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The following is the text of a handy little card distributed to all new LBO subscribers. It was written in May 1994 by Doug Henwood, editor and publisher. It retains its copyright and may not be reprinted or redistributed in any form - print, electronic, facsimile, anything - without the permission of LBO.
Financial markets exercise considerable influence over the economy, and
central banks (like the Federal Reserve)
exercise considerable influence on the markets, who are constantly trying
to divine the central bank's intentions.
CBs have two contradictory functions: minimizing inflation (requiring stringency) and preventing recessions from turning into depressions (requiring indulgence). They operate by changing the level of interest rates and the supply of money and credit.
Theorists differ on just how powerful CBs are. Strict monetarists picture CBs as directing nearly everything economic through their monetary control panels. Mainstream "eclecticists" allow for other influences - fiscal policy, technology, the international environment - but tend to agree that a CB is still in pretty firm control of the money supply. A small band of post-Keynesians argues, persuasively, that private credit demand really runs the show, since in all but abnormal times a CB simply accommodates private demand - itself determined by the current state of the real and speculative economies and players' feelings about the future.
A CB, as banker to the banks, accommodates (or frustrates) private credit
demand by providing (or not providing) the banks with reserves, and by setting
the level of short-term interest rates. (Reserves are that portion of deposits
that banks keep in their vaults or on deposit with the CB; they're meant
to provide a cushion in case of a run.) It's a matter of theological dispute
which of these two policy tools - bank reserves and interest rates - is
pre-eminent; LBO's position is that both matter.
Policy is decided in secret by the Federal Open Market Committee (FOMC), which consists of the Fed's seven-member, Washington-based board of governors (named by the President and approved by the Senate) and five presidents of the Fed's twelve regional branches (who are chosen by each region's banks; they serve in rotation, except for New York's president, who is a permanent member of the panel). At these meetings, the FOMC decides on a target level for short-term interest rates and a desired rate of money supply growth. These decisions are published in highly sanitized form six weeks after their making. In the interim, overpaid Wall Street analysts try to decode the Fed's policy moves. Starting in February 1994, the Fed began announcing FOMC policy decisions immediately after they were made; it's not clear whether this is a permanent change.
The FOMC's policy targets are transmitted to the trading desk at the Fed's Ne