The Policymaking Process

Coordination among the several policy tools is maintained through the Federal Open Market Committee (FOMC), the most important System policy forum. The FOMC meets about every six weeks, more often if necessary, to establish monetary policy. Committee members include the seven members of the Board of Governors, the president of the New York Reserve Bank, and four other Reserve Bank presidents who serve one-year terms on a rotating basis. All 12 Reserve Bank presidents attend Federal Open Market Committee meetings, along with managers of the System’s open market and foreign accounts, some senior Board staff members, and a senior economist from each Reserve Bank.

Before each FOMC meeting, participants assess the state of the national economy and Reserve Bank presidents also assess economic conditions in their region. They evaluate data on output, production, prices, employment and other relevant economic variables. National data are collected, reported, and analyzed in the Green Book, simulations of the impacts of different policy scenarios a represented in the Blue Book, and regional economic conditions are described in the Beige Book. The Green Book and Blue Book are prepared by staff members at the Board of Governors and contain the Board staff’s view of recent monetary and financial developments. Prior to each FOMC meeting, each Reserve Bank prepares a Beige Book that assesses its regions economic conditions. Policy makers also consider any relevant national or international events that might affect the economy.

Committee meetings generally include a review of recent actions by the managers of System accounts (foreign currency and open market operations) and discussions of general economic conditions, financial conditions and monetary policy alternatives. All committee members then present a brief statement that often describes national and/or regional economic conditions, as well as their views on the appropriate monetary policy stance. Discussion is quite open, and often there is considerable diversity of opinion. After discussions, FOMC members vote on monetary policy. Monetary policy actions usually take the form of a targeted (increased, decreased, or unchanged) federal funds rate. In addition, twice each year, in accordance with the Humphrey-Hawkins Act, the FOMC establishes long-term goals for monetary policy and reports them to Congress.

After each FOMC meeting, an FOMC statement is released to the public. The statement summarizes the tone of the discussion at the meeting, announces the policy action taken and gives the policy “tilt” (see next page). In addition, the FOMC writes a directive containing guidelines for the policy to be implemented by the New York Federal Reserve Bank.

The Federal Funds Rate. The federal funds market allows depository institutions to exchange reserve balances held at the Federal Reserve among themselves. The rate charged for overnight exchanges of federal funds between depository institutions is called the federal funds rate. By adding or reducing reserves, open market operations by the Fed have a direct impact on the federal funds market. More available reserves (created by open market purchases of securities by the Fed) will generally decrease the federal funds rate while fewer available reserves (created by open market sales of securities by the Fed) will increase it. Depository institutions respond to the higher federal funds rate by changing the structure of their assets and liabilities (e.g. their loan portfolio). Higher federal funds rates generally lead to higher market interest rates, which will eventually slow the growth of money balances and credit, and abate the growth of real economic activity and inflation. Lower federal funds rates encourage depository institutions to make adjustments to their portfolios that will generally decrease market interest rates, increase credit availability, and increase economic activity.

The “Tilt.” After the FOMC decides on the appropriate direction and size of its monetary policy action, it will determine whether to express a predisposition toward changing the federal funds rate in the near future . If the FOMC is leaning toward a move in one direction at the next meeting, it will write an “asymmetric directive” indicating its predisposition and indicating the conditions that would lead to such a move. This is commonly known as the “tilt” of the directive. The tilt gives economic actors an indication of what monetary policy is likely at the next FOMC meetings.