The Fed Monetary Policy

Standards SSEMA2 The student will explain the role and functions of the Federal Reserve System. Describe the organization of the Federal Reserve System. Define monetary policy. Describe how the Federal Reserve uses the tools of monetary policy to promote price stability, full employment, and economic growth.

Basic Facts Public Government’s bank We go to Wells Fargo, congress goes to the Fed Created by congress Can be dissolved by congress Fiscal agent for the U.S. Government Currency = Federal Reserve note b/c backed by assets of Fed. Reserve Profits = transferred to U.S. Government 2011 = $79 billion transferred to U.S. Government

Board of governors 7 members appointed by President Confirmed by senate 14 yr terms 1 terms starts every 2 yrs, on Feb. 1 of even year Public part of Federal Open Market Committee FOMC = makes decisions about monetary policy Chairman and Vice Chairman serve 4yr terms.

Basic Facts Private Decentralized w/12 banks for the whole country Each Bank: 2/3 directors = elected by privately controlled member banks of that district 1/3 directors = elected by Board of Governors

Basic Facts Private 5 district bank presidents = voting member of FOMC New York Fed. Reserve Bank Pres. = always a voting member FOMC 4 others rotate from other 11 districts District banks organized like private corporation Self-financed through interest on securities or payment for services, i.e. check clearing

Basic Terms Monetary Policy = tools used by the FOMC to stabilize economy 3 main tools of FOMC Open Market Operations Discount Rate Reserve Requirement

Open Market Operations Most common / most used tool of the Fed. Buying and selling of government bonds on the open market. (meaning we can buy them) Bought by banks and people Backed by own money Sell bonds to reduce money in circulation Buy bonds to increase money in circulation

Open Market Operations More we buy, less money in economy. Less $ = no $ for loans No $ for loans = interbank interest rate (Federal Funds Rate) goes up Federal Funds rate goes up = less borrowing activity

Discount Rate The second most common tool of the Fed. The interest The Fed charges banks to borrow money. Prices go up (inflation) = raise discount rate Prices go down (deflation) = lower discount rate Used as signal to banks Encourage/discourage banks to raise/lower federal funds rate Increase/decrease loans to each other.

Reserve Requirement How much of a customer’s deposit HAS TO BE put in the vault or reserve account at the Fed. Reserve. This percentage CANNOT be used as loans. Example: I deposit $10k Reserve requirement = 10% Wells Fargo can only use $9k of that money to make loans for other customers

Reserve Requirement Least common tool Like hardly ever Small changes = big differences in money supply Raise requirement = pulls large amounts of money from economy Lower requirement = increases large amounts of money into economy Like actual money, not theoretical

Concerns of the Fed Inflation Unemployment/ economic growth Uses tools to achieve their goals

Inflation/Price Stability If Fed is concerned w/inflation or price stability = Begin selling bonds on open market Raise discount rate to signal banks to stop borrowing from each other Goal is to remove $ from economy to lower prices

Unemployment Full employment = All factors of production being used efficiently Can refer to labor resources meaning unemployment rate = structural + frictional w/ NO cyclical

Loose Monetary Policy Buy bonds which will Decrease federal funds rate, which will Encourage more borrowing Sometimes = lower discount rate to signal banks to increase lending Rarely = lower reserve rate to allow banks to use more $ out of their deposits