Federal Reserve Chapter 16 Section 2 Federal Reserve Functions

Federal Reserve  Objectives: –1. Describe how the Federal Reserve serves the federal government. –2. Describe how the Federal Reserve serves banks. –3. Describe how the Federal Reserve regulates the banking industry. –4. Understand the Federal Reserve’s role in regulating the nation’s money supply.

Federal Reserve  As the central bank of the United States, the twelve district banks that make up the core of the Federal Reserve System carry out important functions.

Federal Reserve  The Federal Reserve System does the following: 1. Provides banking and fiscal services to the federal government. 2. Provides banking services to member and nonmember banks. 3. Regulates the banking industry. 4. Tracks and manages the national money supply to meet current demand and to stabilize the economy.

Federal Reserve  Serving Government: –U.S. Government has an operating budget of $ 1.7 trillion. –It raises about $ 1 trillion in taxes each year. –It makes about $ 900 billion in transfer payments through programs like Medicare and Social Security. –For its banking needs, the federal government turns to the Federal Reserve.

Federal Reserve  Federal Government’s Banker: –The Federal Reserve serves as a banker for the US government. –It maintains a checking account for the Treasury Department. –It processes payments such as Social Security checks, IRS refunds, and other payments.

Federal Reserve  Government Securities Auctions: –They also serve as a financial agent for the Treasury Department and other government agencies. –The Fed sells, transfers, and redeems government bonds, bills, and notes, or securities. –It also makes interest payments on these securities. –Periodically they auction off Government Bills, Bonds, and Notes to finance the government’s activities.

Federal Reserve  Issuing Currency: –Under the Federal Reserve System, only the federal government can issue currency. –The Department of the Treasury issues coins minted at the United States Mint. –The district Federal Reserve Banks issues paper currency (Federal Reserve Notes), which is printed at the Bureau of Engraving and Printing. –When a bill becomes worn and torn, the Fed takes it out of circulation and replaces it with a fresh one.

Federal Reserve  Serving Banks: –The Fed also provides services to banks throughout the country. –Its most visible function is in its check- clearing services. –It safeguards blank reserves and lends reserves to banks that need to borrow to maintain legally required reserves.

Federal Reserve –Check Clearing –  The process by which banks record whose account gives up money and whose accounts receives money when a customer writes a check.  The Fed can clear millions of dollars of checks at one time using high-speed equipment.

Federal Reserve –Supervising Lending Practices  To ensure stability in the banking system, the Fed monitors bank reserves throughout the system.  Each of the twelve Fed. Reserve Banks sends out bank examiners to check up on lending and other financial activities of member banks.  They also study proposed bank mergers and bank holding companies to ensure competition in the banking and financial industries.

Federal Reserve –Supervising Lending Practices  A Bank Holding Company is a company that owns more than one bank.  The Board of Governors approves or disapproves mergers and charters based on their findings and recommendations of the Reserve Banks.  The Fed also protects consumers by enforcing truth-in-lending laws, which require sellers to provide full and accurate information about loan terms.  Under a provision called Regulation Z – millions of consumers receive information about retail credit terms, auto loans, and home mortgages every year.

Federal Reserve –Lender of Last Resort:  Under normal conditions, banks lend each other money on a day-to-day basis, using money from their reserve balances.  These funds are called Federal Funds.  The interest rate that banks charge each other is called the Federal Fund Rate.  Banks also borrow from the Fed.  They do this in times of financial emergencies.  The Fed is the lender of last resort that makes emergency loans to banks.  They charge what is called a Discount Rate - the interest they charge member banks.

Federal Reserve  Regulating the Banking System: –The Fed supervises banks, savings & loans, credit unions, bank holding companies, and etc. –The US banking system operates on a fractional reserve system – they hold in reserve a fraction of their funds – basically just enough to meet customers’ daily needs.

Federal Reserve  Each financial institution that holds deposits for customers must report daily to the Fed about its reserves and activities.  The Fed uses these reserves to control how much money is in circulation at any one time.

Federal Reserve  Bank Examination: –The Fed and other regulatory agencies also examine banks periodically to make sure that each institution is obeying laws and regulations. –Examiners also make unexpected visits to banks. –Examiners can force banks to sell risky investments or to declare loans that will not be repaid as losses. –If banks have too many risky loans, they can be forced to go through more examinations as a problem bank.

Federal Reserve  Regulating the Money Supply –The Fed is best known for its role in regulating the nation’s money supply. –Factors that affect demand for money  Cash needed on hand  Interest rates  Price levels in the economy  General level of income

Federal Reserve –Cash on hand  We keep money in our wallet to pay for groceries, supplies, clothing, and etc.  The more wealth we have, the easier it is to be able to make economic transactions. –Interest rates  We can’t earn interest on money that we hold as cash.  As interest rates rise, it becomes more expensive for individual to hold the money as cash rather than placing it in assets that pay returns.  As interest rates rise, firms and individuals are more likely to put their money in interest-bearing accounts.

Federal Reserve  General price level –As prices rise, so does the demand for cash. –If your usual cost for an outing with your friends is $ 25 and the prices rise by 10%, then you will need $ for the same outing.  General level of income –If you have a job besides going to school, you will have more cash to carry around with you. –Nationally as real GDP or real income rises, families and firms keep more of their wealth or income as cash.

Federal Reserve  Stabilizing the Economy –The laws of supply and demand affect money as well. –Too much money in the economy leads to a general rise in prices or inflation. –In inflationary times, it will take more money to purchase the same goods and services. –It is the Fed’s job to stabilize the economy.