Federal Reserve

Fed alchemy taken to book

PUBLISHED : Wednesday, 21 March, 2001, 12:00am
UPDATED : Wednesday, 21 March, 2001, 12:00am

At the end of the day, it comes down to the decision of a group of men and women - though largely men - sitting around a large table in a large room.

That the room adjoins the office of Alan Greenspan, board chairman of the US Federal Reserve is no coincidence.

It would not be an understatement to say that the eyes of the global markets were fixed on the Federal Reserve's Open Market Committee (FOMC) when it met yesterday.

However, as an informal poll by your correspondent showed, how the FOMC works is something of a mystery to most.

And so, here are the basics.

Held eight times a year, the FOMC was established by the Banking Act and came into existence on March 1, 1936.

Simply put, the FOMC sets monetary policy by controlling how much money flows through the US economy. Using open market operations, the FOMC is partly responsible for navigating the US economy through the seas of higher growth but away from the rocks of inflation.

Since 1981, the meetings have been held on Tuesdays at the Fed in Washington and it consists of the seven Reserve Board governors, and a rotation of four presidents of the 12 Reserve Banks based on the 12 US financial districts.

Given its importance to the US economy, the New York Reserve Bank president (presently William McDonough) is a permanent fixture at the meetings and also acts as FOMC vice-chairman.

Listening in on a roomful of economists discussing monetary policy could be equated with thrills such as watching paint dry. However, transcripts show that economists are human too.

For example, the May 1995 transcript (although minutes of the meeting are made quickly available to the public, full transcripts are subject to a five-year time lag) has the following exchange between Mr Greenspan and Peter Fisher, manager of the System Open Market Account of the New York Fed:

FISHER: The central bank should exclusively be buying everything that is off the run. But in practice, of course, that would involve the Herculean effort of being the vacuum cleaner of the securities market.

GREENSPAN: Especially if you have to sell.


GREENSPAN: And to whom.

FISHER: And to who.

GREENSPAN: And to whom.


GREENSPAN: I'm sorry Peter, I just thought I would pick on you this morning. I took a pill that says 'Pick on Peter'.

The FOMC begins with an overview of developments in the domestic and financial markets given by the erstwhile Mr Fisher.

Wall Street has nicknamed Mr Fisher the 'repo man' because, in the process of tuning the money supplies, he repurchases debt securities from the open market desk at the New York Fed.

Mr Fisher, who has been at the New York Fed for six years, recently made headlines after President George W. Bush elected him undersecretary of the Treasury Department for domestic finance.

The Greenbook discussion follows Mr Fisher's testimony.

Prepared by the Fed board staff and distributed a week before the meeting, the Greenbook (cunningly named for the cover's colour) looks at how the economy will develop for the remainder of the present year and next year were monetary policy to remain unchanged.

After this presentation, it is then the turn of each FOMC member to give his or her view on the outlook in the first of the 'go-around' sessions of the meeting. This lies at the heart of the FOMC meetings and is led by briefings on the local economies of the Fed banks represented and looks at such issues as consumer spending and wage movements.

Whether or not the Fed chairman takes part in this section of the meeting is left to the chairman's discretion - apparently Mr Greenspan does not.

A coffee break follows, after which the Bluebook (so-called for obvious reasons and, like its green counterpart, distributed prior to the meeting), a presentation on monetary policy options, is given by Don Kohn, director of monetary affairs.

This stands at the very core of the meetings and gives an outline of where the economy is in relation to full employment, how fast the economy is growing and where inflation stands.

Two decisions are then made - the first of which is responsible for the sleepless nights that investors suffer in the weeks leading up to the meeting.

As outlined in the Bluebook, two, sometimes three options are decided by the FOMC members present - to cut the federal funds rate, leave it unchanged or to increase it.

The second decision to be made concerns whether to make a symmetric or an asymmetric stance - in other words, looking at the potential for the change before the next meeting.

This is then followed by Mr Greenspan's forum in the second 'go-around' during which he weighs in with his opinions and recommendations.

After the vote on the direction of monetary policy, instructions are given to the System Open Market Account manager at the Fed in New York to buy or sell government securities in open market operations to try and hit the desired funds rate.

By 2.15pm that day, the FOMC's decision has hit the markets and the world either breathes a sigh of relief or steps out on to the window ledge.

Graphic: fed21gbz