A BUYandHOLDer

What a timely question -- as we've all been on red alert watching the Fed's every move over the last year or so.

A THUMBNAIL SKETCH

First, a thumbnail sketch of the Federal Reserve System. The Fed, created in 1913, is essentially our national bank and thus oversees our economic and monetary policies. However, it's not just one bank -- it consists of 12 separate district banks plus 25 regional branches -- spread around the country. Each district bank has a president and a board of directors.

The 12 district banks are located in:

Atlanta
Boston
Chicago
Cleveland
Dallas
Kansas City
Minneapolis
Philadelphia
New York
Richmond
St. Louis
San Francisco

$TIP: Call the district bank in your area and ask for Consumer Information. Many publish excellent free materials about investing and the economy and also offer free tours of their facilities.

The Fed is run by a seven-member board of governors. The governors are appointed to 14-year terms by the President. They are confirmed by Congress. One term actually expires every two years. The chairman, currently ALAN GREENSPAN, serves a four-year term.

In addition, there is a very key committee -- the OPEN MARKET COMMITTEE -- whose responsibility is to guide the nation's day-to-day monetary decisions. This Committee meets approximately every six weeks to study and evaluate the economy and more specifically to direct the open market operation of the Federal Reserve Bank of New York. (NOTE: The president of the New York Federal Reserve Bank is always on the Committee.)

WHEN THE FED SPEAKS

The Fed impacts on the economy through its monetary policy, which consists of the management of interest rates and the supply of money.

The Discount Rate

When the Fed wants the economy to change direction -- such as to cool off a too hot economy or to jump start a slow one -- it may decide to increase or decrease the DISCOUNT RATE. (The discount rate is the interest rate the Fed charges banks when they borrow money.)

To cool an overheated economy, the Fed will raise the discount rate. If the discount rate is raised, then banks tend to borrow less and subsequently have less money available for making loans to clients. Businesses and consumers also tend to cut back on spending.

Higher rates also tend to pull money out of the stock market and put it into bonds, money market accounts, bank CDs and Treasuries.

To pump up a weak economy, the Fed will lower interest rates. If the discount rate is lowered, banks tend to borrow more and subsequently make more loans to clients at the new, attractive lower rates. Lower rates tend to spur companies to expand and hire new workers and to encourage consumers to spend money and refinance mortgages, take out new loans, etc.

Lower rates also give added appeal to stocks over fixed income investments.

The Money Supply

Another tool the Fed uses is changing the amount of money in circulation. It does this when it buys or sells government securities (e.g., Treasuries) in the open market.

To slow down an economy, the New York Fed sells government securities, thus taking in cash that would otherwise be available for loans.

To pump up the economy, it creates money by buying securities.

FOR MORE INFO

This is a very basic answer to your question. If you'd like more details, log on to the Federal Reserve's site at: http://www.federalreserve.gov/. You'll find a list of board meetings here as well as plenty of other material and useful telephone numbers.

THE PANIC OF 1907

When America broke with England, as a nation we remained quite suspicious of centralized control of almost any kind and for this reason the U.S. was the last major industrial nation to establish a central bank. Even at the beginning of the 20th century, most banks were still keeping relatively little cash on hand and local banks were often unable to meet widespread demand for cash. A series of bank failures resulted in the famous Bank Panic of 1907, when millions of depositors lost their savings and the economy went into a nosedive.

The National Monetary Commission, set up to remedy this chaotic situation, recommended creation of the Federal Reserve Act in December 1913 which required all national banks to become members. It also led to Willie Sutton's famous line -- who, when asked by a reporter why he robbed banks, said: "That's where the money is."