more credit abroad than lenders are permitted to sup
ply in this country, as well as to improve compliance generally, all
U.S. persons who use securities credit are required to comply with
the Board’s margin regulation (Regulation X ).
Regulatory limitations apply to corporate stocks (and bonds con
vertible into stocks) registered on national exchanges or designated as
“over-the-counter margin stocks.” 4 Brokers and dealers are permitted
to extend credit only on such stocks. Brokers and dealers extend the
bulk of all regulated security credit; in recent years they have
accounted for more than four-fifths of such credit.
All bank loans extended for purposes of financing the purchase or
carrying of equity securities that fall within the definition of margin
stocks are subject to the margin requirement if collateralized by any
stock. Other bank loans with similar collateral but for a different pur
pose are not. In addition, bank loans extended to customers for the
purpose of purchasing or carrying nonmargin stocks are not subject to
Regulation U.
The amount that lenders may advance against securities is always
less than the current market value of the securities pledged as collat
eral at the time the loan is made. The difference between the two is
termed the initial margin. For example, if a loan of $3,500 is required
to be secured by stock having a market worth of at least $10,000, the
customer’s margin is at least $6,500, or 65 per cent of the market
4The Federal Reserve maintains a list of selected stocks that are not listed on
a registered national exchange but that have certain characteristics similar to
listed stocks. The stocks on this list, which are designated as over-the-counter
margin stocks, are treated the same as listed stocks for margin purposes. Such
limitations also apply to mutual fund shares and a variety of securities—such as
warrants, rights, and puts and calls—that may be purchased with the object of
controlling an exchange-registered security or margin stock.

Purposes and Functions
value, and the maximum loan value of the stock is 35 per cent. Thus,
the higher the margin requirement, the less that can be loaned. In
recent years margin requirements have varied from 50 to 80 per cent
on stocks and from 50 to 60 per cent on convertible bonds.
Federal Reserve regulations require the lender to obtain the speci
fied margin in connection with the purchase or pledging of securities
to be used as collateral. If the market value of the security that is
used as collateral for the loan subsequently declines, the regulation
does not make it necessary for the borrower either to put up addi
tional collateral or to reduce his indebtedness. Similarly, if the Federal
Reserve raises the margin requirement, borrowers need not reduce
existing loans (or increase the amount of collateral deposited with the
CHART 10
MARGIN REQUIREMENTS AND RELATED ITEMS
100

Per cent of market value

100
T------------------ j-----

1----------------------------1

Margin requirements
9

Ratio scale

Billions of dollars

Dec. 31, 1965 = 50 90
80

Stock prices

Margin debt at brokers
30
1968

1969

1970

1971

1972

1973

tock prices, New York Stock Exchange index, monthly averages. Margin debt, end-offigures for credit extended on stocks or related equity instruments and secured at
n part by stocks.

http://fraser.stlouisfed.org/
IBRARY,
Federal Reserve Bank of St. Louis

Other Policy Instruments
broker, bank, or other lender). However, the lender making the loan
may require additional collateral at any time if he deems it neces
sary. In fact, the New York Stock Exchange requires brokers to
issue calls for more margin if credit extended exceeds 75 per cent of
the market value of the collateral in a customer’s margin account,
and a number of brokers require additional margin even before the
Exchange-imposed level is reached.
In the event that borrowers whose accounts have become undermargined— whether because of declines in market prices or increases
in margin requirements— sell any of the securities they have pledged
as collateral, they must apply a portion of the proceeds of such sales
to reduce their indebtedness. In recent years the portion of the
proceeds to be applied to reduce indebtedness has been 70 per cent.
There is an exception to this rule: Borrowers with margin at or
above a specified level (40 per cent on June 30, 1974) are permitted
to apply all of the proceeds of a sale of securities toward a purchase
of securities when the purchase is made on the same day as the sale.
The main purposes of margin requirements are to minimize the
danger of excessive use of credit in financing stock market specula
tion and to prevent the recurrence of speculative stock market booms
based on credit financing, such as culminated in the collapse of stock
prices in 1929 and the subsequent severe liquidation of securities
credit. Although sharp changes in stock prices are always possible,
the absence of excessive credit-financed speculation is likely to be an
important factor in limiting cumulative price declines and in mini
mizing the risk that stock market fluctuations will have disruptive
effects on financial markets and the economy generally, as well as on
the individual investor.

SELECTIVE CREDIT CONTROLS
During and after World War II and in the Korean war period the
Federal Reserve was given the additional responsibility for selective
regulation of consumer instalment credit, and in the Korean war this
responsibility was extended to real estate credit as well. For both
types of credit the objective was to encourage postponement of spend

Purposes and Functions
ing on durable goods as a means of releasing scarce national resources
for war production and of minimizing inflationary pressures on prices
and wages. The controls established for consumer credit set minimum
downpayments and maximum maturities on instalment purchases of
consumer durable goods; those on real estate credit set maximum
maturities and maximum loan-to-value ratios on mortgage-financed
purchases of housing. As of mid-1974 no such controls were author
ized. But the Credit Control Act of 1969 does provide that “when
ever the President determines that such action is necessary or appro
priate for the purpose of preventing or controlling inflation generated
by the extension of credit in an excessive volume, the President may
authorize the Board [of Governors] to regulate and control any and
all extensions of credit.”
In some other countries the central bank’s authority extends to
programs that grant favorable credit terms to certain classes of bor
rowers— such as exporters, farmers, and small businesses— because
these borrowers are at a disadvantage in competing for credit funds
with large businesses through usual market channels and because the
well-being of such borrowers in the economy is considered to war
rant a special financing subsidy. The United States has a number of
financial programs with somewhat similar objectives, but all of them
are administered by public agencies other than the Federal Reserve.
By keeping decisions regarding the support to be given to particular
groups of borrowers separate from monetary policy decisions, which
affect the flow of credit and money generally, the risk of inflationary
credit expansion through high-powered central bank money is re
duced.
□

The
federal Reserve in
the international
S>ph<ere
QtapterSix

The U.S. economy is an important, interdependent part of the
world economy. Economic and financial developments in this country
have a major influence on the evolution of economic activity in the
rest of the world. In turn, the U.S. economy is significantly affected by
economic and financial developments abroad. The U.S. dollar has
long played a leading role in international monetary arrangements as
the national currency most used in international transactions and most
widely held in official reserves.
The operations and activities of the Federal Reserve are affected by
these international economic and financial interrelationships in various
ways:
• The Board of Governors and the FOMC take account of the U.S.
balance of payments, movements in exchange rates, and other inter
national economic and financial developments in making U.S. mone
tary policy.
• The Federal Reserve Bank of New York handles the mechanics
of official reserve transactions with foreign central banks, and in some
cases these transactions call for Federal Reserve open market opera
tions to offset undesired effects on domestic monetary conditions.

Purposes and Functions
• Transactions may be undertaken by the Federal Reserve in the
foreign exchange markets, and these transactions, as well as similar
transactions by foreign central banks, may be facilitated by currency
“swap” operations.
• The Board of Governors takes various actions of a regulatory or
supervisory nature that affect the international transactions and for
eign operations of U.S. banks and the U.S. activities of foreign banks.
In addition, the Federal Reserve plays an advisory and consultative
role within the U.S. Government in discussions of international finan
cial matters; it supports other agencies of the U.S. Government in this
country’s participation in various international organizations; and it
maintains informational contacts with the central banks of other
countries.

MONETARY POLICY AND INTERNATIONAL
ECONOMIC DEVELOPMENTS
In forming the judgments about prospective economic develop
ments that underlie monetary policy decisions, Federal Reserve policy
makers regularly take into account the relationships that link the
domestic economy to the rest of the world— for example, the forces
that affect foreign demand for U.S. goods and services, the deter
minants of supply and demand in this country for U.S. products that
compete with imports, the factors influencing international flows of
funds, and the effects of international flows of funds on domestic
financial markets. These relationships are viewed from two related
perspectives. First, developments in the rest of the world may have
significant implications for the domestic economic objectives of the
United States and for the use of monetary policy in attaining these
objectives. Second, economic developments in this country have im
portant influences on the net balance of goods and services transactions
and the net flow of long-term and liquid capital between the United
States and foreign countries, which in turn affect the international
value of the dollar and the international reserve position of the
United States.
Changes in exchange rates between the U.S. dollar and other major
currencies, such as those that occurred in 1971-73, are among the
forces that have important effects on demands for U.S. goods as com-

In International Sphere
CHART 11
U S. BALANCE OF PAYMENTS
Billions of dollars 10
T

1961

I___ I___ I___ I____I___ I___ I___ I___ I___ I____I___ I___
1963

1965

1967

1969

1971

1973

Data are from U.S. Dept, of Commerce.

pared with foreign goods. Also, changes in the pressures of demand in
other countries are often communicated to the U.S. economy— some
times through changes in the volume of international trade, and at
other times through effects on the prices of basic commodities ex
ported or imported by the United States. Conversely, developments in
the United States affect the U.S. trade position. For instance, rapid
growth of aggregate demand and disproportionate increases in U.S.
prices will tend to encourage larger imports and discourage higher
exports.
Capital flows between the United States and foreign financial centers
also are taken into account in formulating U.S. monetary policy. Such
flows may have important effects in particular sectors of U.S. financial
markets. In addition, they may at times affect, as well as reflect, con
fidence in the value of the dollar both here and abroad.
International capital flows tend to be generated by changes in inter
national differentials in interest rates— as when U.S. interest rates have

Purposes and Functions
fallen in response to slack demands in domestic monetary markets, or
conversely, have risen in a period of strong credit demands. They may
also be generated by expectations of changes in exchange rates. Funds
tend to flow into the United States when the dollar is expected to rise
in value relative to foreign currencies, and conversely, they tend to flow
out when the dollar is expected to decline in value.
Minor modifications in the instruments of monetary policy can at
times be of some help, at least temporarily, in influencing undesired
outflows or inflows. For example, the reserve requirements imposed on
borrowing by U.S. banks from abroad can be varied so as to moderate
sharp swings in such borrowing. Consideration may be given to inter
national capital flows in decisions about the timing of discount rate
changes. Or to moderate downward pressures on U.S. short-term
interest rates that might cause a capital outflow, the Federal Reserve
may give consideration to purchasing long-term rather than short-term
securities in its open market operations to supply reserves to the bank
ing system.

INTERNATIONAL RESERVE TRANSACTIONS
The extent to which an imbalance in the international payments and
receipts of the United States is reflected in a movement of exchange
rates or in an over-all surplus or deficit in the balance of payments
depends upon the extent to which foreign central banks or the U.S.
monetary authorities intervene in foreign exchange markets. At one
extreme, if exchange rates were allowed to float freely without any
official intervention in exchange markets, any tendency for a net out
flow of private funds from the United States would lead to a
depreciation of the dollar in exchange markets; any tendency for a net
inflow would lead to an appreciation. These changes in exchange
rates would tend, in turn, to limit inflows or outflows. However, when
central banks are willing to buy or sell dollars in quantity in order to
maintain exchange rates within a narrow range around a fixed parity,
as was generally the case during the postwar period to early 1973, or
in order to moderate market fluctuations in exchange rates, as was
generally the case after early 1973, a significant part or even all of
the tendency for a net flow of private funds into or out of the United

In International Sphere
States is reflected in an over-all surplus or deficit in the U.S. balance
of payments.1
These surpluses or deficits are settled either by transfers of primary
international reserve assets— gold, SDR’s,12 or reserve positions in
the International Monetary Fund (IM F)— or by changes in U.S.
liabilities to foreign official institutions.
Normally, surpluses or deficits in the U.S. balance of payments,
either because of the way they are financed or because of offsetting
actions by the Federal Reserve, do not have a direct effect on the U.S.
monetary base. This is true even when surpluses or deficits are very
sizable, as U.S. deficits were, for instance, in 1970-72. In this respect
U.S. experience differs from that in other countries, where balance of
payments surpluses often have a strongly expansionary effect, and defi
cits a contractionary effect, on the monetary base. This is discussed
further in the later section on reserve transactions with foreign central
banks.

OWNERSHIP AND MANAGEMENT OF INTERNATIONAL
RESERVE ASSETS
The international reserve assets of the United States are owned
mainly by the U.S. Treasury. They comprise gold, SDR’s, the reserve
position of the United States in the IMF, and foreign currency balances
(part of which may be held by the Federal Reserve). The SDR’s, a
small part of the gold, and the Treasury’s foreign currency balances
(which are generally small) are held by the Treasury’s Exchange Sta
bilization Fund, which is operated by the Federal Reserve Bank of New
York as fiscal agent of the United States.
At times the Federal Reserve has held in its own name fairly sizable
amounts of the country’s international reserves in the form of foreign
currency balances. Such holdings can arise under the swap network,
as described later in this chapter, or can result from direct market
purchases of currencies by the Federal Reserve Bank of New York
under FOMC authorization.
1 More precisely, in a surplus or deficit on the “balance of official reserve
transactions.”
2As noted in Chapter 3, SDR’s are Special Drawing Rights in the International
Monetary Fund; the first SDR’s were created on Jan. 1, 1970.

Purposes and Functions
CHART 12
U.S. RESERVE ASSETS
Billions of dollars 20

I--------- 1---

Total

Other countries also hold primary reserve assets in the form of gold,
SDR’s, and reserve positions in the IMF. But in addition many of them
hold an important part of their international reserves in the form of
U.S. money market instruments, especially U.S. Treasury securities.
Their holdings of U.S. Treasury securities include marketable issues
and special nonmarketable issues, mostly payable in U.S. dollars.
Other reserve holdings include balances with commercial banks in the
United States and elsewhere and securities and deposits held with
central banks in countries other than the United States.
Some foreign official institutions have part of their gold kept in cus
tody— that is, “under earmark”— at the Federal Reserve Bank of New
York. That Bank also holds in custody most of the U.S. Treasury
securities owned by foreign monetary authorities. In most instances
when foreign central banks decide to buy or sell U.S. Treasury se-3
3 Foreign central banks’ deposits in U.S. banks are reserve liabilities of the
United States, but their dollar deposits with banking institutions operating
abroad are not.

In International Sphere
CHART 13
FOREIGN RESERVE ASSETS IN THE UNITED STATES
Billions of dollars 75

curities, the Federal Reserve Bank of New York executes the transac
tion— sometimes in the market and sometimes through direct trans
actions with the Federal Open Market Account. The foreign central
banks also have non-interest-bearing deposit accounts at the Federal
Reserve, but these are working balances, and they are generally kept
relatively small.

RESERVE TRANSACTIONS WITH FOREIGN
CENTRAL BANKS
It is mainly by intervening in foreign exchange markets in response
to an imbalance in international payments that foreign central banks
acquire or relinquish dollar assets. Because of the wide use of the
dollar in international trade and finance, there is active buying and
selling of dollars against other countries’ currencies in foreign ex
change markets here and abroad. If and when the exchange rate— as

Purposes and Functions
determined by the demand for and supply of dollars by businesses,
investors, and commercial banks— tends to move outside a range set
by international agreement or by national policy, a central bank may
intervene in its market by buying or selling dollars in order to influ
ence the rate. When rates are allowed to float, as has been the case for
many important currencies since early 1973, central banks have
no obligation to support exchange rates within prescribed margins,
but they may intervene from time to time to moderate exchange rate
fluctuations.
In recent years payments imbalances between the United States and
other countries have been settled almost exclusively by changes in U.S.
official liabilities rather than by transfers of primary reserve assets.
That is, foreign central banks have increased their holdings of U.S.
Treasury securities with dollars acquired through exchange market
intervention, or have reduced their holdings in order to sell dollars.
Such market interventions and transactions in Treasury securities,
taken together, have no effect on member bank reserves, apart from
the transitory effects of fluctuations in the deposits of foreign central
banks at the Federal Reserve Bank of New York4 or of transitory
fluctuations in Treasury deposits at the Reserve Banks— such as occur
when the Treasury issues or redeems nonmarketable special securities
for foreign central banks.
When international reserve transactions take the form of transfers
of primary reserve assets between the United States and foreign coun
tries, the bank reserve base is directly affected, but the reductions or
enlargements of member bank reserves in this case can be offset by
Federal Reserve open market purchases or sales of Treasury securities.
This is a normal feature of the procedures by which monetary policy
is executed in the United States.
For example, if a foreign central bank were to use dollars acquired
through exchange market intervention to purchase gold or SDR’s from
this country, there would be an associated reduction in member bank
reserve balances. The reduction in such balances would occur as the
foreign central bank transferred funds out of member banks into its
4 The amounts of funds that flow through these deposit accounts are very large,
but the changes in outstanding balances are generally small. In 1973, for exam
ple, month-end foreign deposits at the Federal Reserve varied only between
$250 million and $455 million.

In International Sphere
account at the Federal Reserve before it bought the gold or SDR’s.
But in the absence of a monetary policy decision to the contrary, such
a reduction in bank reserves would normally be offset by Federal Re
serve open market purchases.
At the time the foreign country’s purchase of primary reserve assets
occurred, the foreign account would be restored to its original level,
and the books of the Federal Reserve would show an offsetting decline
in gold certificate or SDR certificate assets, as was explained in Chap
ter 3. No change would occur in the Treasury balance at the Federal
Reserve if gold or SDR certificates were withdrawn in an amount equal
to the Treasury’s sale of gold or SDR’s.5 No further change in member
bank reserves would occur.
Thus, whether the international reserve transactions that accompany
foreign central bank intervention in the exchange markets take the
form of transactions in U.S. Treasury securities or the form of
transfers of primary reserve assets, in neither case are there any but
transitory changes in the total volume of member bank reserves— in
the absence of some deliberate decision of monetary policy.
Moreover, in each case purchases of securities by monetary authori
ties— whether by foreign central banks or by the Federal Reserve—put
funds back into domestic financial markets when the country’s over-all
balance of payments is in deficit. Or if there is a balance of payments
surplus, official sales of securities— either by foreign central banks or
by the Federal Reserve— take funds out of domestic financial markets
to offset the funds that flow in as the country’s international receipts
exceed payments.
Thus, the general level of interest rates in the United States may
not be raised or lowered by the monetary mechanics set in motion
by a deficit or surplus in the U.S. balance of payments. But relative
yields on different money market instruments are likely to be affected,
especially in the short run. For example, the private withdrawals of
funds from U.S. financial markets associated with a balance of pay
ments deficit may put upward pressure on interest rates in some sec
tors of the market, but the accompanying official purchases will push
Treasury bill yields down.3
3 International reserve transactions handled through the Exchange Stabilization
Fund, without affecting Federal Reserve asset accounts, cause transitory fluctua
tions in Treasury deposits at the Federal Reserve—just as when nonmarketable
special securities are issued to foreign central banks or are redeemed.

P u rp o se s a n d F u n c tio n s

FOREIGN CURRENCY OPERATIONS
The Federal Reserve has engaged in foreign currency operations to
cushion the effects on international reserves of flows of payments due
to temporary forces, to smooth out abrupt changes in foreign exchange
rates, or to avoid disorderly conditions in foreign exchange markets.
Such operations, which are conducted in consultation with the U.S.
Treasury, are not intended to have any far-reaching influence on the
underlying trends in international trade and capital transactions. At
times, however, they may have useful short-run effects on the stability
of foreign exchange markets— such as serving to check speculative
flows of funds stimulated by rapidly changing exchange rates or by
rapid gains or losses in a country’s international reserves.
Federal Reserve foreign currency transactions are directed by the
FOMC. A Special Manager at the New York Federal Reserve Bank
acts as the Committee’s agent in carrying out such transactions. Peri
odic policy directives are issued by the Committee to provide the
authority and operating guidelines for the Special Manager.

“SW A P ” N E T W O R K
A major feature of the Federal Reserve’s foreign exchange opera
tions is the use made of a network of inter-central-bank reciprocal
currency arrangements—commonly known as “swap” facilities. In ex
change market terminology a “swap” is a pair of transactions between
two parties entered into simultaneously: (1) a “spot” purchase or sale
of one currency against another, and (2) a “forward” contract to resell
or repurchase the currency after a specified period of time at a specified
rate. This forward rate may be the same as the rate used in the spot
transaction, or it may differ from the spot rate enough to yield the
equivalent of interest to one of the parties. In effect, the holder of a
currency balance covered by such a forward contract is protected
against any risk of a depreciation of the other currency against his
own; the holder has what is called an “exchange value guaranty.”
The swap arrangements between foreign central banks and the
Federal Reserve have generally provided that if one central bank has
initiated a swap transaction with a second central bank, and if that

100

In International Sphere
CHART 14
EXCHANGE RATES
300 U S. cents * _________________ Ratio scale_______________________U.S. cents*

200
110

Canadian dollar

1969

1970

1971

1972

1973

* Per unit of foreign currency.

101

Purposes and Functions
second central bank and its government are about to revalue its cur
rency upward, the swap will be unwound before the revaluation occurs.
Under these conditions the debtor central bank— that is, the bank
that initiated the swap drawing— will not suffer a loss in obtaining
the currency it needs to fulfill the swap contract. Under circumstances
in which the dollar floats against other currencies, these provisions
may not be applicable. For example, during 1973, when most major
currencies were on a floating basis, the Federal Reserve had agree
ments with certain other central banks specifying that profits and
losses from market intervention by the Federal Reserve would be
shared equally by the Federal Reserve and the foreign central bank
participating in the agreement.
As of mid-1974, the Federal Reserve’s swap network included
arrangements with 14 foreign central banks and the Bank for Inter
national Settlements; together these totaled almost $20 billion. Draw
ings on a particular swap line may be initiated by either party.

DRAWINGS BY FOREIGN CENTRAL BANKS
Foreign central banks have drawn on the swap network to obtain
dollars with which to intervene in exchange markets in order to keep
the exchange rate for their currencies against the dollar from falling
below a predetermined “floor” level. In such cases the Federal Re
serve acquires and retains a balance in the foreign currency— covered,
as explained above, by an exchange-value guaranty— until the swap
is unwound. Any such foreign currency balance is counted as part of
the international reserves of the United States.
The acquisition in this way of foreign currency reserves by the
United States plays the same role in financing a U.S. payments sur
plus as would a decline in the dollar reserve holdings of foreign
countries. However, the swap drawings may help the foreign country
to resist speculative pressures in foreign exchange markets stimulated
by the country’s loss of reserves.
In relation to U.S. domestic financial markets, too, the ultimate
impact of a U.S. acquisition of foreign currency reserves through a
swap drawing by a foreign central bank is much the same as when
a foreign country uses its dollar reserves. In either instance the pay
ments deficit of the foreign country generally involves a sale of U.S.

102

In International Sphere
Government securities— in the first case by the Federal Reserve
(since a rise in Federal Reserve holdings of a foreign currency is
normally accompanied by an offsetting Federal Reserve open market
sale of securities) and in the second by the foreign central bank.
Open market sales by the Federal Reserve in the case of swap draw
ings by foreign countries serve to prevent the increase in member
bank reserves that would otherwise result from the foreign central
banks’ foreign exchange market sales of the dollars it had obtained
through its swap drawing.

DRAWINGS BY THE FEDERAL RESERVE
The Federal Reserve has utilized swap drawings in basically two
types of situations.
Throughout most of the later 1960’s, and particularly prior to the
economic policy measures taken by the administration in August 1971,
swap drawings of foreign currencies by the Federal Reserve enabled
the System to give a temporary exchange-value guaranty to foreign
central banks accumulating dollars, and thereby to delay or avoid
additional foreign requests for gold sales by the U.S. Treasury. In such
cases the Federal Reserve used the foreign currency immediately to
buy the additional dollars accumulated by the foreign central bank.
Thus, the foreign central bank’s additional holdings of “uncovered”
dollars were replaced by dollar assets that were “covered” or protected
against exchange rate risk.
Ordinarily, these “covered” dollar assets took the form of special
nonmarketable U.S. Treasury securities, while the rate protection was
afforded by the Federal Reserve’s obligation to return a specified
amount of national currency to the foreign central bank at the termi
nation of the swap. To fulfill this obligation, the Federal Reserve
acquired the foreign currency through subsequent market purchases,
or it arranged to buy such currency directly from the foreign central
bank. Otherwise, the Federal Reserve had to buy the needed currency
from the U.S. Treasury following either a gold sale or an IMF draw
ing through which the Treasury acquired the foreign currency.
Swap drawings of the type just described— to help delay or avoid
reductions in U.S. reserve assets— had not been made since August
1971 up to the time of this writing. As of August 15, 1971, when

103

Purposes and Functions
the U.S. Government suspended convertibility of the dollar into gold
or other reserve assets, drawings outstanding amounted to about
$3 billion. By the spring of 1974, repayments amounting to roughly
$1.8 billion had been made on these swap drawings initiated prior
to August 15, 1971.
In the second type of situation, the Federal Reserve has drawn on
the swap lines to finance sales of foreign currencies in the New York
market in order to maintain orderly trading conditions in the ex
changes. In fact, this is the way swap drawings were utilized in
the early days of the network. Such direct operations in support of
the dollar were initiated again in July 1972 and were conducted
prior to the devaluation of the dollar in February 1973. Between
February 12, 1973, and early July 1973, there were no System
operations. Following the announcement of the expansion of the swap
network to $18 billion on July 10, 1973, however, the Federal Re
serve resumed intervention in the New York market.
When a swap drawing is made to finance market intervention, the
Federal Reserve acquires foreign currency from the foreign central
bank, which it sells in the New York market. The account of the
foreign central bank with the Federal Reserve is simultaneously
credited with an equivalent amount of dollars and that bank in turn
uses the dollars to acquire a U.S. Treasury security. As in any
other swap drawing, the two parties agree to reverse the transaction in
3 months; in order to do this, the System obtains the required foreign
exchange either by subsequent market purchases or by some nonmarket transaction.

REGULATION OF FOREIGN OPERATIONS OF
U. S. BANKS
In the field of regulation and supervision, the Board of Governors
takes various kinds of actions that affect the international transactions
and foreign operations of U.S. commercial banks and the U.S. activi
ties of foreign banks. For example: (1) By establishing reserve re
quirements against borrowings by member banks from their foreign
branches and lending by these branches to U.S. residents, in part for
balance of payments reasons and in part to serve domestic monetary
policy objectives, the Board affects the costs, and hence the volume,

104

In International Sphere
of these transactions. (2) Through guidelines promulgated for bal
ance of payments reasons, the Board for a number of years limited
the volume of foreign lending and investing of U.S. banks and non
bank financial institutions. (3) The Board acts on applications by
member banks to establish or acquire foreign branches and foreign
affiliates, as well as to establish, under the Federal Reserve Act, cor
porations engaged in foreign banking and financing (“Edge Act
corporations” ); and once these entities have been established, the
Board regulates and supervises their activities in various ways.
The following paragraphs deal with the first two kinds of actions.
The third is described in Chapter 7.

SPECIAL RESERVE REQUIREMENTS AGAINST
FOREIGN BORROWING BV MEMBER BANKS
With the growth of the Euro-dollar and other Euro-currency mar
kets in recent years, many of the largest banks in the United States
have been able to supplement their borrowings of interest-sensitive
funds from such domestic sources as the market for large negotiable
CD’s and the interbank loan market for Federal funds by obtaining
from their branches abroad funds that these institutions in turn had
borrowed in the Euro-currency markets. The reserve requirement
against member banks’ liabilities to their branches, introduced in
1969, adds to the net cost of loanable funds obtained in this way.
At the time the Board adopted this so-called “Euro-dollar reserve
requirement,” U.S. banks had been borrowing very large sums from
the rest of the world through Euro-dollar channels. This development
had had undesirable effects on some other countries’ balances of pay
ments and on their financial markets, as well as on conditions in U.S.
credit markets. A requirement of 10 per cent against increases in
such borrowing above specified reserve-free bases was imposed in the
early fall of 1969. The requirement was also applied against borrow
ings directly from a foreign bank and against loans by a foreign
branch of a U.S. bank to U.S. residents (unless the U.S. resident was
a business firm using the proceeds of the borrowing abroad pursuant
to the capital control program supervised by the Department of
Commerce). Since 1969 the reserve requirement on Euro-dollar
borrowings has been adjusted in various ways in light of balance of
payments and monetary policy objectives.

105

Purposes and Functions
VOLUNTARY FOREIGN CREDIT RESTRAINT (VFCR)
A program for voluntary restaint of foreign lending— the second
kind of Federal Reserve action mentioned above— was started in
1965 at the request of the President of the United States with the
immediate aim of ameliorating the U.S. balance of payments deficit by
holding down the net outflow of bank loans to foreign borrowers and
of investments abroad by other financial institutions. Flows to Canada,
after February 1968, long-term investments in developing countries
by nonbank financial institutions, and after late 1971, credits to fi
nance U.S. exports were exempt from coverage. The VFCR program
was terminated on January 29, 1974, along with various other capital
control programs administered by the U.S. Government.
□

106

Bank Regulatory
and Supervisory
fu n ctio n s
QTapter Severi

One of the purposes of the original Federal Reserve Act, stated in
its preamble, was “to establish a more effective supervision of bank
ing”; to this end the Federal Reserve System has been given important
responsibilities for regulating the structure and operations of the U.S.
banking system and related activities. These responsibilities include
(1) the regulation and supervision of banks that are members of the
Federal Reserve System— especially those that are State-chartered;
(2) administering the Bank Holding Company Act and, in part, the
Bank Merger Act; (3) regulating foreign activities of U.S. banks; and
(4) administering “truth in lending” regulations covering consumer
credit.

BANK REGULATION AND SUPERVISION
Commercial banks play a vital role in the economic life of a com
munity, and the maintenance of their economic health represents a
major aim of public policy. The supervision and regulation of such
banks by both Federal and State regulatory agencies is important to
the maintenance of a sound banking system.

107

Purposes and Functions
While the terms bank regulation and bank supervision are often
used interchangeably, they are different. Essentially, bank regulation
is the formulation and issuance by authorized agencies, under govern
ing law, of specific rules or regulations for the conduct of banking.
Bank supervision is concerned primarily with the safety and the
soundness of individual banks, but it also involves the general and
continuous oversight of the activities of this essential service industry
to determine whether the industry’s component business units are
operating competitively and constructively in accordance with appli
cable regulation and statute.

FEDERAL SUPERVISORY STRUCTURE
Several governmental bodies share the responsibility for the wide
range of functions associated with bank regulation and supervision.
This supervisory structure has evolved partly as a legislative response
to the complexity of the U.S. banking system— with its thousands of
banks of varying size and numerous bank-chartering authorities. In
part, however, it is the product of a succession of problems that U.S.
banking has faced over the past century and of the wide variety of
Federal and State banking laws and regulations designed to remedy
these problems. As a result, three Federal bodies with related but
somewhat different bank regulatory functions now complement the
supervisory authorities of the 50 States.
This arrangement has inevitably led to some overlapping of respon
sibility. For example, the Comptroller of the^Currency possesses by
statute the power to grant charters to national banks. As their char
tering authority, the Comptroller also has principal responsibility for
the regulation and supervision of these banks. By statute, the Federal
Reserve has a general regulatory and supervisory responsibility for the
operations of all member banks— including national banks, since they
are required by law to be members of the System. Statutes also assign
to the Federal Reserve a special and more immediate regulatory and
supervisory responsibility over State member banks. The third regu
latory body, the Federal Deposit Insurance Corporation, has limited
supervisory responsibility over member banks because, by statute, the
deposits of national banks and of State-chartered member banks must
be insured by that body. However, its principal supervisory responsi

108

Regulatory and Supervisory Functions
bility is over insured nonmember banks. In practice, the several State
and the three Federal supervisory agencies have established arrange
ments that reduce substantially the effects of overlaps associated with
joint regulatory responsibility.

SCOPE OF FEDERAL RESERVE SUPERVISORY
FUNCTIONS
The Federal Reserve has authority to conduct field examinations of
all its member banks. Inasmuch as the Federal Reserve recognizes
that the Comptroller of the Currency has primary responsibility for
the supervision and examination of member banks that are nationally
chartered, it carries out its responsibilities concerning those banks pri
marily by keeping informed of changes in their operating conditions,
as disclosed in reports received from them and from the Comptroller.
Therefore the Federal Reserve exercises a primary supervisory re
sponsibility only for those member banks that are State-chartered.
This primary supervisory role of the Federal Reserve System de
rives from its statutory responsibility for admission of State-chartered
banks to membership in the System. In addition to supervising such
admissions, the Federal Reserve has responsibility for examining
State member banks, for enforcing regulations and statutory provi
sions pertaining to State member banks (such as restrictions on asset
holdings), and for requiring that unsatisfactory operating conditions
of such banks be corrected.
In addition to these functions, the Federal Reserve possesses regu
latory power over relevant technical matters pertaining to the opera
tions of State member banks. These include the scope of their corpo
rate functions, the authorization of any new branches they may seek
to establish, and approval of such permissible changes as they may
desire to make from time to time in their capital structures.
The Board of Governors delegates certain of its supervisory func
tions to the Federal Reserve Banks; these functions include the con
duct of field examinations of State member banks and the authority
to approve certain types of applications of State members— for ex
ample, to establish domestic branches. However, the Board of Gover

109

Purposes and Functions
nors directs and coordinates the supervisory work of the Reserve
Banks, and it determines the broad supervisory policy of the Banks
and reviews actions that the Banks take under delegated authority.
Since State member banks are chartered by States, the Federal
Reserve shares its regulatory responsibility with the bank supervisory
authorities of the States. In view of the overlapping jurisdictions, both
the Federal Reserve and the various State supervisory authorities
must approve bank applications for new branches, permissible
changes in bank capitalization, and other relevant matters. However,
they cooperate, where feasible, in joint or alternate examinations of
banks.

BANK HOLDING COMPANY RESPONSIBILITIES
In 1956 Congress passed the Bank Holding Company Act and
gave to the Board of Governors the responsibility for administering
the Act. This Act, as amended in 1966 and 1970, was designed to
achieve two basic objectives. The first was to control bank holding
company expansion in order to avoid the creation of monopoly or
restraint of trade in banking. The second was to allow bank holding
companies to expand into nonbanking activities that are related to
banking while maintaining a separation between banking and com
merce. This second objective reflected a long accepted policy of the
Congress that the “public interest” aspects of banking require a clear
separation of banking from other unrelated activity.
Under the Act as amended, a bank holding company is defined
as any company that: (1) directly or indirectly owns, controls, or
has power to vote 25 per cent or more of the voting shares of a
bank; (2) controls in any manner the election of a majority of the
directors or trustees of a bank; or (3) exercises a controlling influ
ence over the management or policies of a bank. Any company that
qualifies as a bank holding company must register with the Federal
Reserve System and file reports with the System. And a registered
bank holding company must obtain the approval of the Board of

110

Regulatory and Supervisory Functions
Governors before acquiring more than 5 per cent of the shares of
either additional banks or permissible nonbanking companies. To
limit interstate banking operations by holding companies, the Act
provides that a holding company operating in one State may not ac
quire a bank in a second State unless the second State expressly
authorizes such acquisition by statute.
For about a decade following the passage of the Bank Holding
Company Act in 1956, the number of holding companies registered
with the Federal Reserve remained relatively constant, as did the per
centage of commercial bank deposits in the Nation controlled by hold
ing companies (Table 7). Between 1965 and 1970, however, the
number of registered holding companies more than doubled, and
total deposits of their subsidiary banks almost tripled— raising the
share of commercial bank deposits held by subsidiaries of holding
companies from 8.3 to 16.2 per cent.
When Congress passed the Bank Holding Company Act in 1956,
it exempted one-bank companies from regulation because almost all
of these companies controlled small banks. During the late 1960’s,
however, many very large banks converted to the one-bank-holdingcompany form of organization. The conversion allowed these organi
zations to engage in nonbanking activities in which they could not
engage as a bank. In order to preserve the traditional separation of
banking and commerce, Congress amended the Bank Holding Com
pany Act in December 1970 to embrace all one-bank holding comTABLE 7
NUMBER AND DEPOSITS OF REGISTERED BANK
HOLDING COMPANIES, SELECTED YEARS

Year-end

Number
of
holding
companies

1957
1960
1965
1970
1971
1972
1973

50
47
53
121
1,567
1,607
1,677

Deposits of subsidiary banks
| Percentage of
Billions
all commercial
of dollars ! bank deposits
15.1
18.3
27.6
78.1
297.0
379.3
446.6

7.5
7.9
8.3
16.2
55.1
61.5
65.5

111

P u rp o se s a n d F u n c tio n s

panies. Primarily as a result of this new legislation, the number of
registered bank holding companies increased from 121 at the end of
1970 to 1,677 at the end of 1973. Over this same period the propor
tion of commercial bank deposits held by such registered bank hold
ing companies increased from 16.2 per cent to 65.5 per cent.

B A N K A C Q U ISITIO N S
Before acquiring more than 5 per cent of the shares of any bank,
a bank holding company, as stated earlier, must obtain prior approval
of the Board of Governors. In making its decision, the Board must
consider the likely effects of the acquisition on banking competition,
the convenience and needs for banking services of the community to
be served, and the financial and managerial resources and future
prospects of the holding company and the bank. The Board may not
approve any acquisition that would result in a monopoly or that
would substantially lessen competition, unless the anticompetitive ef
fects are clearly outweighed by the acquisition’s favorable impact on
the convenience and banking needs of the community.
In assessing the competitive impact of a proposed acquisition of a
bank by a holding company, the Board usually focuses on the rele
vant local banking markets, for it is in these markets that bank cus
tomers may have the fewest alternatives. Such markets are frequently
approximated by counties or metropolitan areas. If a holding com
pany already has one or more banks in the market in which it seeks
to acquire another bank, the Board determines the extent to which
existing competition would be adversely affected by the acquisition.
This determination depends on the total number of banks in the mar
ket, but more importantly on the market shares already within the
holding company’s family of banks as well as on the share held by
the bank to be acquired.
If the holding company is not already represented in the market
of the bank to be acquired, the Board assesses the likely effects of
the acquisition on future competition. In making this assessment, the
Board judges first the possibility that a holding company might enter
the market de novo (that is, with a newly chartered bank or branch)
should the proposed acquisition be denied. Basically, this possibility
depends on the holding company’s characteristics— such as its over
all size and its aggressiveness— and on the general attractiveness of

112

Regulatory and Supervisory Functions
the particular market. Second, the Board determines on the basis of
the present structure of the market the extent to which de novo entry
into the market is needed. The Board is likely to give greatest weight
to future competition in cases where (1) the market is highly concen
trated; (2) the holding company proposes to acquire the largest or
one of the largest banks in the market; (3) the market is attractive for
de novo entry; and (4) the holding company is one of a few possible
entrants.
In addition to antimonopoly and competitive considerations, the
Board assesses the likely effect of a proposed acquisition on the
convenience and banking needs of the public. Specifically, the Board
is interested in whether the acquisition will result in the provision of
new or better quality services, such as the introduction of trust serv
ices or longer banking hours, or will result in more favorable prices
for bank services to customers, such as the offer of higher interest
rates on savings deposits, more competitive loan rates, or reductions
in service charges on checking accounts.
The Board also considers carefully how any proposed bank acqui
sition is likely to affect the financial and managerial resources of the
bank to be acquired and of the holding company. Important factors
bearing on its final decision are (1) the present capital position of
the bank and of existing bank subsidiaries, and what plans the hold
ing company has to augment the capital of the bank or of its existing
subsidiaries, if deficient; (2) the quality of the bank’s management
and any plan the holding company may have for improving it; (3)
how the holding company intends to finance the acquisition; and
(4) the holding company’s debt and its ability to service such debt.

NONBANKING ACQUISITIONS
In enacting the Bank Holding Company Act in 1956, Congress
indicated its intent that holding companies, with few exceptions, be
prevented from acquiring nonbanking companies. Such intent was
rooted in the long-accepted public policy of keeping the control of
banking separate from the control of unrelated nonbanking activities.
At the same time, however, Congress recognized that a complete
prohibition of holding company acquisitions of nonbanking companies
might not, in every case, be in the public interest. Over the years
banking organizations had developed considerable expertise in cer

113

Purposes and Functions
tain bank-related areas, and allowing holding companies to enter
these areas could both increase competition and improve the quality
of the financial services they made available to the public. Conse
quently, Congress provided some exceptions to the general prohibi
tion against bank holding companies engaging in nonbanking activi
ties, and the 1970 amendments broadened the exceptions somewhat.
The most important exception is that holding companies may un
dertake activities that are so closely related to banking or managing
or controlling banks as to be a proper incident thereto.
As of mid-1974, the Board had ruled that 12 nonbanking financial
activities may be engaged in by a bank holding company either directly
or indirectly through an affiliate. With certain qualifications, these
activities include:
1. Making or acquiring, for its own account or for the ac
count of others, loans and other extensions of credit;
2. Operating as an industrial bank;
3. Servicing loans and other extensions of credit;
4. Performing trust activities;
5. Acting as an investment or financial adviser;
6. Leasing real and personal property;
7. Making equity and debt investments in corporations or
projects designed primarily to promote community wel
fare;
8. Providing bookkeeping and data-processing services;
9. Acting as an insurance agent or broker;
10. Acting as an underwriter for credit life insurance and
credit accident and health insurance directly related to
extensions of credit by the bank holding company system;
11. Providing courier services; and
12. Providing management consulting advice to nonaffiliated
banks.
As already indicated, before a bank holding company may acquire
more than 5 per cent of the shares of a company engaging in a per
missible nonbanking activity, it must obtain the approval of the Board
of Governors. In determining whether to grant approval of the acqui
sition, the Board is required to consider competitive and other public
interest factors.
In assessing the competitive impact, the Board determines in what
product and geographic markets the company to be acquired oper

114

Regulatory and Supervisory Functions
ates, and to what extent, if any, the holding company’s subsidiaries
already compete in those markets. In addition, the Board considers
whether the acquisition would have any adverse effect on future
competition. It must also assess what effects, if any, the acquisition
might have over the longer run on the solvency of the holding com
pany’s banks. Finally, the Board is required to consider whether the
acquisition might produce efficiencies or greater convenience for the
public, or whether it might lead to conflicts of interest or to an undue
concentration of resources.
There are other exceptions to the general prohibition concerning
ownership or control by holding companies of shares of nonbanking
companies. Two of the more important ones permit holding companies
to own or control shares of companies engaged in holding or operating
properties used by any banking subsidiary of the holding company,
and to own shares of the kinds and in the amounts that national banks
may invest in directly.

BANK MERGER RESPONSIBILITIES
During the 1950’s there was a sharp rise in the number of bank
mergers, several of which involved large banks located in the same
metropolitan area. Fearing that a continuation of this merger trend
could seriously impair competition in banking and could lead to an
excessive concentration of financial power, Congress passed the Bank
Merger Act of 1960.
This Act requires that all proposed bank mergers between insured
banks receive prior approval from the Federal bank regulatory
agency under whose jurisdiction the surviving bank will have legal
status. That is, if the surviving bank is to be a national bank, the
Comptroller of the Currency has jurisdiction; if a State-chartered
member bank, the Board of Governors of the Federal Reserve Sys
tem; and if a nonmember insured bank, the Federal Deposit Insur
ance Corporation. In order to maintain uniform standards among the
three agencies, the Act also provides that the responsible authority
request reports on competitive factors from the other two banking
agencies, as well as from the Department of Justice.

115

Purposes and Functions
The law, as amended, stipulates that in every case the responsible
agency shall take into consideration not only the financial and man
agerial resources and future prospects of the existing and proposed
institutions but also the convenience and banking needs of the com
munity to be served.1 The responsible agency shall not approve any
merger that would result in a monopoly. Moreover, it shall not ap
prove any merger that might substantially lessen competition or tend
to create a monopoly unless the agency finds that the anticompetitive
effects are clearly outweighed by the probable effect of the transac
tion in meeting the convenience and needs of the community.
In determining whether to approve a proposed merger where the
surviving bank is to be a State-chartered member bank, the Board
of Governors follows essentially the same procedures as were dis
cussed earlier with regard to proposed acquisitions of banks by hold
ing companies.

RESPONSIBILITIES FOR MEMBER BANKS’
INTERNATIONAL OPERATIONS
The Board of Governors has three statutory responsibilities in con
nection with international operations of member banks. These relate
to (1) issuing licenses for foreign branches and regulating the scope
of their activities; (2) chartering and regulation of international bank
ing subsidiaries, called Edge corporations (after Senator Edge, who
introduced the legislation in 1919); and (3) authorizing overseas
investments by banks, Edge corporations, and bank holding com
panies, and regulating the activities of such foreign subsidiaries as
they may have.
Sections 25 and 25(a) of the Federal Reserve Act form the prin
cipal statutory framework for the international activities of member
banks. Section 25 governs the operations of foreign branches of mem
1The criteria specified for granting prior approval to bank mergers in the
Bank Merger Act are the same as those used in the Bank Holding Company
Act for proposed acquisitions of banks by holding companies.

116

Regulatory and Supervisory Functions
ber banks and provides for the direct investment by such banks in
foreign banks (but not in other foreign financial corporations). Sec
tion 25(a) provides for the establishment of Edge corporations by
U.S. banks. Under the 1970 amendments to the Bank Holding Com
pany Act, the Board also has responsibility for regulating the foreign
activities of bank holding companies.
In authorizing U.S. banks to have operations abroad, the Congress
provided scope for the conduct of a broader range of activities than
banks have usually been permitted in this country. Banks’ foreign
activities were made subject to supervision of the Board, and the
Board was given wide discretionary power to regulate those activities
with the aim of allowing U.S. banks to be fully competitive with insti
tutions of the host country in financing U.S. trade and investment
overseas. In addition, through Edge corporations, banks may conduct
a deposit and loan business in an out-of-State market, provided the
corporations’ operations are strictly related to international transac
tions. The statute and the regulations relating to these matters are so
written as to assure that the foreign operations of member banks do
not undermine the objectives of domestic banking regulation.
Board policy has accommodated the rapid growth in recent years
of the international business of U.S. hanks that has reflected the
expansion of overseas financing of U.S. companies and their foreign
subsidiaries and the development of the Euro-currency and Euro-bond
markets. By the end of 1972, 37 large U.S. banks were operating fullservice branches overseas, and $60 billion, or 30 per cent, of the total
deposits of the 20 largest of these banks were held in foreign offices.
During this period when foreign operations of U.S. banks have been
growing so dramatically, there has been a similar growth in the
activities of foreign banks in the United States. Operations of foreign
banks in this country are subject to the various State regulations but
not to Federal regulation, except to the extent required by the Bank
Holding Company Act.
As these two types of banking activity have been increasing, inter
national aspects of banking regulation have been receiving more
attention by the Federal Reserve and also by the Congress and other
groups. In 1973 the Board began a review of such regulation, under
a Steering Committee made up of three members of the Board and
the presidents of three Reserve Banks.

117

Purposes and Functions

RESPONSIBILITIES FOR TRUTH IN
CONSUMER LENDING
In 1968 Congress passed the Truth in Lending Act (Title I of the
Consumer Credit Protection Act) and gave the Board of Governors
responsibility for formulating and issuing a regulation (Regulation
Z) to carry out the purposes of the Act. This legislation was based
on the premise that uniform disclosure of credit costs would enable
the consumer to compare more readily various credit terms and would
avoid the uninformed use of credit. Amendments to the Act in 1970
prohibited the unsolicited distribution of credit cards and limited the
liability for unauthorized use of lost or stolen cards to $50.
The coverage of Truth in Lending is far-reaching, because almost
everyone uses consumer credit in one form or another. Many retail
stores offer charge accounts v/ith extended repayment privilege sub
ject to special financing charges; credit cards may be used for depart
ment store purchases, travel, or entertainment; cars and furniture may
be bought on an instalment purchase plan; most homes are purchased
with a mortgage; and medical bills, vacations, and even tax payments
are often financed through personal loans repayable in monthly in
stalments. Although the precise number of creditors subject to Truth
in Lending is unknown, an estimated one million persons or organiza
tions are extenders of consumer credit.
A 20-member advisory committee, consisting of representatives of
creditors, consumers, and the public, assists the Board in carrying
out its regulatory functions in the consumer credit area. The Board
prepares an Annual Report to Congress on Truth in Lending, which
contains information on the Board’s administrative role under Truth
in Lending, an assessment of the extent to which compliance is being
achieved, and suggestions for changes in the Act.
While the Board of Governors has sole responsibility for preparing
regulations implementing the Truth in Lending Act, enforcement of
the regulations is spread among nine Federal agencies, with the Fed
eral Trade Commission having the bulk of the enforcement task. The
Board is responsible for enforcing Truth in Lending only with respect
to State member banks.
□

118

‘I n d e x

Acceptances, bankers
Annual reports to Congress, Board of Governors

14-15, 31, 51, 53, 63, 7
14, 58, 11

Balance of international payments ( S e e U.S. balance of payments)
Balance sheet of Federal Reserve Banks
25, 26
Bank:
Credit ( S e e Credit)
Examination
109, 110
Regulation and supervision:
Bank holding companies and bank mergers ...................107, 110-15, 116
Federal Reserve functions ........................................................... 1, 2, 107-19
Federal supervisory structure
108
Foreign operations of U.S. banks
2, 14, 92, 104-06, 107, 116-18
Reserve equation .............................................................................................. 36-47
Reserve factors ............................................................................................. 36-47
Reserves ( S e e Reserves)
Bank for International Settlements
102
Bank Holding Company Act and Bank Merger Act
110-15, 116
Bankers acceptances ..................................................... 14-15, 31, 51, 53, 63, 71
Banking Act of 1 9 3 5 .........................................................................................
1
Board of Governors ( S e e a l s o Federal Reserve System):
Annual reports to Congress ............................................................. 14, 58, 118
Audit of accoun ts...........................................................................................
14
Contacts with other officials and organizations
3, 92
Delegation of certain functions
109
Expenses, assessments on Federal Reserve Banks
14
Foreign credit restraint program
106
Members and staff
3-4, 14
Regulation and supervision:
Bank holding companies and bank mergers
107, 110-15, 116
Federal Reserve Banks ..............................................................................
15
Foreign operations of U.S. banks
2, 14, 92, 104-06, 107, 116-18
Stock market .......................................................................... 2, 14, 69, 87-89
Truth in lending .......................................................................................
118
Regulations (S e e Regulations, Board of Governors)
Structure and fun ction s..............................................................................13, 15

Capital accounts
34
Cash ( S e e Currency)
Central banks
2-3, 24, 33, 51, 66, 90, 91, 92, 94, 96, 97-99, 100, 1C2-03

119

Certificates of d ep osit..................................................................53, 75, 77, 81, 85
Check clearing and collection .......................................... 15, 20-22, 31, 34, 40
Commercial banks ...................................... 2, 19, 27, 33, 40, 47, 83, 104, 107
Comptroller of the Currency.................................................4, 19, 108, 109, 115
Condition statement of Federal Reserve Banks .......................................... 25, 26
Conferences of System advisory committees
19, 73
Credit { S e e a l s o Credit and money and Discount operations):
Bank ............................................................................................................ 2, 49, 69
Changes, effec ts................................................................................................ 6-8
C onsum er...............................................................................2, 7-8, 90, 107, 118
Emergency ...................................................................................................... 70, 74
Federal Reserve ............................................ 14-15, 27, 30, 31, 32, 34, 36-47
M ortgage................................................................................................6, 7, 83, 89
Policy of Federal Reserve:
Determination ..............................................................................................
36
Instruments .................................................................................... 49-67, 69-90
Relation of System to instruments of credit policy (chart) ...............
50
Seasonal ...............................................................................
73
Stock market ...............................................................................2, 14, 69, 87-89
Voluntary foreign credit restraint program ............................................... 106
Credit and money:
Bank ...............................................................................................................2, 6, 69
Federal Reserve efforts to influence ........................................................ 46, 61
Regulation ........................................................................................... 2, 5, 49, 90
Currency:
Circulation ....................................................................................... 22, 38, 45-47
Demand for .................................................................................................... 22, 45
Elasticity ...........................................................................................................
1
Federal Reserve notes ....................................................................23, 29, 30, 32
Treasury .................................................................................................. 30, 37, 38

Deposits:
Definition
78
Foreign central banks ................................................................................. 24, 33
Gold certificates ..............................................................................................
28
Growth at thrift institutions (chart) .......................................................
84
Liabilities ...........................................................................................................
32
Time and savings ........................................................... 2, 7, 14, 69. 75. 83-87
Treasury tax and loan and other accoun ts.................................................
33
Directors, Federal Reserve Banks ....................................................................
15
Discount operations:
Administration .......................................................................... 14, 17, 71-73, 75
Coordination with open market operations
77
“Eligible paper” ...............................................................................................70, 71
Emergency credit .............................................................................................70, 74
Instrument of monetary policy ..................................................... 49, 69-78, 94
Mechanics ........................................................................................................
70

120

Index

Discount operations— Continued
Purpose ..................................
Rates ......................................
Seasonal borrowing privilege

.......................

14, 17, 30, 40, 75-77
............................
73

Earnings, Federal Reserve Banks ....................................................................17, 35
Edge Act corporations ........................................................................ 105, 116, 117
Electronic funds transfers .................................................................................21, 34
Euro-dollar markets ...........................................................................................
105
Examinations, member banks ...................................................................... 109, 110
Exchange Stabilization F u n d .....................................................27, 29, 30, 95, 99

Federal Advisory Council .................................................................................
17
Federal agency obligations............. 14-15, 22, 31, 51, 52, 55, 57, 62, 63, 71
Federal Deposit Insurance Corporation........................................ 4, 83, 108, 115
Federal fu n d s................................................................................................22, 58, 77
Federal Home Loan BankB o a rd .......................................................................... 4, 83
Federal Open Market Committee ( S e e a l s o Open market operations):
Directives ..................................................................................................55, 58, 60
Foreign currency operations ....................................................... 15, 60, 100-04
Functions ..........................................................................................................
14
International economic and financial matters,
effects on policy-making............................................................................
91
Meetings:
Frequency ..................................................................................................... 15, 55
Preparation for ...........................................................................................
59
Membership and organization ......................................................................
15
Monetary policy a n d .......................................................................................
91
Operations, conduct ........................................................................................ 53-67
Photographs of Committeeand Trading D e s k ............................................ 54, 56
“Swap” arrangements............................................................. 32, 92, 95, 100-04
Federal Reserve Act ....................................................... 1, 17, 75, 105, 107, 116
Federal Reserve Banks:
Balance sheet ...................................................................................................25, 26
Borrowing at .....................................................................................................70-78
Branches and facilities ...................................................................................
15
Capital s to c k ...................................................................................................... 19, 34
Checks handled by (chart) ..........................................................................
21
Credit policy ...............................................
36
Decision-making responsibilities .............
17
Delegation of supervisory functions to .
109
Directors .....................................................
15
Discount rates ( S e e Discount operations)
Districts .......................................................
15

121

Federal Reserve Banks—Continued
Earnings ............................................................................................................ 17, 35
Fiscal agency functions...................................................................................
23
Foreign accounts .............................................................................................24, 33
New York B a n k .................................. 15, 24, 31, 33, 55, 56, 91, 95, 96, 98
Officers ...............................................................................................................
17
Representation in FederalOpen MarketCommittee
15, 55
Surplus .............................................................................................................. 17, 35
Federal Reserve B u l l e t i n ...................................................................................
14
Federal Reserve notes .........................................................................23, 29, 30, 32
Federal Reserve System ( S e e a l s o Board of Governors):
Advisory council and committees ......................................................17, 19, 73
Contacts with other officials andorganizations .............................................3, 92
Establishment ..................................................................................................
1
Functions ..................................................................................... 1, 2, 13, 107-19
Influence on bank reserves, bank credit, and m o n e y ..............................
2, 5
International sphere, operations and activities..........................................91-106
Map ...................................................................................................................
16
Membership ............................................................................................19, 72, 109
Monetary policy:
Guides ............................................................................................................. 9-11
Instruments .................................................................................... 49-67, 69-90
Operations and commercial bank reserves .................................................. 25-47
Organization and relation of parts to instruments of credit policy
(charts) .......................................................................................................... 18, 50
Role in Governm ent........................................................................................ 2-5
Securities ...........................................................................................................
31
Structure.............................................................................................................. 13-19
“Swap” drawings, use by ...............................................................................
103
Federal supervisory structure ........................................................................... 108
Fiscal agency functions ......................................................................................
23
“Float” ............................................................................................................32, 34, 40
Foreign banks ( S e e a l s o Central banks ) .............................................92, 116-17
Foreign credit restraint........................................................................................ 106
Foreign currency operations ............................................................ 15, 60, 100-04
Foreign exchange rates
92, 94, 97, 100, 101, 103
Foreign operations of U.S. b a n k s............................2, 14, 92, 104, 107, 116-18

Gold:
Bank reserve factors a n d ...............................................................................
36
Certificate account ......................................................................................... 27, 30
Certificates ................................................................................................ 23, 28, 29
“Earmarked” ....................................................................................................24, 96
International reserve transactions ................................................................. 95-99
Stock .........................................................................................................27, 30, 96
“Swap” drawings, relationship
..................................................................
103

122

Index

Interest rates:
Ceilings
.....................................................2, 14, 75, 83-87
Discount rates .......................................................................... 14, 17, 30, 40, 75
Expectational factors .....................................................................................
6
Financial guide for monetary policy
9-11
Instrument of monetary policy
69, 94
Selected (charts) ........................................................................................... 76, 84
International Monetary Fund ( S e e a l s o Special Drawing Rights) . . . . 4 , 29, 95
International operations of U.S. banks
2, 14, 92, 104-06, 107, 116-18
International reserve transactions .....................................................................94-99
International sphere, Federal Reserve operations and activities
91-106

Loans and investments

5, 7

Margin requirements ..................................................................... 2, 14, 69, 87-89
Member banks ( S e e a l s o State member banks):
Borrowing
70-78
Examination
109, 110
International operations
104-06, 116-18
Number ............................................................................................................
19
Obligations and benefits ofSystem membership .........................................20-23
Regulation and supervision
2, 14, 104, 107, 108, 109, 115, 116-18
Reserve requirements ( S e e Reserve requirements, member banks)
Reserves ( S e e Reserves)
Monetary aggregates
9
Monetary policy:
Economy and
1-12
“Even keel” ..................................................................................................
67
Financial effects
5
Financial guides
8-12
Goals .................................................................................................................
5
Impacts on economic activity
6-8
Instruments .................................................................................49-67. 69-90. 94
International conditions,effects on policy-making
91-94
Money ( S e e a l s o Credit and m oney):
Definition
10
Demand f o r ......................................................................................................
27
Money stock
9-11
Mortgage credit ( S e e Credit)
Mutual savings b a n k s.........................................................................................
6

National banks
Nonmember banks

19, 108, 109, 115
23, 70, 75, 83, 108-09, 115

123

Open Market Account ( S e e System Open Market Account)
Open market operations ( S e e a l s o Federal Open Market Committee):
Conduct ..............................................................................................................53-65
Coordination of discountoperations a n d .....................................................
77
Impact on reserves..........................................................................................42, 44
Instrument of monetary policy ..................................................................... 49-67
Purpose .............................................................................................................14, 49
Securities ...........................................................................................................
31
Securities markets, role
...........................................................................51-53
Treasury financings and
..........................................................................
66

Par, payment of checks at

Regulations, Board of Governors
30, 36, 75, 87, 88, 118
Repurchase agreements ...................................................................................... 62, 64
Reserve requirements, member banks: ( S e e a l s o Reserves)
Changes .................................................................................................... 69, 78-83
Establishment
14
Kuro-dollar
105
Instrument of monetary policy
49, 69, 79-81, 94
Special, against foreign borrowing by member banks
105
Structure ............................................................................................................81-83
Table .................................................................................................................
82
Reserves:
Currency in circulation and .................................................................. 38, 43, 45
Gold certificate ...............................................................................................28, 29
International reserve transactions ................................................................. 94-99
Member banks:
Bank reserve equation ................................................................................ 36-47
Changes, effects ............................................................................................5, 49
Excess ............................................................................................................ 22, 43
Factors affecting ........................................................................................ 25-47
Open market operations and
49, 57, 61, 64, 65
Operation in banking system ........................................................................42-47
Special Drawing Rights .............................................................. 23, 29, 95, 98

Savings and loan associations
6, 75, 83, 84
Securities markets, role in open market operations
51-53
Special Drawing Rights .................................................................. 23, 29, 95, 98
State member banks ( S e e a l s o member banks):
Examination ................................................................................................ 109, 110
Regulation and supervision.............................................2, 107, 108, 109, 115
System membership, eligibility, obligations, and benefits
19, 20-23
Stock market c r e d it........................................................................ 2, 14, 69, 87-89
Surplus ................................................................................................................. 17, 35

124

Index

“Swap” operations ....................................................................32, 92, 95, 100-04
System Open Market Account
14-15, 55, 62, 63, 64

Tax and loan accounts
33
Thrift institutions
83-85
Treasury, U.S.:
Contacts of Federal Reserve with
3
Currency ..................................................................................................30, 37. 38
Financings and open market operations
66
Fiscal agency services for
......................................................................
23
International reserve assets of United States
95-97
Tax and loan and otherdeposit accounts
33
Truth in lending
....................................................................2, 19, 107, 118

U.S. balance of payments:
Chart
93
Foreign currency operations
15, 60, 100-04
International reserve transactions
94-99
Monetary policy and ....................................................................
92-94
U.S. Govt, agencies, contacts of Federal Reserve with
3, 92
U.S. Govt, securities:
Collateral for Federal Reserve n o te s ......................................................... 23, 29
Definition
31
Federal agency obligations
14-15, 22, 31, 51, 52, 55, 57, 62, 63, 71
Federal Reserve Banks’ processing
23
Federal Reserve holdings
31
Foreign currency operations and .................................................................102-03
International reserve transactions .......................................................96, 98, 99
Open market operations
14-15, 51-53, 55, 57, 62, 63, 66
Treasury securities
22, 52, 62, 96, 99, 103

Voluntary foreign credit restraint program

106

Full text of The Federal Reserve System : Purposes and Functions, (1974)

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