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Why new faces at the Fed will impact the Fed funds rate

Part 2
Why new faces at the Fed will impact the Fed funds rate (Part 2 of 4)

How the Board of Governors and the FOMC set US monetary policy

The use of monetary policy tools by the Fed’s Board of Governors and the FOMC

The Fed has three major monetary policy tools: the discount rate, reserve requirement, and open market operations. The first two come under the purview of the Board of Governors, while the FOMC decides on open market operations. Through the use of these tools, the Fed can influence the demand for and supply of balances held at Federal Reserve Banks by depository institutions and ultimately the level of the Federal funds rate, the base rate for the whole economy. Depository institutions include financial institutions like Goldman Sachs (GS) and Wells Fargo (WFC). Both GS and WFC are part of the iShares S&P 100 Index (OEF), which is composed of the 100 largest publicly listed companies in the U.S. by market capitalization.

Changes in the base rate, which has been at near zero levels since December 2008, would likely impact both stock (OEF) and fixed income markets, including ETFs like the iShares 20+ Year Treasury Bond ETF (TLT) and the iShares iBoxx $ High Yield Corporate Bond ETF (HYG).

Part 2Enlarge Graph

How are members to the Board of Governors appointed?

Board members are appointed by the president and must be confirmed by the U.S. Senate. Each board member may serve one 14-year term. However, should a board member to appointed to fill in the unexpired term of another board member, he or she may be reappointed for a second term for the full 14 years.  The U.S. president designates and the U.S. senate confirms two members of the board as the chair and vice-chair. Both are four-year terms.

Structure of the FOMC

The seven members of the Board of Governors, along with presidents of five of the 12 Federal Reserve Banks, form the FOMC. The governors as well as the president of the New York Fed have a permanent seat on the FOMC. The presidents of the remaining 11 Federal Reserve Banks serve on the remaining four seats on the FOMC on rotational one-year terms. One bank president from each of the following groups is chosen to serve on the committee each year by rotation:

  • Boston, Philadelphia, and Richmond
  • Cleveland and Chicago
  • Atlanta, St. Louis, and Dallas
  • Minneapolis, Kansas City, and San Francisco

Presidents of non-voting Federal Reserve Banks attend committee meetings as well as participate in the discussions and contribute to the committee’s assessment of the economy and policy options (source: US Federal Reserve).

In the next part of this series, we’ll look at further changes in the composition of the Board of Governors that we can expect in the near future.

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