The Federal Reserve and Monetary Policy

Monetary Policy What is monetary policy? The expansion and/or contraction of the money supply in order to influence the cost and availability of credit. Carried out when a central bank manipulates the money supply. Monetary Policy

Limit Unemployment Control Inflation Goals of Monetary Policy

Monetary Policy Expansionary Monetary Policy Increasing the money supply to lower unemployment by increasing the amount of credit available and decreasing interest rates. Can lead to increased inflation. Lending and investment increase, causing price changes to speed up. Monetary Policy

Monetary Policy Contractionary Monetary Policy Decreasing the money supply to to decrease inflation by decreasing the amount of credit available and increasing interest rates. Can lead to slower economic growth and declining inflation. Lending and investments decline causing price increases to slow down Monetary Policy

The Structure of the Fed What is the Federal Reserve? The “Fed” is the central bank of the United States. It was established to regulate U.S. banks and to implement monetary policy Created by the Federal Reserve Act of 1913. The Structure of the Fed

7 member board appointed by the president & approved by the Senate to supervise the Federal Reserve System. Members serve a single term of 14 years. One person is appointed by the President from among the board to act as chairperson for a 4 year term. The Chairman can be appointed for multiple terms. Board of Governors is supposed to operate free of political influence Fed Board of Governors

District Reserve Banks Twelve district banks located across the United States. Each bank has its own president and board of directors. They take deposits from member banks and lend money to banks and thrift institutions. They also provide anecdotal reports to the FOMC on economic conditions within their district

Federal Open Market Committee The FOMC makes monetary policy decisions that increase or decrease the money supply. Members Include: The 7 members of the Fed Board of Governors Presidents of four of the 12 Federal Reserve district banks rotate. The President of the New York Fed is a permanent member. Federal Open Market Committee

The FOMC

Tools of Monetary Policy Open Market Operations The Federal Reserve can buy and sell securities from banks to influence the supply of money. Buying securities gives banks more money to lend (bonds/mortgages). Selling securities give banks less money to lend. Changing the money supply affects the Federal Funds Rate. Banks lend each other money that is stored by the Federal Reserve. Increasing the money supply lowers the rates that banks charge each other. Tools of Monetary Policy

Tools of Monetary Policy The Discount Rate When the Fed loans money to banks, the bank’s reserve balances increase. The interest rate on these loans is usually called the discount rate, but the official name is the primary credit rate. Lowering this rate signals that the Federal Reserve is increasing, or loosening, the supply of money and credit. Raising the rate signals a policy of tightening the supply of money and credit. Tools of Monetary Policy

Tools of Monetary Policy Reserve Requirement Changes The Fed Board of Governors sets the percentage of deposits that banks must keep in reserve. Lowering the reserve requirement increases a bank’s ability to make loans. Because more money would be available to loan, interest rates would fall. This policy tool is rarely used by the Fed. Tools of Monetary Policy

Tools of Monetary Policy Interest on Excess Reserves In 2006 Congress gave the Fed power to pay interest on the deposits by banks in their reserve accounts. If this interest rate is very low, banks might look for opportunities to use their reserves to make loans to consumers or businesses so they can earn a higher interest rate. if the interest rate is higher, banks could be encouraged to leave the deposits in reserves and make fewer loans. This is another way to increase or decrease the money supply to speed up or slow down the economy. Tools of Monetary Policy

Open Market Operations

Open Market Operations

The Structure of the Federal Reserve Advisory Committees The three committees that advise the Fed’s boar of Governors are the Federal Advisory Committee Consumer Advisory Committee Thrift Institutions Advisory Council.

Federal Reserve Regulatory Responsibilities 1. Checks the Money It is responsible for checking the money that state-chartered member banks set aside. The reserved money pays checks that bank customer write and is used to control the money supply.

Federal Reserve Regulatory Responsibilities 2. Regulates Bank Holding Companies It regulates the corporations that own one or more banks to ensure that they are operating within the interests of all stakeholders.

Federal Reserve Regulatory Responsibilities 3. Regulates Foreign Banking Operations It supervises and regulates foreign banks operating in the United States, as well as, foreign ownership of shares in U.S. banks. It also supervises overseas operations of American banks.

Federal Reserve Regulatory Responsibilities 4. Approves Bank Mergers It approves mergers of state banks that are members of the Federal Reserve System.

Other Federal Reserve Services Clearing Checks The reserves of member banks are used as checks that are written by bank customers move back through the system to the check writer’s bank.

Other Federal Reserve Services Carrying Out Consumer Laws The Fed was given authority to require banks, stores, and other lenders to follow truth-in-lending procedures for borrowers through Regulation Z.

Other Federal Reserve Services Maintaining Currency The Fed produces and stores currency. The Fed sends banks new money and destroys worn-out money.

Other Federal Reserve Services Government Financial Services It sells government securities and savings bonds. It pays out social security payments. It maintains accounts for collected tax payments.