The Fed and Money Supply Chapter 15 Sections 1 and 2 The Fed and Money Supply

The Federal Reserve (AKA – The Fed) The central bank of the United States of America. The “Fed” is a system/network of banks. Responsible for Monetary Policy. Monetary Policy – Changing the growth of money supply in circulation

Federal Open Market Committee Board of Governors, head of NY Fed Bank, and 4 rotating heads of the other 11 district banks. Meet 8 times a year to set MONETARY POLICY Extremely important decision making body.

Banking System 12 District Banks – 25 branch banks underneath it. All national banks must become members of the Federal Reserve System. 12 Federal Reserve Districts Different in size because when it was organized in 1913, it was based on population Idaho’s Federal Reserve District Has 1 district bank and 4 branch banks

Loose Money Policy “Expansionary” Credit is abundant and inexpensive to obtain. Encourages economic growth Tight Money Policy “Contractionary Credit is in short supply and expensive to obtain. Used to control inflation Think money when money is “tight” it is harder to get, not as much available.

Reserve Requirements A requirement by the Fed – % of Money that banks must keep on reserve from deposits. Example – Sam deposits $1000 into a checking account. The reserve requirement is 10%. The bank must therefore hold $100 and may loan out the remaining $900.

Multiple Expansion of the Money Supply

The Federal Reserve The main goal of the Federal Reserve is to keep the money supply growing steadily and the economy running smoothly

Tool #1 – Changing Reserve Requirements Reserve Requirements – The % of money that banks must hold from a deposit. Increase Requirements – Less money available to lend out Think about it if banks are required to hold more of your money in the bank that means less can be lent. Decrease Requirements – More money available to lend out The opposite is also true if the bank have to hold less of your money that means more money can be lent out.

#2 – Discount Rate Banks can borrow money from the Fed (to meet reserve requirements). The interest charged by The Fed on these loans is the Discount Rate Prime Rate – Interest rate banks charge its best business customers. Banks pass on discount rate changes to customers

Cont. Decrease Interest Rate = Loans become cheaper to obtain = Loans INCREASE in Quantity Demanded Increase interest rates – Loans become more expensive – discourages borrowing

#3 – Open Market Operations Buying and selling government securities (Most common tool Fed uses to control money supply Fed buys securities it is increasing money supply Fed sells securities it is decreasing money supply

Federal Funds Rate Interest rate that banks charge each other for short-term loans. Banks that cannot meet reserve requirements must borrow or pay a penalty.

Delays in Effects of Monetary Supply Full effects can take months, sometimes up to a year

Cont. Some Recommend – Money supply increased at same rate each year (no monetary policy) Gov’t (spending and taxation) also has a dramatic affect on the economy.