| Chapter 1 |
General Economic Concepts
What is Policy?
History of Macroeconomic Policies in the United States
Policy Goals: Maximum Employment
Policy Goals: Maximum Production
Policy Goals: Price Stability
Policy Goals: External Balance
Subsidiary Policy Goals
Conflicting Policy Goals
The Policy Makers
The Policy Instruments
The Policy Indicators
The General Economic Model
Monetarist Monetary and Fiscal Policies
Keynesian Monetary and Fiscal
Debt Management Policies
Supply Management Policies
The Long Wave
I. Fiscal Policy
- Fiscal Policy
- Debt Management Policy
- Incomes Policy
- Supply Management Policy
- Supply-Side Policy Summary
The Budget Process
The Budget Process Calendar Each year a new budget for the coming fiscal year must be constructed. However, "new
budget" is a misnomer. For the most part, tax considerations are inconsequential. The existing tax structure is taken for granted and a projection of tax
revenues from forecasted income growth is assumed. Therefore, the major portion of budget formulation involves passage on the overall
level of spending and the individual appropriations, which must be enacted each year.
The fiscal year for the federal government begins on October 1. About 18 months before (in April of the preceding year), the individual bureaus and
agencies of the government formulate preliminary estimates of their financial needs for the year. They are not concerned with the source of revenues. They
simply prepare spending estimates. Administrators tend to pad or inflate their requests, knowing that the figures will be trimmed anyway. The agency
estimates are submitted to the Office of Management and Budget (OMB) for review.
About the same time, officials of OMB, the Treasury Department, and the Council of Economic Advisers
(CEA) prepare tentative budget guidelines. They draw up assumptions about the state of the economy and estimate income
projections and tax revenues for the coming fiscal year. In late spring, the director of OMB discusses the proposed figures with the President and his
advisers, who also have information available about general economic conditions. The President then establishes budget guidelines in conformity with his
general plans for governmental activities and fiscal policy.
Around September, OMB requests formal detailed estimates from all departments in
conformity with the guidelines. The formal requests are submitted to OMB, where, for the next two months, the bureau's examiners study and discuss them with
personnel from the agencies involved. OMB holds hearings and weighs the evidence. The recommendations of the examiners are then discussed with the director
OMB adjusts the figures where necessary to bring the overall level and pattern of expenditures into line with presidential requests. Then,
following the wishes of the President, OMB will allow for expansion in some departments and will contract or disallow expansion of expenditures in others.
The expenditure proposals are reworked into a consolidated major spending program for the federal government. The process is one of paring, trimming, and
readjusting the figures to reflect the prevailing political philosophy of the Executive Branch.
In November, the agencies are notified of the
amounts to be recommended for them, and they prepare statements to justify these amounts. At the same time, the final figures are submitted for review to the
President, who analyzes the impact of the proposed expenditures. He also consults again with the CEA for the general economic outlook and with the Treasury
Secretary for estimated tax collections. The estimated tax collections are based on certain economic assumptions about the growth of the economy and the
prevailing tax rates legislated by Congress. Finally, the entire budget is evaluated to determine if the expenditure programs and tax revenues are in line
with the overall political, social, and economic objectives of the Administration. When the budget and goals are in agreement, the budget document is
In late January, the President delivers his State of the Union Address. In this speech, he
outlines where the U.S. is currently and where he hopes to see it go. The President emphasizes the social and economic imbalances he wants to see redressed,
and he takes the opportunity to suggest ways in which the U.S. can accomplish these goals. In other words, he sets the stage for his pet programs and
policies which will be submitted to Congress in his "Budget Message."
On the first Monday in February, the President delivers his Budget Message to Congress. In his Budget Message, the President emphasizes the necessity of passing on certain
programs, appropriations, and tax reforms that he believes will accomplish the goals outlined in his "State of the Union Address." The first part of the
"Budget Message" contains major policy outlines with detailed proposals for appropriations to specific programs and agencies for Congress to consider. The
second part is a summary of detailed studies on certain aspects of the budget's impact. The third part includes special analyses of selected items —
the President's "pet" projects.
The budget document consists of several volumes,
including The Budget, Cuts, Consolidations, and Savings, Analytical Perspectives (analyses highlighting special areas
of presidential concern), Historical Tables, Supplemental Materials, Appendix (detailed spending projections by agency), and Fact Sheets on Key Issues. The Budget, the basic document, is
delivered in two expenditure forms. The first, its core, is a description of spending programs in each of the 21 functional categories, e.g. national
defense, interest on the debt, roads, education, etc. The second lists expenditure by user (agency or department), e.g. legislative branch, judicial branch,
Defense Department, etc. The volume emphasizes changes proposed by the President. In addition, it includes a statement of his general priorities, an
accounting for receipts, an exposition of the underlying economic assumptions, a description of the budget process, and explanations and justifications for
budget choices. All told, the budget document is over 1000 pages in length.
Enactment of Authorizations and
Budget Calendar After presentation, the budget is submitted to the several committees for consideration. The House Ways and Means Committee and the
Senate Finance Committee evaluate any proposed tax changes. The House and Senate Appropriations Committees review the proposed program and agency
expenditures. The House and Senate Budget Committees are responsible for overall fiscal tax and spending targets and for designing a budget resolution to be
presented for vote in each House.
By April 1, the Congressional Budget Committees report on the concurrent resolution, setting expenditure and tax
levels. Congress then debates the proposed Budget Committee levels and the pending deficit or surplus. No later than April 15 of the year in which the new
fiscal year begins, Congress reports on budget estimates from the major committees and a general fiscal policy report from the Budget Committee, and adopts a
concurrent resolution establishing expenditure and revenue targets as a guide to action on the appropriations measures. Targets are set for major functional
categories, but no appropriations are made in, the resolution. The Congress considers, amends, and votes on the targets by May 15. If the House and Senate
resolutions differ, the measure goes to a conference committee. By June 15 Congress completes action on reconciliation legislation for the coming fiscal
Next, the actual appropriations legislation is considered. By tradition, all appropriations measures originate in the House and are initially
considered by one of the 13 subcommittees of the House Appropriations Committee. These subcommittees, organized by functional expenditure, review the
recommendations, hold hearings in which agency officials are asked to testify, and may revise expenditure estimates upward or downward. The subcommittee
recommendations are merged by the Appropriations Committee and reported out to the floor to the full House as a series of bills, generally with little change
from the subcommittee version. By June 30 the House is expected to After voting on the appropriations, the House sends its bills to the Senate for
consideration. The Senate follows the same committee-subcommittee procedures as the House, but with a somewhat less lengthy and detailed review. During July
Congress begins to pass on specific appropriations bills. Any differences between the Senate and House bills are ironed out by a conference committee and the
bill is sent to the President, who can sign or veto it. He cannot change particular items.
The appropriations measures authorize the expenditures of
certain amounts; the authorizations may extend beyond the current year. Frequently, congressional action is not completed by July 31, and expenditures on the
basis of last year's appropriations are extended on a temporary basis.
In 1985, Congress passed the Gramm-Rudman-Hollings Balanced Budget Act. The Act was designed to reduce some of the friction between Congress
and the Administration by mandating that the federal budget deficit be reduced over the next five years to achieve a balanced budget by 1991. The law set
deficit targets in billions of dollars for each fiscal year through 1991. In 1987, after a futile effort to reduce the budget deficit for 1986, Congress
passed a revision to Gramm-Rudman, postponing budget balance. The 1987 amendment called for revising the
deficit targets and extending the deadline for budget balance to 1993.
|1985 Deficit Targets |
1986 ||$171.9 billion |
|FY 1987 ||$144 billion |
|FY 1988 ||$108
|FY 1989 ||$72 billion |
|FY 1990 ||$36 billion |
|FY 1991 ||$0 billion |
For fiscal years 1989 through 1992, the projected deficit that Congress
approved could not be more than $10 billion greater than the target amount. Although the law dictated only a maximum allowable deficit and not aggregate
budget revenues and expenditures, it was designed to force the President to propose and the Congress to pass on a budget with tax revenues and expenditures
in line with the Gramm-Rudman deficit targets.
Gramm-Rudman required OMB and CBO to report annually on how far off the actual deficit was from the target. The
two reports were to be made public on August 10 of each year and, on August 15, they were to be sent to the GAO. The GAO had a weekend and three days to
issue its own findings on whether the deficit target had been missed. The original Act provided that, if the target had been missed, the Comptroller General,
director of the GAO, was to calculate, according to a predetermined formula, the cuts required in each Federal "program, project, and activity" and to
present the GAO report to the President and Congress, specifying where and to what extent cuts must be made. The President was to present his proposed cuts
by September 1, and they would become law at the end of the month unless Congress passed an alternative plan.
|1987 Revised Deficit Targets |
1988 ||$144 billion |
|FY 1989 ||$136 billion |
|FY 1990 ||$100
|FY 1991 ||$64 billion |
|FY 1992 ||$28 billion |
|FY 1993 ||$0 billion |
In 1986, a year after Gramm-Rudman was passed, the Supreme Court ruled that the GAO reporting procedure was unconstitutional. As a
result, the procedure reverted to the "fallback plan." This provision of the Act still required that the CBO and OMB size up the economy and project the
deficit and that the GAO crunch the numbers and issue a report stating where the budget needed cutting. However, instead of taking effect automatically with
a Presidential order, the report was to be presented to Congress. In this case, the budget cuts by the Comptroller General take effect only if Congress were
to pass a joint resolution, subject to Presidential approval, ordering the cuts to be made. Congress was otherwise free to rewrite the recommendations to
reduce the size of the cuts necessary to comply with the Act.
After enactment by Congress, the budget bill is sent to the President. The President
can either sign it into law or veto it. If he signs it, the budget goes into effect without any further ado on October 1. If he vetoes the bill, the budget
gets returned to the Congress. A two-thirds vote by each house is needed to override a presidential veto.
In recent years, Congress and the
administration have been at odds over the aggregate budget as well as the composition of expenditures. Fearful of a presidential veto, Congress has stalled
on passage of the second resolution and a final budget bill until the new fiscal year has begun. Technically, the government was closed because of budget
bill delays on at least two occasions during the Reagan administration, once during the Bush administration, and once, for almost a whole year, during the
Clinton administration. Although Gramm-Rudman was supposed to reduce friction between the Administration
and Congress, the friction remained. Since Gramm-Rudman targets only deficits and says nothing about how
those deficits are to be achieved, the Administration and Congress have argued on whether expenditures should be cut (Reagan) or taxes increased (Congress).
A House amendment to Gramm-Rudman would have empowered the President to make across-the-board
spending cuts if Congress and the administration failed to agree to stay within statutory deficit ceilings. Annual reductions could have been made with more
sensitivity to the growth of the economy. However, by the time the plan became legislation and received the President's endorsement, it had changed. The
enhanced rescission authority had disappeared.
Needless to say, Gramm-Rudman was a total failure.
Congress could not manage to keep expenditures down and the Presidents refused to raise taxes. In a further effort to reduce federal budget deficits,
Congress passed the Budget Enforcement Act of 1990. The Act established five budget categories: domestic
expenditures, international expenditures, entitlements, defense, and taxes. If Congress wants to raise expenditures in any one category, it must find an
offsetting expenditure in the same category to cut. If it cannot find or agree on an offsetting expenditure reduction, it must raise taxes.
On October 1 of each year, the new budget goes into effect. The funds authorized are released to
the agencies by OMB, usually with allotments by quarter and with reserves kept for emergencies. Expenditures are made by the agencies in conformity with the
authorizing legislation. Checks are written by the disbursing officer of the agency and paid through the Treasury. The departments and agencies are required
to file periodic reports with the OMB on the use of their disbursements. Although a department or agency gets a budget authorization, it may not spend the
entire amount in the allotted time period. If not, the funds are reserved for next period. Alternatively, it may draw against past reserves to pay this
period's obligations. Should a department or agency run out of funds prematurely, requests for supplemental appropriations may be authorized by Congress.
The appropriations are allotted by agency, but with considerable flexibility in the use of funds. Control over the timing and amount of expenditure
has been used in part as a stabilization tool. Prior to 1974, the President could withhold or impound funds appropriated by Congress. The Impoundment Control Act
of 1974 specifically denies this power.
Subsequent to the Impoundment Control
Act, Presidents had little power to withhold appropriations or sequester monies appropriated by Congress. Their power to rescind appropriations
had to be approved by Congress within a very short time after budget enactment or the rescission authority was lost. This inability left a void in the budget
process and tipped the scales in favor of a liberal spending Congress. After Ronald Reagan became President in 1980, he lobbied vigorously for a line item
veto to help trim budget deficits. A line item veto allows the President to strike various appropriations from the budget on a line-by-line basis. President
Reagan, a Republican, was unsuccessful in his efforts. However, fifteen years later, President William Clinton, a Democrat, persuaded Congress to pass the Line Item Veto Act of 1996
(Public Law 104-130, 110 Stat. 1200).
The Line Item Veto Act reversed the rescission authority. Instead of requiring the President to obtain the support of both
houses within a specified time period, the Act put the burden on Congress to disapprove presidential proposals, acting under expedited procedures, within a
30-day period. Any bill or joint resolution of disapproval was subject to a presidential veto, ultimately requiring a two-thirds majority in each chamber for
override. These procedures delegated important new powers to the President, affected the balance between the legislative and executive branches, and changed
the budget process.
The line item veto was short-lived. On June 25, 1998, the Supreme Court, in a 6-3 decision, struck down the Line Item Veto Act, declaring
it unconstitutional. In the case of Clinton v. City of New York, No.
97-1374 (1998), the Court held the law unconstitutional on grounds that it violates the presentment clause; in order to grant the President line item veto
power a constitutional amendment is needed (according to the majority opinion). Since that time, other measures seeking some presidential oversight of budget
appropriations have been introduced in Congress. All have met with little success.
Congress's most recent attempt to keep government spending in
check was its passage of the Spending Control Act of
2004. The Spending Control Act
establishes annual statutory limits on increases in discretionary spending and requires any increase in mandatory spending to be financed by a decrease in
other mandatory spending or an increase in taxes (the "pay-as-you-go" rule).
The General Accountability Office (GAO) is responsible for auditing
departmental and agency expenditures. The job of the GAO is to certify that funds are spent in conformity with the law and that the accounts of bureaus and
agencies reflect underlying fiscal operations. The head of the GAO, the Comptroller General, is appointed by, and responsible only, to Congress.
Unlike spending bills, which must be passed each year, tax bills are considered less
frequently. In the forty-nine years, between 1948 and 1997, there were about 20 tax bills, not all of significant import. The major tax legislation for the
period included the Kennedy Tax Cut of 1963, the Johnson Surcharge of
1968, the Ford Rebate of 1976, the Reagan Tax Cut of
1981, and the Tax Reform Act of 1986. The rest were incidental levies and modifications
to the existing tax codes, including excise taxes, tax credits, and changes in capital gains tax rates.
Primary responsibility for preparation of tax recommendations lies with the Treasury. On major issues of
policy, and particularly those relating to the level of tax collections, compared to expenditures, decision-making is shared with the OMB and CEA.
The Treasury has a permanent staff that studies the effects of the current tax structure as well as proposed changes. It considers various objections raised
by taxpayer groups and comments by the IRS. It, then, evaluates the economics of these objections and comments, weighs the advantages and disadvantages of
alternative proposals, and reports its findings to the Secretary of the Treasury. The Secretary, in consultation with the President, will determine if new
taxes should be levied, old taxes removed, or existing taxes changed. When the Secretary receives approval from the President, he asks the staff to construct
a detailed proposal of the tax measure. In the latter stages of development, the Treasury will consult with the OMB and CEA. The President will receive the
final draft and either make general reference to the tax proposal(s) in his "State of the Union Address" or he will present a separate "Tax Message" to
Congress following his delivery of the annual budget.
The process of passing on tax
legislation is not so tedious as budget legislation. Nonetheless, it generally takes at least six months before tax proposals become law. According to the
Constitution, all tax measures must originate in the House of Representatives. Inside the House, the proposed tax changes are submitted to the Ways and Means
Committee. The Committee holds hearings, inviting comments from the Secretary of the Treasury as well as various interest groups on the advantages and
disadvantages of the proposal(s). The Committee analyzes the economic as well as the popular effects of the tax measure(s). After careful review of the
evidence and statements, the Committee will consult with the Joint Committee on Internal Revenue Taxation and the Secretary of the Treasury. Finally, the
committee reaches a position on the tax proposal(s) and produces a tax bill. The committee votes on its bill and, if approved, sends the bill to the floor of
the House. According to the rules, debate on the House floor is limited and amendments are barred. If the House votes to approve the bill, it is then sent to
the Senate. If the House votes down the bill, it dies. Generally, the chairperson of the Ways and Means Committee is an influential representative. With his
approval, tax bills invariably are passed by the House. Without his approval, tax bills die in committee.
In the Senate, a similar procedure is
followed. The bill goes first to the Senate Finance Committee, which considers the provisions of the bill and makes its own modifications. When the Finance
Committee has voted on its version, the revised version is submitted to the full Senate. According to the rules, debate on the Senate floor is unrestricted
and amendments to the committee's proposal are allowed. If The Senate votes to approve a version identical to the House bill, with no modifications, the bill
is sent to the President for his signature or veto.
If the Senate votes to approve a version that differs from the House version, the two bills are
sent to a conference committee, where differences are ironed out and a compromise reached. The compromise is then sent to the House fort final vote. If the
House approves, the bill is sent to the President for his signature or veto. If the House votes down the compromise, its fate is uncertain. Generally, the
whole procedure, from design to passage, must be repeated. However, most compromise tax bills are automatically passed by the House and sent to the President
for his signature or veto. If the final version meets with the President's approval, he will sign the bill into law. If the final version differs
substantially from the President's original version, he will veto it, in which case, any tax changes will have to go through the same process an over again.
Alternatively, a two-thirds vote by each house is needed to override a presidential veto.
Once a new tax law is signed, the Internal Revenue Service, the official enforcement and collection agency for the federal government, issues copies
of the new guidelines to corporations and employers. Generally, these guidelines are available within two weeks of passage so that the delay in executing the
new legislation is minimized. Employers can then adjust the withholding from employees' pay checks and corporations and other required individuals can adjust
their quarterly estimated tax filings and payments.
II. Monetary Policy
The Discount Rate
The discount rate is reestablished every two weeks. The district boards meet once or twice a month to review the value of the
discount rate. Generally, the president of the District Bank, the first vice president, research officers, the secretary, and the assistant secretary attend
the board meetings. When a board meets only once a month, an executive committee is empanelled to evaluate the discount rate on an interim basis.
Prior to these meetings, the directors are apprised of the economic and financial conditions in their districts. The information, its depth, and complexity
vary from district to district. In some cases, the boards receive correspondence from constituents in the district. In other cases, the boards get summaries
of communications from the Board of Governors. In all cases, each district board is informed about rate requests from other districts.
District Bank Board of Directors Meeting The procedure for a
decision on the discount rate starts in the district bank board meeting. The agenda for a board meeting in which a discount rate change is requested is
fairly straight forward.
Reports The research officers report on developments in the domestic financial and
international foreign exchange markets, on loans to members banks, and on recent economic developments. During these presentations, the directors may ask
questions. Any attendant representatives from branch offices in the district may make formal presentations. Board of Governors Meeting The Board of
Governors considers discount rate requests once a week at a meeting attended by Board members and appropriate officers and staff. The Board members are
prepped through a series of memoranda listing the recommendations of the various district boards and with periodic briefings by their staff on economic and
financial developments. The agenda for the Board of Governors meeting is similar to that of the district board meetings.
Go-around The directors and the branch office representatives engage the "go around." The "go around" is a period where each
person gets to express his views on the subject under discussion. During a "go around" on the discount rate, each director comments on such matters as retail
sales, production, inventories, and financial developments.
Proposal The president (or, in his absence, the
senior vice president) presents his views along with his policy proposal, which he offers in the form of a motion.
Discussion The directors and branch representatives discuss each others views.
The Vote The proposal
is put to a vote. Representatives from branch offices are not present when the vote is taken. The decision, along with the general feelings of the directors,
is remitted to the Board of Governors in Washington by an encoded telegram.
Reports Staff members make presentations on specific issues relating to the discount rate. Board members ask questions.
Periodically, the Discount Policy Group, composed of senior officers of the Board, also makes a presentation. The functions of this group are:
of the members of the Board of Governors gets the uninterrupted opportunity to express his/her views and positions on the current discount rate and any
- to oversee the operation of the discount function and uniform application by the district banks;
- to assess the impact of
discount policy on domestic and international economic activity and on the banking system;
- to study operating and regulatory matters
pertaining to the discount function;
- to anticipate emergency situations that may call for more liberal credit at the discount window;
- to evaluate trends in types and volumes of discount window credit.
General discussion Although the Board considers a proposal relating to only one policy tool at
each meeting, it is not considered in isolation. Other monetary tools may be included to the discussion, especially since a change in one policy tool may
require a change in other policy tools to accomplish the objectives.
The Vote At last, a vote is taken.
Once a decision to change the discount rate is made, the Board will make a public
announcement and the change is accomplished, generally, the next day. Immediately, any and all new borrowings by banks are at the changed rate.
Open Market Operations
Open Market Committee (FOMC) is the key decision-making body. It meets eight times a year. Twice a year, in February and July, the committee meetings are
used to formulate annual objectives, develop forecasts for the coming year, and write the semi-annual Monetary Report to Congress, pursuant to the Humphrey-Hawkins Act in 1978. The remaining
meetings are used to review the annual objectives and to review and revise the methods of open market operations used to achieve these objectives. As of
January 2008, the FOMC plans to increase its transparency and release four (4) forecasts annually.
The principal people who attend the FOMC meetings
are the Governors, all of the District Bank presidents, Committee Staff officers (secretary, assistant secretary, economist, associate economists, etc.), the
System Open Market Account (SOMA) Manager (from New York), and deputy managers. Staff officers, the SOMA Manager, deputy managers, and all District Bank
presidents serving on the committee in a voting capacity are selected at the first meeting on or after March 1 each year.
In preparing for each
meeting, committee members do two things: (1) absorb all factual and analytical information received before the meeting, and (2) consult with staff
Before each meeting, members receive three books: Beige Book, Green
Book, and Blue Book. The Beige Book analyzes current business and
financial trends in the individual districts and includes a national summary. It is prepared by the various districts on a rotating basis and it compares
district trends to national trends, noting any significant differences.
The Green Book reviews the facts and
implications of recent domestic and foreign economic developments, including a statement showing how actual events seem to be conforming to or deviating from
the last recent economic projections. At least three times a year (more, if necessary), the members receive a comprehensive economic forecast extending one
to two years into the future. In between, the forecasts are updated for each meeting. The forecasts are composites based on two independent sources: (1)
detailed projections of GNP components prepared by staff experts in the various areas, and (2) the MlT/Penn-Social Science Research Council econometric
The Blue Book lays out the policy alternatives relevant to the state of the economy. Each alternative
includes such things as operating targets for the monetary aggregates (M2, MZM, etc.) consistent with FOMC objectives. In addition, a target is established
for "credit proxy," which includes member banks' deposits and other liabilities subject to reserve requirements, e.g. Eurodollar borrowings from foreign
banks. These targets are expressed as ranges because it is difficult for the SOMA Manager to hit a specific number exactly and there may be some conflict in
achieving all monetary aggregates simultaneously.
In addition, the Board of Governors will have gained information from the Federal Advisory
Committee, with whom it meets four times a year.
Before each meeting, the district presidents and the Board of Governors meet with and are briefed
by their respective staff aides. About two weeks before the FOMC meeting, the Beige Book is released. A few days later,
the president of each district holds a meeting with his staff from the bank's research department and senior officers. At that time, the Green Book and both reports of the SOMA Manager are available. Discussion revolves around analyses of economic developments in
the district and their relation to national trends. From this discussion emerges a consensus as to the direction of monetary policy. On Saturday (three days
before the FOMC meeting), the Blue Book arrives and is studied. On Monday, each president and his associate(s) travel to
Washington, where each receives additional material covering developments up through the close of domestic and foreign markets the previous Friday. They also
receive supplementary material to the Green Book that arrived the preceding Thursday. On Monday evening, the president
and his associate(s) review the summaries of their staff aides' research in light of the new information. Then, the president finalizes the general position
he will support at the FOMC meeting the next day. (FOMC meetings are generally held on Tuesdays.)
The Committee's general approach to decision-making The Committee uses a
concensus-building approach to to decision-making. Each member is a professional and respected for his/her expertise. The members are congenial and
deferential to one another. The meeting is the place where they discuss and thresh out one another's views on the current state of the economy and its
prospects for the future. The Committee sorts out the views of its members on the appropriate course for open market actions. It engages in a give-and-take
discussion in an effort to synthesize individual views into a consensus.
The Committee's approach to monetary policy
involves formulating strategy and tactics
Strategy is long-term planning and setting longer-term
intermediate objectives. Strategy is the basic "policy stance": tight money, loose money, tighter/looser money. In developing its strategy or "policy stance"
the Committee takes into consideration objectives for economic growth, employment, and prices as well as the expected course of fiscal policy. It then sets
targets for monetary aggregates or money market conditions. The strategy is not changed at every meeting and changes only slowly over time as economic
conditions and fiscal policy evolve. In response to the Humphrey-Hawkins Act in 1978, the Board of Governors is required to report these targets and the general stance of monetary
policy to the Congress twice a year, in February and July. The agenda for FOMC decision-making
Tactics are short-run plans to achieve longer-term
intermediate objectives. If the policy stance is expressed in targets of certain monetary aggregates, the Committee devises the best tactic it knows for
hitting those targets. Such tactics may include targeting nonborrowed reserves, net free reserves, total reserves, or the fed funds rate.
Call to Order/Minutes The first order of business
is the call to order by the FOMC Chair and a request for apparoval of the Minutes of the last meeting. Minutes of FOMC Meetings The minutes of the meeting are
kept secret for thirty days before public disclosure. This allows the Federal Reserve some lead time to execute its policy directive before other market
participants can decipher what is going on and perhaps thwart the policy initiative. The disclosure period used to be longer (two months), but a court
decision ruled that the public had a right to this information and the disclosure period was cut to one month.
Foreign Exchange Operations The second order of business is a report from the Foreign Exchange Operations Manager.
The Manager reports on events in the foreign exchange markets since the last meeting. Following the report is a go-around, during which each governor
and bank president gets to comment on international developments, the balance of payments, the state of the international "swap" network, and reciprocal
credit lines with other foreign central banks for intervening in and stabilizing currency markets. The go-around is followed by a discussion. At the
end of the discussion, the Chairman translates the consensus into a policy proposal on foreign exchange operations and puts it to a
Domestic Open Market Operations The Manager reports on developments in the financial markets since
the previous meeting. The report includes comment on domestic open market operations, levels of nonborrowed and total reserves, M1 and M2, borrowing at the
discount window, the fed funds rate, and Treasury financing plans.
Economic and Financial Developments and the Longer-Term
Outlook The senior Board staff economist comments on the state of the economy and the forecasts in the Green
Book, which are macroeconomic models, one in the Keynesian framework, the other in the Monetarist framework.
Policy Alternatives A senior Board staff member comments on the policy alternatives presented in the Blue Book and the likely effect that each will have on money market conditions. Each alternative is documented with a set of
intermediate operating targets along with its expected effect on key variables such as bank reserves, monetary aggregates, and interest rates. The
presentation relies heavily on microeconomic models to predict how reserves influence interest rates and the supply of money balances through the money
Go-around Each Governor and district president summarizes his views and recommendations. Since open
market operations are conducted through the New York District Bank, its president generally makes the first presentation. Each report relies heavily on the
District Bank staff reports in the Beige Book and considers the economic outlook as will as how the member's views agree
or disagree with the staff reports and what each member considers an appropriate monetary policy for the circumstances.
Target Formulation Toward the end of the meeting, members translate general policy preferences into specific recommendations
for monetary growth rates and money market conditions. About once a quarter the Committee also reviews its longer-run monetary objectives.
The Vote In the end, the Chairman guides the Committee members to a consensus. The Chairman then translates the consensus into
a directive and presents it to the Committee for final discussion. After the discussion, the directive, often with some amendments, is put to a vote.
Although 19 individuals (the BOG and each District Bank president) participate, only the 12 sworn members vote. The approved directive gives broad
instructions to the Manager about open market operations.
When the manager for domestic operations returns from the FOMC meeting to the New York Reserve Bank, he
oversees seven officers and a group of professionals, who are charged with carrying out the FOMC directive from the trading room on the eighth floor. The
FOMC's instructions govern both dynamic and defensive open market operations.
Dynamic Operations Dynamic open
market operations are active purchases and sales designed to meet the Intermediate range targets, allowing for seasonal variations and intermittent
aberrations in the demand for money balances. The manager of operations and the staff director for monetary policy determine the level of nonborrowed
reserves, given a specified level of borrowing at the discount window, that best achieves the desired growth in M1 and M2. They also specify an acceptable
range for the fed funds rate. If the level of nonborrowed reserves is set too high, borrowing slows, and the fed funds rate falls. If the level of
nonborrowed reserves is set too low, borrowing increases, and the fed funds rate rises. Every Friday, the manager and his staff director review and recast
weekly nonborrowed reserves objectives to achieve the optimum ease or restrictiveness of monetary policy. when the fed funds rate moves out of the desired
range, the manager of domestic operations reports to the FRB Chairman.
Defensive Operations Defensive open
market operations are passive purchases and sales designed to enable depository institutions to accommodate highly variable short-run demands for currencies,
deposits, and credit and to offset intermittent aberrations, such as seasonal factors, Federal Reserve float, and changes in the Treasury's balances, federal
agency balances, and foreign central bank balances at the Fed. Defensive operations are simply offsetting or correcting transactions to keep dynamic
operations "on track" Sometimes defensive operations are known as "leaning against the wind."
the FRS wants a loose monetary policy that would be executed through the purchase of securities supplying nonborrowed reserves to the barking system. on any
one day, however, the Manager of the Trading Desk could be a net seller, if other factors left the banking system with an excess of reserves that would have
increased the expansiveness of the loose monetary policy stance.
Strategies The Trading Desk can employ either
of two strategies in its open market operations. Which strategy is pursued depends on the outlook for reserves.
purchases and sales of Treasury and agency securities Generally, outright purchases and sales have a greater impact on interest rates and the
financial markets because they are not so readily reversed. These transactions are more likely dynamic operations geared to achieving longer-term objectives.
Repurchase and Match-sale Purchase Agreements (RPs and MSPs) of Treasury and agency securities and bankers
acceptances These transactions are very short-term (less than 15 days) and, by contractual arrangement, reversible. They are generally defensive
operations designed to counteract short-run seasonal flows. Their use minimizes the impact on interest rates over the short-run.
Trading in Short-Term T-Bills Most of the trading activity is in T-bills to minimize the impact on interest rates and to
maintain orderly markets. (The prices and yields on short-term securities vary less than the prices and yields on long-term securities from any given charge
in supply and demand.) However, at the margin, the FRB tends to buy issues that are in excess supply and to sell issues that are in excess demand, again, to
maintain orderly markets.
Trading in Intermediate and Long-Term Issues When the economy is weakening, the Fed
may buy intermediate or long-term Treasury securities to encourage rates to fall; and when the economy is over heating, it may sell these longer-term
securities to encourage interest rates to rise.
Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment, Ben S. Bernanke, Vincent R. Reinhart, and Brian P. Sack,
Finance and Economics Discussion Series 48, Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board, Washington, D.C., 2004
Prohibitions The Fed does not buy new or refunding issues, although it may use the Treasury's retirement of securities to
reduce its portfolio.
Primary Dealers Open market operations is conducted through a select group of securities
dealers called primary dealers. These dealers report daily on
their trading activities, their cash and futures positions in Treasury and other securities, and their means of financing their positions. They conduct
purchases and sales not only for their own accounts, but also for other securities dealers. New dealers are admitted to this exclusive club only rarely and
only when the manager determines that this inclusion would help the desk perform its own functions. To be admitted, a securities firm must apply to the
three-member Treasury-Federal Reserve Steering Committee, of which the Manager is a member, that oversees dealer activities and performance. To be
considered, a dealer must have attained a minimum amount of capital and minimum trading volume in US government securities. Several years ago, an antitrust
suit was filed against the Federal Reserve for its "exclusive dealings." Firms that had to trade through the primary dealers wanted direct access to the
Federal Reserve Trading Desk. These firms did not prevail. In fact, the number of primary dealers with whom the Federal Reserve has exclusive dealings has declined from about 40 in the 1980s to only 18 as of June
Members of the Board of Governors receive memoranda containing information and analyses prepared by the staff on the reserve requirements. The
memoranda may also discuss possible alternative courses of action. Board members also benefit from weekly briefings by the staff on economic and financial
The agenda for reserve requirement
Reports Staff economists specializing in reserve requirements policy make oral presentations.
Board members may ask questions during the presentation(s). The Reserve Requirement Policy Group composed of senior officers of the Board, presents its
findings on questions of reserve requirements and rates as they pertain to the Board's responsibilities on monetary policy. Throughout the 1970s, the Group's
main concern was dwindling membership in the FRS resulting from the burden of reserve impositions above state-mandated requirements. As of 1980, all banks
are de facto members of the Federal Reserve and subject to FRS reserve requirements, unless state requirements are more stringent. Execution
Go-around Each member expresses his views on the state of reserve requirements and proposed changes.
General Discussion The governors discuss each others views.
The Vote A vote is
taken, each member voting in turn. The result represents the decision of the Board.
decision can be announced as early as the close of the meeting. If reserve requirements are to be lowered (loosened), the order can be processed immediately.
If reserve requirements are to be raised (tightened), the order is not processed for at least two weeks. This time lag in execution permits the banks
sufficient time to adjust their reserve positions to desired levels.
Board of Governors meets to consider changes in the selective controls. It follows the procedures for reserve requirement policy. On interest rate ceilings,
the Board of Governors is required to consult with the Federal Deposit Insurance Corporation (FDIC) and the Office of Thrift Supervision (OTS). On margin
requirements, the Board of Governors is not required to consult with the Securities and Exchange Commission (SEC) or any other federal agency. However, as a
matter of practice, the Board does consider the views of others in making its determinations.
Note that, unlike Congress, where members bicker
openly, the members of the Board of Governors, the Boards of Directors, and the FOMC are very collegial and respectful of each others views. This
collegiality and the consensus process have lent considerable credibility to Federal Reserve decisions.
Debt Management Policy
No formal procedure exists for determining maturities for refunding the public debt and for financing current
deficits. Sales of savings bonds are random and at the discretion of households and other holders. Issues of cash management bills are related directly to
cash flow of the Treasury. Government agency series depend on the profitability of these governmental units. State and local issues depend on any surplus
from municipal bond offerings. Dollar-denominated and foreign currency-denominated issues are dominated by international events. Other issues — bills,
notes, and bonds — depend on the needs of the Treasury and financial market conditions.
Unlike corporate securities that are formally underwritten by investment banks, US. securities are marketed directly by the Treasury, with the
Federal Reserve acting as fiscal agent and handling all of the mechanical details. In 1970, the Treasury Department started experimenting with the sale of
its securities by auction rather than by announced and preset terms. Since that time the method of auctioning has been changed and extended so that at
present almost all Treasury offerings are sold by auction.
Types of Auctions
Price Auction This method is used generally for
the sale of bills, sold at discount with no coupon, and occasionally for the sale of notes and bonds.
Regular bill issues are arranged by the Treasury on Thursday of each week. Bids on 3- and 6-month issues are due the following Monday at 1:00 pm, EST.
Interested buyers must fill out a form tendering an offer to the Treasury for a specific bill issue at a specific price, accurate to three decimal places
(assuming a par value of $100). These forms must be filed by the appriate deadline with one of the 37 regional Federal Reserve banks or branches. Applicants
can appear in person at the Fed, submit the form by mail, place an order through a security dealer, bank, or other depository institution, or submit the bid
online through the Treasury Automated Auction Processing System ("TAAPS"). Filing at the Fed, by mail, or online is free. Other intermediaries may charge a
fee from $25-$75. Dutch Auction On a few occasions, the Treasury has employed this "uniform price" method for
selling long-term bonds. After all competitive bids are in, the Treasury proceeds to award the available securities (once noncompetitive orders are filled)
beginning with the highest bidder on down until all securities are allocated (at the stop-out price). The price paid by all buyers (competitive and
noncompetitive, alike) is that tendered by the lowest accepted competitive bid - the stop-out price.
All bids are confidential and are kept sealed until the auction date. At the designated time on the auction date, Federal Reserve
officials open all the bids and array them from highest price to lowest price. After subtracting the total amount of noncompetitive bids from the public
offering, the officials start awarding the remaining amount to competitive bidders, starting with the highest price and working down to the stop-out price,
at which point the Treasury's order is filled. No one bidding below the stop-out price receives bills at the auction. All successful bidders (at or above the
stop-out price) pay their bid price, while noncompetitive bidders pay an average of the competitive bid prices. All bills are issued in book-entry form — a computerized record of ownership
maintained in Washington — with the owner receiving a statement of account about 4-6 weeks after purchase. Unless reinvestment is requested, the
Treasury automatically remits a check to the holder at maturity.
Note and Bond Auctions The Treasury issues 2-,
5- and 10-year notes. It discontinued the 30-year bond issues in October 2001. The 2-year notes are auctioned monthly. The 5-year notes are auctioned four
(4) times a year in February, May, August, and November. The 10-year notes are auctioned six (6) times a year in February, May, July, August, October, and
The Treasury sets the coupon rate and the minimum price it is willing to accept on notes and announces the amount of notes for sale.
Competitive bids are accepted with prices above and below par, accurate to two decimal places (assuming a par value of $100). Notes are allotted first to the
highest price bidder and then to buyers submitting successively lower price bids until the amount available (less any noncompetitive tenders) has been
exhausted at the stop-out price. All successful competitive bidders pay their bid price. Noncompetitive bidders pay the average price established by the
Auction The yield auction is the method used most frequently to float notes and bonds. Neither the price nor the coupon rate on the new securities
is set in advance by the Treasury. Instead, it merely announces the amount of securities available and calls for yield bids. Competitive bidders must express their offers on an
annual pencentage yield basis, accurate to two decimal places (e.g., 9.75%). Securities are allotted first to the lowest yield bidder and then to buyers
submitting successively higher yield bids until the amount available (less any noncompetitive tenders) has been exhausted. All successful competitive bidders
receive their bid yield. Noncompetitive bidders receive the average yield established by the competitive bidders.
In order to secure informal
underwriting, pricing must be attractive to the market. When pricing is attractive, most of the underwriting support is given by government securities
dealers, who purchase most of the new issues. Some new issues can be paid for with simultaneously maturing issues. This means that the cyclically issued
bills and notes held by smaller buyers are rolled over with a minimum of disturbance in the markets. The market has become so skilled at these auctions that
the range of successful bids is usually within 5 basis points (1/20th of 1%).
Types of Bids
Competitive bids are typically submitted by large buyers, including commercial banks and government securities dealers,
who buy several million dollars worth at one time. These institutions bid aggressively, offering an attractive price (yield), in line with market conditions,
so as to win an allotment.
Noncompetitive bids (normally less than $500,000) are tendered by small buyers. All
noncompetitive bidders receive an allotment up to a maximum determined by the Treasury. The maximum is currently $1 million. The price (yield) of an issue to
noncompetitive bidders depends on the results of the competitive bidding.
tendering bids for a bill issue, buyers pay the full par-value price of the bill and, on the issue date, receive refund checks from the Federal Reserve for
the difference between the amount paid and the auction price. On notes and bonds, buyers submit a deposit of 5% of the amount bid, unless they represent an
institution with special exemption — commercial banks, state and local governments, public pension funds, federally insured savings and loan
associations, major government securities dealers, Federal Reserve Banks, U.S. government agencies and trust funds, foreign central banks and governments,
and special international organizations. Payment for securities must be made in cash, immediately available funds, the exchange of eligible securities
(accepted at par value), or by a check to the Federal Reserve banks or to the Treasury, provided the check is issued early enough to clear by the required
payment date (5-day settlement).
Form of Issue
means that the buyer receives an engraved certificate representing the Treasury's indebtedness. The ownership is not recorded on the books of a bank or at
the Treasury Department nor is there any notice to the Treasury of a change in ownership when such securities are traded in the open market. Bearer notes and
bonds with interest coupons attached are known as coupon securities. In order for the holder to receive interest, the coupon must be detached and presented
to the Treasury Department or to a Federal Reserve Bank. Similarly, when bearer securities are redeemed or rolled over at maturity, they must be presented to
the Treasury or Fed for these purposes. The disadvantage is that bearer securities belong to anyone who happens to hold them. They can be very easily lost,
stolen, destroyed, or mutilated, in which case, the owner has no recourse to his funds.
Registered form means
that the securities are engraved with the owner's name and recorded on the Treasury's books. While the owner typically holds the securities, the Treasury
automatically pays (without notice or receipt of coupon) any interest due on these securities to the owner of record. If registered securities are lost,
stolen, destroyed, or mutilated, the owner mav be able to recover the funds. Each year the Treasury honors a few such claims after careful screening, but
usually only after the owner deposits an indemnity bond.
Book-entry form means that the buyer does not get an engraved certificate representing the Treasury's indebtedness. Rather, the
buyer's name and amount of securities are recorded on the books of a bank or at the Treasury Department. In book-entry form, checks for interest and payment
at maturity are automatically remitted by the Treasury to the owner. Today, the book-entry system is fully computerized. The advantage is that ownership is
undisputed. The disadvantages are that ownership can be traced (not "hidden," as with bearer form) and transfers may be more cumbersome. No transfers are
allowed less than 30 days prior to maturity nor soner than 10 days after Issue. However, if the securities are held in book-entry accounts at the Federal
Reserve, they may be transferred using the Fed's electronic wire transfer network. This device makes it easy to sell Treasury securities before maturity on a
In 1985, the Treasury announced a STRIPS program in which the interest and principal payments on Treasury securities can be
separately owned and traded. To be eligible for stripping, the buyer must keep the securities in a book-entry account at a Federal Reserve bank.
IV. Incomes Policy
Incomes policies are the domain of the federal government. The same
administrative-legislative procedure is involved. Wage and price controls may be imposed unilaterally by Presidential order or enacted into law by Congress.
The Nixon wage and price controls were mandated under the Economic Stabilization Act of 1971. Thus, they
passed through typical legislative channels before implementation. Interest rate controls may be mandated through congressional legislation, or Congress may
defer to the Board of Governors of the Federal Reserve. Tax incentive programs must go, first, to the Congress (via the House Ways and Means Committee and
the Senate Finance Committee) and, second, to the President for signature (or veto). Indexing would require congressional legislation, and, where interest
rates are concerned, congressional consultation with the Board of Governors of the Federal Reserve.
Supply Management Policy
Supply management policies includes budget (expenditure) policy, tax policy, regulatory policy, and monetary
policy. Necessary budget revisions would follow the budget process for fiscal policy. Revisions in the tax code would follow the tax process for fiscal
policy. Changes in regulatory policy would follow the familiar administrative-leglslative process, each measure succeeding to its relevant congressional
committee. Monetary policy would follow the traditional channels of Federal Reserve procedure.
All budgetary or regulatory policy measures must pass through the proper channels of enactment by the Congress
with approval from the President. The imposition of incomes policies may require congressional-administrative approval or they may be imposed by executive
order. Interest rate controls are the domain of the Federal Reserve under general guidelines passed by Congress. Monetary aggregate targets are the sole
domain of the Federal Reserve.
Because of the formalities and the generally confrontational nature of the legislative process, policy measures that
require congressional passage and presidential approval tend to have extremely long administrative lags. Measures that require only an executive order by the
President can be carried out more quickly and expeditiously. Monetary matters, which are carried out by the policy-making arm of the Federal Reserve, tend to
be accomplished rather quickly as well. Because of the frequency of its meetings and the generally collegial attitudes of the members of the FOMC, its policy
decisions have a relatively short administrative lag.
Economics of the Public Sector, 7th ed., John F. Due and Ann F. Friedlaender, Richard D. Irwin, Inc., Homewood, IL, 1981: ch. 7 and App. I to ch.
Monetary Policy, Money Supply, and the Federal Reserve's Operating Procedure, Stephen H. Axilrod, in Central Bank Views on Monetary
Targeting, Paul Meek, ed., FRBNY, 1982
Implementation of Federal Reserve Open Market Operations, Peter D. Sternlight, in Central Bank Views on
Monetary Targeting, Paul Meek, ed., FRBNY, 1982
Legislative Summary: History of the Line Item Veto Act of 1996, Public Citizen
The Federal Reserve System: Purposes and Functions, Board of Governors of the Federal Reserve System, Washington, DC, 1996: chs. 3,
Practical Issues in Monetary Policy Targeting, Stephen G.
Cecchetti, Economic Review (FRBClev), 32(1) 1Q96
of Interest Rate Targeting: A Partial and a General Equilibrium Analysis, Charles T. Carlstrom and Timothy S. Fuerst, Economic Review (FRBClev),
Budget Process: A Brief Outline, James V. Saturno, 96-368 GOV 26 Apr 1996
Line Item Veto Act: Procedural Issues, Louis Fisher and Virginia A. McMurtry, CRS Report For Congress, 2 Dec 1996
Understanding Open Market Operations, M.A. Akhtar, FRBNY, 1997
The October '87 Crash Ten Years Later, Robert T. Parry, Economic Letter
(FRBSF), 97(32) 31 Oct 1997
U.S. Monetary Policy and Financial
Markets, Anne-Marie Meulendyke, FRBNY, 1998
Strategy of Monetary Policy, Laurence H. Meyer, The Alan R. Holmes Lecture, Middlebury College, Middlebury, VT, 16 Mar 1998
Line Item Veto, THOMAS, Legislative Information Service of the Library of Congress, 9
History of Line Item Veto Notices, U.S. National Archives and
Records Adminsitraton, updated 7 Jan 2000
How does the Fed spread the word? Colin Hurlock,
MSNBC.com, 2 Feb 2000
Fed Rate Meetings: The Basics, Scott Gerlach, MSNBC.com, 21 Mar 2000
How Our Laws Are Made, Charles W.Johnson, Parliamentarian, U.S. House of
Representatives, updated 19 Nov 2003
Deficits, and Public Policy, Ayman Ismail, Principles of Macroeconomics, Ch. 17
The American Congress, 3d ed. Online Version, Steven S. Smith, Jason Roberts, and Ryan Vander Wielen, Houghton Mifflin Company, 2003.
See ch. 12
Budget of the United States Government, Fiscal Year 2006
How to Make Congress Work For You
How a Bill Becomes Law, Georgia State University School of Law
Constitutional Topic: How a Bill Becomes a Law, The U.S. Constitution Online
The Federal Reserve System In Brief, FRBSF
The Fed: Our Central Bank, What does the Fed do and how does
it affect us? FRBChi, Nov 2000
U.S. Monetary Policy:
An Introduction, FRBSF
FOMC Meeting Calendar
Primary Dealers, Fedpoint (FRBNY)