Monetary Policy

Monetary Policy A government policy that manages the economy by controlling the money supply and interest rates.

Structure of “The Fed” The Board of Governors Over see the Federal Reserve System Composed of seven members who appointed by the President for staggered 14 year terms The President also appts the Chair of the Board of Governors and the Senate must confirm this position. The Chair serves a four year term that can be renewed. Ben Bernanke

Structure of “The Fed” Twelve Federal Reserve Districts One Federal Reserve Bank is located in each district One Bank represents several states Keeps one bank from exploiting others Each bank monitors that regions economic conditions Each bank has nine directors that represent the regions various interests Three each: banks, regional industries, appointees by Board

Duties of “The Fed” Bank for the Treasury Department Processes IRS refunds, issues Social Security checks, and other gov’t payments Issues currency to banks Serves as the financial agent for the Treasury Dept by buying and selling bonds, notes, and bills.

Duties of “The Fed” Financial Services for Banks: Check clearing Supervises lending practices to ensure stability of banks by monitoring their reserves Lender of Last Resort Uses the “Discount Rate” for all emergency loans

Duties of “The Fed” Supervisory & Regulatory Functions: Monitors the reserves each bank keeps on hand Performs bank examinations and audits

Money Creation How is money entered into the banking system: You get a loan from the bank and deposit that money into your account. Ex) $1,000  $900  $810 ….. Required Reserve Ratio (RRR) Usually about 10%

RRR To calculate the amount of money that will be created use the money multiplier formula: 1/RRR = If the RRR is 10% than 1/10 An initial deposit of $1000 = $10,000

RRR The Fed does not like to alter the RRR but… If the RRR increases than the money supply decreases If the RRR decreases than the money supply increases

The Discount Rate Lender of Last Resort: The Fed can raise or lower the Discount Rate on emergency loans This is the only interest rate The Fed can actually change…it “targets” the federal fund rates that banks charge each other by using Open Market Operations

Open Market Operations The buying and selling of government bonds to alter the supply of money and thus effect interest rates and the economy

Purchasing Bonds In order to increase the money supply the FOMC will purchase bonds on the open market The Fed will purchase bonds with money/checks The bond dealers give The Fed the bonds in exchange for the money The bond dealers then deposit the money from the bond sales in to their banks The banks now have more money and the interest rates fall and funds enter the economy

Selling Bonds If the FOMC chooses to decrease the money suppy, it will make an open market bond sale. The Fed now sells in bonds back to the dealers receiving from them checks drawn on their own banks. The money goes back to The Fed and is now out of circulation. There is now a decline in the money supply and interest rates climb

Lags in Policy Changes Inside lags: The time it takes to decide on a policy change and implement the new policy Outside lags: The time it takes for the monetary policy to have an effect as they effect business plans.