Federal Open Market Committee

The exhibit to the right, commonly termed the Federal Reserve pyramid, indicates the connection between the Federal Open Market Committee and the rest of the Federal Reserve System. The Federal Open Market Committee is connected directly to the Federal Reserve Board of Governors at the top of the pyramid.

7 + 1 + 4

• The Board Rules: The 7 members of the Federal Reserve Board of Governors form the voting majority of the Federal Open Market Committee. This is intended to keep primary control of monetary policy in the hands of the Board, which is after all the supervising authority of the Fed. Should the Federal Reserve Board desire to pursue a given monetary policy, then it can easily do so through the FOMC with a majority vote. As might be expected, the Chairman of the Federal Reserve also functions as the Chairman of the Federal Open Market Committee meetings.


• New York, New York: Because New York City is the financial center of the country, the President of the New York Federal Reserve Bank is always on the FOMC and is invariably selected as the Vice Chairman. The New York Federal Reserve Bank is charged with carrying out specific policy actions. The permanent membership of the New York Federal Reserve Bank President gives the FOMC a direct line to policy implementation.


• With a Little Help: The remaining 4 voting slots on the FOMC are shared and rotated among the remaining 11 District Banks. One slot is shared by Boston and Philadelphia. Another is shared by Dallas, Atlanta, and Kansas City. A third by Cleveland, Chicago, and Richmond. And the fourth by San Francisco, Minneapolis, and St. Louis. The Federal Reserve District Bank Presidents serve one-year terms as voting members. Actually the Presidents of all 12 Federal Reserve District Banks are present at committee meetings, and contribute to discussions, providing input and perspectives from their individual districts. However, only 5 serve as voting members at any given time.

Open Market Operations

• Buy, Buy, Buy: When the Fed buys U.S. Treasury securities, banks end up with more reserves. This induces a decrease in interest rates and subsequently an increase in the money supply.


• Sell, Sell, Sell: When the Fed sells U.S. Treasury securities, banks end up with fewer reserves. This induces an increase in interest rates and subsequently a decrease in the money supply.

When the Fed buys it pays for the securities by adding reserves of the banks of the securities dealers doing the selling. When the Fed sells it receives payment for the securities by reducing reserves of the banks of the securities dealers doing the buying. The banks then react to any changes in reserves by adjust interest rates and lending activity that affects the money supply through the money creation process.

The Fed uses open market operations for monetary policy because the transactions are quick, easy to control, and can be implemented with a great deal of precision.

Open market operations actually come in two varieties--reactive and proactive.

• Reactive open market operations respond to day-to-day economic and banking conditions. They are designed to stabilize the normal ebb and flow of banking activity without seeking an overall increase or decrease in the money supply. The Fed might buy securities one day to counter a temporary reduction in reserves caused by unusual cash withdrawals, the sell securities a few days to counter a temporary increase in reserves caused by a big influx of end-of-the-month paychecks Reactive operations generally balance out over the course of a few days--a little buying one day, then a little selling the next. Without such operations, the banking operations would be a great deal more volatile.


• Proactive open market operations are intended to change the overall money supply to stabilizing business cycles, reduce unemployment and inflation, and promote economic growth. Proactive operations are longer term and sustained. The Fed might continue to buy securities over a period of several days or weeks as it seeks to increase the money supply and stimulate the economy. Alternatively, it might sell securities for an extended period to decrease the money supply and reduce inflation.