Chapter XII
The Federal Open Market Committee
The Federal Open Market Committee was created by Congress in 1933 as an amendment to the Federal Reserve Act and is apart of the Federal Reserve System. It is a committee composed of the seven members of the Board of Governors and the presidents of the twelve Federal Reserve banks. However, only five Federal Reserve bank presidents at a time are permitted to be voting members. The voting members are rotated on a regular basis. The president of the New York Federal Reserve bank, however, is a permanent voting member, so actually it is only the other four Federal Reserve presidents who rotate as voting members.
The committee must meet at least four times each year, but it usually meets almost every third Tuesday. It sets the policy to be implemented by the manager of the Open Market Account. The manager, an agent of the Federal Reserve bank of New York, buys and sells the securities for all twelve Federal Reserve banks. Every day this manager buys, sells, and otherwise exchanges securities worth millions of dollars and sometimes more than a billion.
The Annual Report of the Board of Governors for 1970 shows that the value of the Federal Open Market Committee transactions for that year was $110 billion. (Page 73 of Hearings before the Committee on Banking and Currency, House of Representatives, Ninety-third Congress-First Sessions, October 2 and 3, 1973. [p. 124]
A special manager buys and sells foreign currencies and bills but we shall not discuss that aspect of the Committee operations.
The most important function of the Federal Open Market Committee (F.O.M.C:) is to increase or decrease the money supply. It does this by the deliberate and judicious buying and selling of securities on behalf of the twelve Federal Reserve banks.
The F.O.M.C. can, without informing the government, the public, or the banks (its meetings are held in secret), increase or decrease the reserves of the banks. For example, if it wants the money supply to increase, it will buy government securities. If it wants the money supply to decrease, it will sell securities. The Federal Reserve banks can buy an unlimited amount of securities because they do not have to pay for the securities with anything. They pay for the securities by making bookkeeping entries in the member banks' reserve accounts. They, of course, pay for the securities with a check, but that check is not redeemed with cash. The member bank that cashes the check, instead of receiving cash, receives credit in its reserve account.
Even if the Federal Reserve bank were called upon to pay with currency, an officer could take the U.S. securities, walk to the office of the Federal Reserve agent, who is located in the same building, deposit the securities with him and receive the currency (Federal Reserve notes).
When a bank's reserves are increased, the bank may increase its loans of bank credit from five to ten times its reserves. Thus, the money supply is increased much more than the amount of increase of the reserves.
Because the Federal Reserve banks are not primarily concerned with profit or loss, they can buy securities by bidding up the prices until they obtain the amount they deem necessary. Likewise, they can lower the prices of the securities that they wish to sell until they find a buyer.
The increase or decrease of the price of the securities will cause an increase or decrease of the interest rates on all securities. Thus, the Federal Reserve banks [p. 125] through the operations of the F.O.M.C. can, without announcing any change in interest rates, cause the interest rates to increase by offering securities for sale at a lower price. Or they can cause a decrease in the interest rates by buying securities at a higher price. The local banks will then merely adjust their rates accordingly.
The F.O.M.C. can thus establish the market price for the government securities and also establish the market rate for interest on those securities. The price and the interest rates on government securities influence the price and the interest rates on all securities.
Let us give an example to show the power of the F.O.M.C. Suppose the government wanted to reduce inflation of the purchasing media by one billion dollars and did so by increasing taxes in the amount of billion dollars. If the government collected that amount and did not spend it, there would be one billion dollars less purchasing media in circulation.
But if the F.O.M.C. wished, it could offset the action of the government by buying about $100,000,000 worth of securities (assuming the banks were operating on a 10% reserve basis), thus increasing the reserves in the commercial banks by $100,000,000. That would enable the banks to loan out about one billion dollars' worth of additional bank credit. If that amount were loaned out the money supply would be increased by that amount: That would offset the anti-inflationary effects of the one billion dollars the government collected in taxes.
Or suppose the government wished to increase the money supply by one billion dollars by paying for one billion dollars worth of its expenses with newly minted coins. If the F.O.M.C. wished, it could sell about $100,000,000 worth of its securities and thereby reduce the reserves of the banks by that amount. That would force the banks to reduce their loans of bank credit by about one billion dollars. That would offset (as far as the money supply is concerned) the effect of the government's action of placing one billion dollars' worth of newly minted coins in circulation.
A comparable incident seems to have taken place in [p. 126] May 1975 when the government paid out a rebate check of up to $200 to each individual who paid 1974 U.S. income taxes. And in June 1975, the government paid $50 to every recipient of Social Security Insurance, Supplemental Security Income or Railroad Retirement annuity or pension payments.
The government officials paid out that money in order to increase the money supply in circulation with the hope that these actions would increase the buying and selling of goods and services and thus create more jobs. One side effect of that action was that the government officials had to incur additional interest-bearing debts in order to make those payments. But what happened?
About July 1, 1975, the prime interest rates began to increase. Between July 1 and August 8, 1975, the prime interest rates increased about one percent, from 6 & 3/4% on July 1 to 7 & 3/4% on August 8.
The F.O.M.C. buys and sells securities in secret. It does not tell the public the amount of securities it buys and sells until weeks later. However, the people who understand what makes the interest rates go up or down can deduce what actions the F.O.M.C. has taken.
When the interest rates increased in July 1975, we could conclude that the F.O.M.C. offered for sale on the open market enough securities to cause the price of the securities to decline. That act caused the interest rates to rise.
We thus witnessed a situation in which government officials incurred an extra interest-bearing debt to increase the money supply in circulation and at almost the same time the F.O.M.C. took action to decrease the money supply.
Interest rates might be expected to rise if too great an amount of U .S. funds is sent to foreign countries. But that did not happen, because the United States had a balance of payments surplus and the exchange value of the U.S. currency increased in relation to the exchange value of some foreign currencies. Both of these occurrences indicated that more U.S. funds came into the United States than were sent out. [p. 127]
These are the reasons why we believe the F.O.M.C. sold more securities than it bought during the month of July 1975. The result was a decrease in the money supply in circulation and an increase in the interest rates, thus offsetting the actions taken by the government.
It is reasonable to conclude that the Federal Reserve System through the operations of the F.O.M.C. is in a position to control, to a large extent, the economic conditions of the country .Is that desirable? If not, what can be done about it?
The answer, again, is that if the government, in lieu of incurring interest-bearing debts, issued bona fide tax credit certificates and paid these certificates out as currency for its needed goods and services, the result would be the following:
- There would be no government securities for the F.O.M.C. to buy or sell because there would be no government debts.
- There would be enough debt-free currency in circulation for a 100% reserve demand deposit banking system.
- There would be no need for agencies such as the Federal Reserve System and the Federal Open Market Committee to control (to increase or decrease) the reserves of the commercial banks.
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