The Federal Reserve System The Fed and Monetary Policy

Structure of the Fed Board of Governors -7 members -14 year terms -appointed by Prez 12 District Banks - nearest is in Dallas Member Banks -all national banks and some state banks

Responsibilities Clear checks Consumer legislation (ex., credit) Issues currency ( does NOT print it) Financial services for federal gov’t

Leadership The current chairman of the Fed is BEN BERNANKE

MONETARY POLICY The Federal Open Market Committee (Board of Govs + presidents of 5 district banks) or FOMC uses the three tools of monetary policy to -control the money supply -steer the business cycle

The 3 Tools of Monetary Policy 1. OPEN MARKET OPERATIONS 2. THE DISCOUNT RATE 3. THE RESERVE REQUIREMENT STOP DAY 1

The 3 Tools of Monetary Policy OPEN MARKET OPERATIONS -used most often -buy and sell government bonds (securities) on the open market -BUY = bigger money supply (increases $$ in circulation)**recession -SELL= smaller money supply (decreases $$ in circulation)**expansion (anti- inflation)

THE DISCOUNT RATE -makes most headlines - is actually a signal for what they want rates to do -interest rate the Fed charges member banks to borrow from the Fed -Lower rate = increase money supply Use during recession to stimulate economy - Raise rate = decrease money supply Use during expansion to control inflation

RESERVE REQUIREMENT -Used least often of the 3 (this change is the toughest adjustment for banks) -Cash that a bank must keep to cover checks ( it is a %) -Raise RR = decrease money supply Use during expansion to fight inflation - Lower RR = increase money supply Use during recession to stimulate economy

The Money Multiplier Determined by the RRR 1/RRR= money multiplier EX : RRR= 10% 1/.1=10 Money multiplier=10 Indicates how much money may be generated through the process of deposits>loans>deposits

Just a note…the Fed Funds Rate Some banks reluctant to use discount window Opt to borrow funds from other banks Federal Funds Rate Determined thru OMO, but FOMC sets a target rate May be higher or lower than DR, but usually lower

During a recession What is the problem? –A sluggish economy What is needed? –More money in the supply to stimulate borrowing and spending Monetary policy solutions? –Buy bonds, lower discount rate, lower RR

During an expansion What is the problem? –Things are good, but there is too much money in circulation > inflation What is needed? –Put the brakes on the money supply; pull money out Monetary policy solutions? –Sell bonds, raise discount rate, raise RR

“New” Info As of Dec. 2007, another tool has been added to the Fed’s arsenal TERM AUCTION FACILITY (TAF) Designed to overcome reluctance some banks had about using discount window Banks can bid against each other for 28-day loans ($10M-$3B) Rate is usually between DR and FFR