Federal Open Market Committee

The employment of open market operations as an instrument of credit control disclosed the weakness of the procedure that permitted each Federal Reserve bank to buy and sell Government obligations at its own discretion. This could easily result in offsetting transactions, thus vitiating partially or totally their effect on the credit structure or even creating credit conditions directly opposite to those deemed desirable by the Federal Reserve banks located in the important financial centers. It became obvious that determination and execution of open market policy must be centralized to avoid conflicting action and confusion.

The law stipulates that "no Federal Reserve Bank shall engage in open-market operations...except in accordance with the direction of and regulations adopted by the Committee." The Committee has authority to direct all operations without the necessity of obtaining consent of the individual banks. The Federal Reserve Bank of New York operates the System Open Market Account, in which the twelve Federal Reserve banks participate according to an allocation formula which is based at present on estimates of each bank's expenses, dividends, and earnings for each year but may also be adjusted to changed reserve positions of individual banks. The New York Bank with the approval of the Open Market Committee appoints as Manager of the System Open Market Account one of its officers, who executes the Committee's policy through open market operations.

Repurchase Agreements

In addition to outright open market purchases the Reserve banks, at their initiative only, buy Government obligations (as a rule short-term and since early 1953 Treasury bills) under repurchase agreements from nonbank dealers in Government securities. The repurchase agreement is a sales contract in which the dealer obligates himself to buy back the securities at his or the Reserve bank's option any time within the specified period, usually not exceeding 15 days, at the same price plus interest for the number of days the securities are held by the bank. In practice it is a loan to the dealer similar to the advances made to member banks, except that the dealer cannot initiate the borrowing as is the case with the member banks. It is a method of supplying to the banking system temporarily needed reserves without the member banks' becoming indebted to the Reserve banks -- a condition which renders the former reluctant to make loans and investments.

Unlike open market operations, the repurchase agreement provides for automatic extinction of the reserves created through the purchase and for removal of the acquired securities from the portfolio of the Reserve banks. It is obvious that repurchase agreements can be employed successfully only in easing a credit stringency which is expected to reverse itself within a short period of time. The agreement also enables dealers to maintain and increase their position in Government securities in periods of tight money market conditions, when interest rates charged by the banks to dealers climb above the yields of short-term Government obligations.