The Federal Reserve System 1913 signed into law W. Wilson Goal: more responsive money supply

The Fed 4 Main Parts 1. B oard of Governors 2. F ederal Open Market Committee Federal Reserve banks 4. M ember banks MONETARY POLICY

Board of Governors Makes policy for nations banking system Makes policy for nations banking system Consists of 7 members appt’d by President and confirmed by Senate Consists of 7 members appt’d by President and confirmed by Senate 14 year terms (1 is up every 2yrs) 14 year terms (1 is up every 2yrs) Chairman & Vice named by Pres. Chairman & Vice named by Pres. Decisions not subject to approval by govt to keep politics out Decisions not subject to approval by govt to keep politics out

Federal Open Market Committee 7 members from Board of Governors +5 presidents of Fed Reserve Banks Sets policy on purchase of securities which is part of Monetary Policy* * discussed later

Federal Reserve Banks 12 banks each a separate district in US 12 banks each a separate district in US Each is a corporation Each is a corporation Stocks only sold to member banks in district not public Stocks only sold to member banks in district not public 9 member Board of Directors– bankers, industry members 9 member Board of Directors– bankers, industry members

Member Banks All national banks are members of Federal Reserve and chartered by nat’l govt State banks can decide to join or not Must comply with federal laws and permit supervision 1980 deregulation law– makes little difference= all must follow Fed’s reserve requirements

6 Major Functions of Fed 1. Holding required reserves 2. Regulating supply of money 3. Clearing checks 4. Supplying economy with paper currency 5. Acting as fiscal agent for govt 6. Supervising member banks

Reserve Requirements A tool to regulate money supply A tool to regulate money supply Amt of money banks must hold and not loan out Amt of money banks must hold and not loan out Raising Reserve Requirement: Raising Reserve Requirement: --reduces the size of loans banks can make which reduces the money supply and can help stop inflation Lowering Reserve Requirement Lowering Reserve Requirement --increases the size of loans banks can make which adds to the money supply and can combat recession

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Regulating the supply of money To combat the ups and downs of the business cycle Can adjust the amount of money in the economy (see previous slide) MONETARY POLICY

Clearing Checks The Fed deducts appropriate amount from buyers bank and deposits it in sellers bank -no real money changes hands—entries in bank records are made

Paper Currency Federal Reserve notes are our paper bills Federal Reserve notes are our paper bills Issued by the 12 Fed Banks Issued by the 12 Fed Banks Bank is indicated on seal on left side of front of bill Bank is indicated on seal on left side of front of bill Created by US Treasury’s Bureau of Engraving and Printing in WA, DC but put in circulation by one of 12 Created by US Treasury’s Bureau of Engraving and Printing in WA, DC but put in circulation by one of 12

Fiscal Agent of govt Works with US Treasury Holds checking acct for govt Ex– pensions, vets benefits, govt purchases

Supervising Member Banks Ensures members comply with laws Ensures members comply with laws Ensures members use sound banking practices Ensures members use sound banking practices Ensures adequate capital, oversees mergers, and est. of branches, sets loan/investment limits Ensures adequate capital, oversees mergers, and est. of branches, sets loan/investment limits Shares this resp. with govt agency Shares this resp. with govt agency

*Back to Open Market Operations (Monetary Policy) Another way the Fed can add or subtract money in the economy The Fed itself can either buy or sell government bonds (securities) The Fed itself can either buy or sell government bonds (securities) Ex. #1—the Fed BUYS a bond from ‘you’—you deposit the money=more $ in economy Ex. #1—the Fed BUYS a bond from ‘you’—you deposit the money=more $ in economy EX. #2—the Fed SELLS a bond to ‘you’—you withdraw $ from bank=less $ in economy EX. #2—the Fed SELLS a bond to ‘you’—you withdraw $ from bank=less $ in economy

bond $$ $$$ bond FED Bank $ $$

Manipulating Interest Rates (Monetary Policy, too) Banks sometimes need more cash than they have in reserve thus they can borrow $ just like ‘you’ Banks sometimes need more cash than they have in reserve thus they can borrow $ just like ‘you’ The Fed loans $ to banks The Fed loans $ to banks Banks must pay an interest rate on the borrowed money (just like ‘you’) Banks must pay an interest rate on the borrowed money (just like ‘you’) Called the Discount Rate Called the Discount Rate By raising or lowering the % the Fed can influence the amt $ in economy By raising or lowering the % the Fed can influence the amt $ in economy

Discount Rate Raising the rate signals ‘tight money’—attempt to reduce amt of money in economy Lowering the rate signals ‘easy- money’—attempt to add amt of money to economy 3% 5% 6% 7% 8% 9% 10%

FED 3% FED 5% Bank 5% Bank 7% $ Too expensive

Summary Adding Money in the economy fights recession Subtracting money from economy fights inflation Purpose: to prevent business cycle from being too ‘bumpy’ (boat on waves analogy)