The Federal Reserve Act established the Federal Reserve as the central bank of the United States. The Federal Reserve comprises the Board of Governors—an agency of the federal government in Washington, D.C., the 12 Reserve Banks, and the Federal Open Market Committee (FOMC). FOMC comprises all members of the Board of Governors and five Reserve Bank presidents who serve on a rotating basis. The Federal Reserve Act gives the Federal Reserve responsibility for setting and implementing monetary policy—actions taken to influence the availability and cost of money and credit—to promote full employment and ensure stable prices. To this end, section 19 of the Federal Reserve Act requires the Board of Governors to impose reserve requirements within certain ratios on specified liabilities—transaction accounts, nonpersonal time deposits, and Eurocurrency liabilities—of all depository institutions, solely for the purpose of implementing monetary policy. The definition of “transaction account” was added to section 19 in 1980 and defines “transaction account” to mean an account that permits the account holder to make withdrawals by negotiable or transferable instruments (such as checks), payment orders of withdrawal, telephone transfers, and other similar items for the purpose of making payments to third parties or others. The Board of Governors promulgated Regulation D pursuant to section 19’s authorization “to prescribe such regulations as it may deem necessary to effectuate the purposes of this section and to prevent evasions thereof.” The Federal Reserve Act also assigns other responsibilities to the Board of Governors and to the Reserve Banks in addition to monetary policy responsibilities, including supervising and regulating certain financial institutions and activities, providing banking services to depository institutions and the federal government, and ensuring consumer protection in the banking system. The Federal Reserve Act requires the Board of Governors and FOMC to take measures aimed at promoting the goals of maximum employment, stable prices, and moderate long-term interest rates. Accordingly, before the financial crisis of 2007–2009, the Board of Governors and FOMC set monetary policy to promote national economic goals by targeting the cost of overnight loans between depository institutions (interbank loans), which influence other interest rates, and then adjusting the supply of reserve balances in the banking system to achieve that target. The relevant cost of interbank loans in this approach is the federal funds rate—the interest rate at which depository institutions lend reserve balances to other depository institutions overnight. According to the Federal Reserve, FOMC has targeted the federal funds rate since roughly 1984. Before the financial crisis, the Federal Reserve’s toolkit for implementing monetary policy primarily comprised three tools: Reserve requirements: The minimum amount of funds that depository institutions must hold against transaction account balances (determined by applying a specified reserve requirement ratio). Currently, only transaction accounts are subject to a reserve requirement ratio greater than zero. As noted previously, the Federal Reserve Act authorizes the Board of Governors to impose reserve requirements only on certain deposit liabilities that do not include savings deposits. Depository institutions may satisfy reserve requirements by holding vault cash or reserve balances at Reserve Banks. The Board of Governors is responsible for establishing reserve requirements, and can adjust reserve requirements by changing reserve requirement ratios within limits established by the Federal Reserve Act. Open market operations: The purchase and sale of federal government and federal agency securities in the open market by the Reserve Banks at the direction of FOMC. The Federal Reserve can use open market operations to adjust the supply of reserve balances in the banking system overall in order to control the federal funds rate within the target range set by FOMC. Open market operations directly affect the total supply of reserves: purchases of securities (such as Treasury securities) by the Federal Reserve increase reserve balances; the sale of securities has the opposite effect on reserve balances. Adjusting the supply of reserve balances in the banking system through open market operations helps the Federal Reserve control the federal funds rate. To lower the federal funds rate, the Federal Reserve increases the supply of reserve balances; decreasing the supply of reserve balances has the opposite effect on the federal funds rate. Lower interest rates lower the cost of borrowing, generally leading to increases in consumption and business investment. Discount rate: The interest rate that Reserve Banks charge on loans to depository institutions. The Reserve Bank lending function is often generically referred to as “the discount window.” The discount window allows the Federal Reserve Banks to extend credit to depository institutions under certain conditions. This complements open market operations in achieving the target federal funds rate by making balances available to depository institutions when the supply of balances falls short of demand, and by serving as a backup source of liquidity for individual depository institutions. If a depository institution needs to borrow funds to meet reserve requirements or for other operational needs, it typically will try to borrow at (or near) the federal funds rate from another depository institution in the federal funds market. If it has established borrowing privileges at the discount window, a depository institution may borrow directly from its Reserve Bank at the discount rate, which is set above the target federal funds rate. There are three discount window programs: primary credit, secondary credit, and seasonal credit, each with its own interest rate. A generic reference to “the discount rate” usually refers to the primary credit rate. The rate for each lending program is established by each Reserve Bank’s board of directors, subject to the review and determination of the Board of Governors. Pre-crisis, FOMC would set a target for the federal funds rate consistent with its monetary policy objectives of maximum employment and price stability and then direct the use of open market operations to achieve a federal funds rate at or very close to the target rate. The Federal Reserve conducted open market operations to maintain the federal funds rate within the target range. Specifically, the Federal Reserve implemented monetary policy by affecting the demand for and supply of reserves (reserve balances held at Reserve Banks). In the federal funds market, depository institutions and other eligible entities, including the government-sponsored enterprises (GSE), trade reserves (federal funds) with each other. By conducting open market operations, imposing reserve requirements, and extending credit through the discount window, the Federal Reserve exercised considerable control over the demand for and supply of reserves and in turn the federal funds rate. Since changes in the federal funds rate are transmitted to other short-term interest rates, which affect longer-term interest rates and overall financial conditions, the Federal Reserve used its three main policy tools to influence inflation and overall economic activity and to achieve its monetary policy goals. According to Board of Governors officials, in response to the 2007–2009 financial crisis, the Federal Reserve expanded its monetary policy toolkit. First, in 2008, the Federal Reserve began to use its authority to pay interest on reserves, enabling the Board of Governors to break the strong link between the quantity of reserves and the level of the federal funds rate allowing for control over short-term interest rates with a large amount of reserves in the system. The Federal Reserve also added two other major tools to its toolkit: large-scale asset purchases and increasingly explicit forward guidance. Both of these tools were used to provide further monetary policy accommodation after short-term interest rates fell close to zero. The Federal Reserve used its open market operations purchase authority to purchase longer-term government securities and agency securities to put downward pressure on longer-term interest rates, ease broader financial market conditions, and support economic activity. During the crisis, the Federal Reserve also established emergency lending programs to lend directly to banks and other financial institutions in disrupted markets to improve the flow of credit to U.S. households and businesses. Currently, the Federal Reserve’s monetary policy approach involves FOMC setting a target range for the federal funds rate consistent with achieving the monetary policy goals of maximum employment and stable prices and directing the use of the Federal Reserve’s monetary policy toolkit to meet this target. Regulation D, pursuant to section 19 of the Federal Reserve Act, imposes reserve requirements on transaction accounts solely for the purpose of implementing monetary policy. For example, according to officials from the Board of Governors, before 2008, reserve requirements were useful for implementing monetary policy because they provided the Federal Reserve with a predictable demand for reserves against which the supply of reserves could be adjusted to control interest rates (i.e., move or maintain the federal funds rate to or at the target set by FOMC). Given the Federal Reserve’s mandate of promoting maximum employment and stable prices, a predictable demand for reserves allowed the Federal Reserve to have a predictable effect on interest rates through its targeting of the federal funds rate and conducting open market operations to adjust the supply of reserves, according to officials. As noted previously, the Federal Reserve Act requires the Board of Governors to impose reserve requirements on specified deposit liabilities of depository institutions, but provides in most cases for a range of reserve requirement ratios that the Board of Governors may apply to such liabilities. Reserve requirements on transaction accounts are based on ratios that the Board of Governors has specified in Regulation D within ranges established in the Federal Reserve Act, and these ratios have not changed since 1992. The reserve requirement ratios are graduated—zero percent, 3 percent, and 10 percent—depending on the aggregate level of a depository institution’s net transaction accounts (see table 1). The dollar amount of a depository institution’s reserve requirement is determined by applying the applicable reserve requirement ratios to the balances held in its net transaction accounts. The reserve requirement ratios correspond to three ranges for net transaction account balances: “exemption amount” (amount of net transaction accounts subject to a zero percent reserve requirement), “low reserve tranche” (amount of net transaction accounts subject to a 3 percent reserve requirement ratio), and “over low reserve tranche” (amount of net transaction accounts subject to a 10 percent reserve requirement). The Depository Institutions Deregulation and Monetary Control Act of 1980 (Monetary Control Act) requires that the Board of Governors apply transaction account reserve requirements uniformly to all transaction accounts at all depository institutions.