The Federal Reserve System, or the "Fed", is the U.S. central bank. The regulation of the banking system, consumer protection laws and the control of monetary policy to this quasi-government institution were mandated by Congress. The Federal Reserve is independent of the Treasury, but is the Treasury Department's personal banker. The President appoints the seven governors (designating a Chair and Vice-chair) to the Board of Governors for 14-year terms, but the Senate must confirm them. The Fed, through a system of 12 district banks, provides services to the commercial banking sector. The district banks regulate and examine commercial banks.

 

The Fed manages monetary policy through the Federal Open Market Committee (FOMC), which is composed of the seven governors and five of the 12 district bank presidents. A distinctive feature of the FOMC is the rotation of the 12 district bank presidents as active voting members of the FOMC. As the European Central Bank ponders what expansion will do to their already sizable policy making executive committee, one of things they are considering is mimicking the Fed's rotation policy. The FOMC meets eight times a year to set the agenda for credit market policy based on economic conditions.

 

In the mid-1980s, the estimation of daily reserve needs and forecasts of M1 and M2 money supply were monitored closely by Fed-watching economists. But since the Fed no longer directly targets monetary aggregates, following economic indicators has gained stature instead. This was especially so when Alan Greenspan, a bonafide card carrying economist was Fed chairman. His successor, Ben Bernanke, was another card carrying economist as well. Janet Yellen, who was the Board's vice chair under Mr Bernanke, is a well-known economist in her own right. Ms Yellen has been Fed Chair since February 2014.

 

 

The Fed maintained a 1 percent Fed funds interest rate from June 2003 to May 2004 before beginning its series of 25 basis point increases. Most overseas analysts thought that the increases were long overdue. In the wake of the August 2007 financial market unraveling, the Fed once again cut interest rates aggressively sending the fed funds target rate to a range of zero to 0.25 percent as the Fed fought both the credit crunch and the collapsing real economy. The Fed also turned to aggressive quantitative easing programs in its attempts to right the financial sector and turn the economy around. The FOMC confirmed that it will be patient with regards to normalizing the fed funds rate.

 

The Fed had implemented four quantitative easing programs before beginning to reduce bond purchases. Purchases at their maximum included purchases of mortgage backed securities at a pace of $40 billion per month and purchases of longer term Treasury securities at a pace of $45 billion per month.

 

In addition, the Fed has embarked on an enhanced communication program to make its actions more transparent to financial markets. The chair now holds quarterly press conferences to discuss the Fed's latest economic forecasts and respond to questions from the media. The Fed followed in the footsteps — at least partially — in instituting the press conferences. Both the Bank of Japan's chairman and the European Central Bank's president just to name two, hold press conferences after each policy announcement to discuss their latest decision.

 

As part of the Fed's expanded communications, the Bank also offers guidance to future policy. By guidance, the Fed now gives the direction and timing expected for policy moves. In January 2012, it announced a specific inflation goal of 2.0 percent for the long term. It has also suggested that rates would remain exceptionally low until a 6.5 percent unemployment threshold is reached. The Bank emphasized that its future moves would be data driven. Now each data bit is evaluated on whether it was good enough for the Fed to begin curtailing its stimulus.

 

At its December 2013 meeting, the FOMC announced that it would begin cutting back on its monthly bond purchases from $85 billion to $75 billion beginning in January 2014. Both mortgage back securities and long term Treasuries were cut back by $5 billion each to $35 billion and $40 billion respectively. At the same time, the Fed said that further cuts would be data dependent as all policy moves are. The Fed cut back another $10 billion of stimulus at its January 2014 meeting and again at its March meeting.

 

In April, the Committee added $25 billion to its holdings of agency mortgage backed securities rather than $30 billion per month and added $30 billion to its holdings of longer term Treasury securities rather than $35 billion per month. In May, the FOMC reduced purchases again by $10 billion. It reduced to $20 billion its holdings of agency mortgage backed securities and reduced to $25 billion its holdings of longer term Treasury securities.

 

And at its June meeting, the FOMC again reduced its holdings by $10 billion. Beginning in July, its holdings of agency mortgage backed securities were $15 billion and its holdings of longer term Treasuries were $20 billion. The Committee also continues to reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage backed securities and of rolling over maturing Treasury securities at auction.

 

The reductions continued at the July FOMC meeting when it reduced its holdings by another $10 billion. Beginning in August, its holdings of agency mortgage backed securities were $10 billion and its holdings of longer term Treasuries were $15 billion. Both were reduced again at the September and October FOMC meetings. The Committee completed its reduction in October.

 

At its last meeting of 2014, Chair Yellen indicated that there is no preset time table for normalization of policy rates. Rate changes will be data dependent and "relatively gradual." She also said that the FOMC likely can hold its stance for the next two policy meetings. The Chair stated that any potential rate change is not limited to FOMC meetings that have press conferences.

 

Although the FOMC upgraded its opinion of economic performance, it basically left unchanged its December announcement at its January 27 and January 28 meeting statement. In March, the FOMC no longer included the word 'patient' in its post-meeting statement. It maintained that the committee continues to be data driven. It also marginally lowered its forecast of growth for the economy leading traders to push their estimate of a first increase in the fed funds rate to September. It maintained the status quo at its April 29 and 29 meeting.

 

The FOMC published its updated forecasts for growth and unemployment along with its decision to maintain the status quo. The FOMC lowered its growth forecast for 2015 to 1.8 percent to 2.0 percent from its March forecast of 2.3 percent and 2.7 percent. The latest forecast no doubt reflects the first quarter contraction and the slower than expected pickup in the second quarter. The FOMC also increased its unemployment forecast to 5.2 percent to 5.3 percent from 5.0 percent to 5.2 percent, reflecting slower growth in the economy. In her press conference, Chair Janet Yellen emphasized that when the Fed did begin increasing the fed funds rate, it would be a very slow process.

 

The FOMC statement at the end of its July 28 and 29 meeting was little changed from the June meeting although the committee did add the word 'some' to its description of the improvement it is looking for in the labor market. The FOMC said that it would "be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market", suggesting the data only need to improve modestly from current levels to warrant a rise in interest rates. The Fed said economic growth continued to meet its expectations, and it indicated officials did not need to see much more progress before raising rates.

 

The FOMC maintained the status quo in September and again at its October meeting. However, in its October statement, it indicated that it was still considering a fed funds rate increase at its December 2015 meeting.