Federal Reserve Banks Bell Ringer: How do banks create money? Explain the basic process.

Federal Reserve Banks How it works and what it does.

Introduction The fed’s control over the supply of money is the key mechanism of monetary policy. MONETARY POLICY IS THE USE OF MONEY AND CREDIT CONTROLS TO INFLUENCE MACROECONOMIC ACTIVITY.

Introduction Congressional spending can also effect the economy FISCAL POLICY: USING GOVERNMENT SPENDING TO INFLUENCE MACROECONOMIC ACTIVITY. Example: Gov’t spends more money on roads and bridges, more money goes into the economy.

The Fed monitors banking in every part of the United States. E. Napp

Federal Reserve Banks CLEARS CHECKS BETWEEN BANKS HOLDS BANK RESERVES. The Federal Reserve performs the following services: CLEARS CHECKS BETWEEN BANKS HOLDS BANK RESERVES. PROVIDES CURRENCY TO THE PUBLIC. PROVIDES LOANS TO PRIVATE BANKS. FEDERAL GOVERNMENTS BANKS Deposit taxes; pays Gov’t bills

The Board of Governors The Fed is controlled by a seven person Board of Governors. Each governor is appointed to a 14-year term by the President (with confirmation by the U.S. Senate).

The Board of Governors The long term is intended to give the Fed a strong measure of political independence. THE PRESIDENT SELECTS ONE OF THE GOVERNORS TO SERVE AS CHAIRMAN FOR A 4-YEAR TERM. Currently: Jerome Powell

Structure of the Federal Reserve System Private banks (depository institutions) Federal Reserve banks (12 banks, 24 branches) Board of Governors (7 members) Federal Open Market Committee (12 members) Federal Advisory Council and other committees

Monetary Tools The Federal Reserve controls the money supply using the following three policy instruments: RESERVE REQUIREMENTS Change loan requirements DISCOUNT RATES Makes it cheaper or more expensive to loan money OPEN-MARKET OPERATIONS Adds to takes away money

Reserve Requirements The Fed requires banks to keep a minimum amount of required reserves. People deposit money Banks loan money: REQUIRED RESERVES – THE MINIMUM AMOUNT OF RESERVES A BANK IS REQUIRED TO HOLD;

Discounting Discounting refers to the Federal Reserve lending of reserves to private banks. A bank can deal with a reserve shortage by going to the Fed’s “discount window” to borrow reserves directly. BY RAISING OR LOWERING THE DISCOUNT RATE, THE FED CHANGES THE COST OF MONEY FOR BANKS AND THE INCENTIVE TO BORROW RESERVES.

The Discount Rate Excess reserves earn no interest. Banks have a tremendous profit incentive to keep their reserves as close to their required reserve level as possible.

The Federal Funds Market The federal funds market is where a bank that finds itself short of reserves can turn to other banks for help. THE FEDERAL FUNDS RATE IS THE INTEREST RATE FOR INTER-BANK RESERVE LOANS. Reserves borrowed in this manner are called “federal funds” and are lent for short periods - usually overnight.

Sale of Securities A bank that is low on reserves can also sell securities. Banks use some of their excess reserves to purchase government bonds.

Open-Market Operations Open-market operations are the principal mechanism for directly altering the reserves of the banking system.

Hold Money or Bonds The Fed’s open-market operation focus on the portfolio choices people make. The Fed attempts to influence the choice by making bonds more or less attractive, as circumstances warrant.

Hold Money or Bonds Bond sales by the Fed reduce the flow. When the Fed buys bonds from the public, it increases the flow of deposits (reserves) to the banking system. Bond sales by the Fed reduce the flow. Likewise, when the Fed sells bonds, it removes money from the banking system.

Open Market Operations The Fed The Public Banks Buyers spend account balances Fed SELLS bonds Open market operations Reserves decrease Sellers deposit bond proceeds Reserves increase Fed BUYS bonds