PowerPoint # 8: The Federal Reserve Economics

The Federal Reserve System is the National Banking Network 4 major parts of the Federal Reserve System (the Fed) 1. Board of Governors— directs/makes policy Appointed by the President, approved by the Senate 14 year term, Only one term allowed Keep independent of politics Sets Reserve Requirements Reviews Discount Rate

4 Major Parts of the Fed 2. Federal Open Market Committee (FOMC): Consists of the 7 members of the Board of Governors Plus the presidents of 5 of the Federal Reserve Banks Sets Fed policy on purchase and sale of government securities (bonds)

4 Major Parts of the Fed 3. Federal Reserve Banks 12 National Banks that carry out the Fed’s policy Each bank with 9 directors that appoint the President of the Federal Reserve Bank Sets the Discount Rate

4 Major Parts of the Fed 4. Member Banks All national banks that carry out the Fed’s policy Have the word “National” in their title The Fed Diagram

6 Functions of the Fed 1. Holding reserve requirements 2. Regulating supply of Money 3. Clearing checks—transfers money from your account to another when you write a check

6 Functions of the Fed 4. Supplying economy with paper currency to: Replace old worn out bills Supply seasonal demand for cash Not used as a tool to control the money supply

6 Functions of the Fed 5. Acting as the fiscal agent for the federal government—holds the “checking account” for the Treasury 6. Supervising member banks

Which function is not necessary?

Tools of the Fed Monetary policy: the Federal Reserve’s decisions that affect the availability and cost of bank reserves, bank credit, and ultimately, money. They increase or decrease money supply.

1. Reserve Requirement The Fed regulates (determines the %) of the reserve requirement keep control over the nation’s money supply Changing the reserve ratio is the least often tool used by the Fed It is the tool of last resort as a part of the Fed’s monetary policy %

Reserve Requirement If the Fed raises the reserve requirement, it is requiring the banks to save more of the depositor’s money, decreasing their excess reserves. Banks will have less $ available for loans This decreases the money supply

Reserve Requirement If the Fed lowers the reserve requirement, it is requiring the banks to save less of the depositor’s money, increasing their excess reserves. Banks will have more $ available for loans This increases the money supply

2. Open Market Operations (OMO) OMO—the buying and selling of government securities (Treasury Bill, Treasury Notes, and Bonds) When the Fed buys bonds from individuals it put $ into circulation This increases, loosens, expands the money supply

Open Market Operations (OMO) When the Fed sells bonds, it takes $ out of circulation This decreases, tightens, contracts the money supply OMO is the most flexible and most often used tool of the Fed to manipulate the money supply

3. The Discount Rate The discount rate is the interest rate the Fed charges depository institutions (banks, savings and loans…) for loans If the Fed raises the discount rate, it is increasing the cost of borrowing Banks will be less likely to borrow Their reserves will not increase They’ll have less $ available for loans This decreases the money supply

The Discount Rate If the Fed decreases the discount rate, then it is decreasing the cost of borrowing $ Banks will be more likely to borrow This will raise bank reserves Banks will have more money available to loan out This increases the money supply This is usually the first tool used by the Fed

Questions What is the Fed doing if they decrease the reserve requirement? What is the Fed doing if they increase the discount rate? What is the most expansionary form of monetary policy? List all the tools and how they would be used.