Federal Reserve of the United States



The Federal Reserve System is the central bank of the United States with a regional structure of 12 districts (12 regional banks with 25 branches). It is subject to the Congress authority and operates on its own earnings.

The twelve regional banks (with their respective branches) are:

1-A. Boston

2-B. New York City (Buffalo - until Oct 31, 2008)

3-C. Philadelphia

4-D. Cleveland (Cincinnati and Pittsburgh)

5-E. Richmond (Baltimore and Charlotte)

6-F. Atlanta (Birmingham, Jacksonville, Miami, Nashville, and New Orleans)

7-G. Chicago (Detroit)

8-H. St. Louis (Little Rock, Louisville, and Memphis)

9-I. Minneapolis (Helena)

10-J. Kansas City (Denver, Oklahoma City, and Omaha)

11-K. Dallas (El Paso, Houston, and San Antonio)

12-L. San Francisco (Los Angeles, Portland, Salt Lake City, and Seattle)

Like the other central banks, the Federal Reserve of the United States affects the foreign exchange markets in three general areas:

- Discount rate

- Money market instruments

- Foreign exchange operations

For the foreign exchange operations most significant are repurchase agreements to sell the same security back at the same price at a predetermined date in the future (usually within 15 days), and at a specific rate of interest. This arrangement amounts to a temporary injection of reserves into the banking system. The impact on the foreign exchange market is that the dollar should weaken. The repurchase agreements may be either customer repos or system repos.

Matched sale-purchase agreements are just the opposite of repurchase agreements. When executing a matched sale-purchase agreement, the Fed sells a security for immediate delivery to a dealer or a foreign central bank, with the agreement to buy back the same security at the same price at a predetermined time in the future (generally within 7 days). This arrangement amounts to a temporary drain of reserves. The impact on the foreign exchange market is that the dollar should strengthen. The major central banks are involved in foreign exchange operations in more ways than intervening in the open market. Their operations include payments among central banks or to international agencies. In addition, the Federal Reserve has entered a series of currency swap arrangements with other central banks since 1962. For instance, to help the allied war effort against Iraq's invasion of Kuwait in 1990-1991, payments were executed by the Bundesbank and Bank of Japan to the Federal Reserve. Also, payments to the World Bank or the United Nations are executed through central banks.

Intervention in the United States foreign exchange markets by the U.S. Treasury and the Federal Reserve is geared toward restoring orderly conditions in the market or influencing the exchange rates. It is not geared toward affecting the reserves. There are two types of foreign exchange interventions: naked intervention and sterilized intervention.

Naked intervention, or unsterilized intervention, refers to the sole foreign exchange activity. All that takes place is the intervention itself, in which the Federal Reserve either buys or sells U.S. dollars against a foreign currency. In addition to the impact on the foreign exchange market, there is also a monetary effect on the money supply. If the money supply is impacted, then consequent adjustments must be made in interest rates, in prices, and at all levels of the economy. Therefore, a naked foreign exchange intervention has a long-term effect.

Sterilized intervention neutralizes its impact on the money supply. As there are rather few central banks that want the impact of their intervention in the foreign exchange markets to affect all corners of their economy, sterilized interventions have been the tool of choice. This holds true for the Federal Reserve as well.

The sterilized intervention involves an additional step to the original currency transaction. This step consists of a sale of government securities that offsets the reserve addition that occurs due to the intervention. It may be easier to visualize it if you think that the central bank will finance the sale of a currency through the sale of a number of government securities.

Because a sterilized intervention only generates an impact on the supply and demand of a certain currency, its impact will tend to have a short-to-medium-term effect.

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