The Federal Reserve System & its Tools (2 days) AP Macroeconomics

Where we came from…  Previously, we discussed financial intermediaries, which are the go-between borrowers and lenders.  Financial intermediaries take deposits from households and businesses and make loans to other households and businesses.  In essence, they help money circulate through the economy.  We also learned about the money creation process.

Where are we going?  In this lesson, we’ll learn about the Federal Reserve System and how its actions relate to the money creation process.

What is the Federal Reserve? The central bank for the United States, created in Holds regulatory authority for many financial institutions that hold checkable deposits. Controls the money supply

Control of the Ms does what? Promotes the following economic goals:  Full employment  Price stability  Stable economic growth

How is “The Fed” structured? Board of Governors – oversees the entire system. 7 members appointed by the President, approved by the Senate. 12 regional Fed Reserve Banks serving a Federal Reserve District. Each run by a board of directors. Federal Open Market Committee – make decisions about federal monetary policy. Consists of the Board of Govs and five of the regional bank presidents. At the top is a chairman.

To view the 12 regions… Follow this link:

A part of, or apart from, the US government? Not really a part of the US government, but it’s also not a private institution. Prior, we had a national banking system.

Weighing the pros and the cons… Pros: In theory, the Fed is accountable to the voting public because members are appointed by the President and approved by the Senate. Cons: The downside? They serve long terms, politically sheltering them from certain political pressures. management-company/

What is the role of the chairman? Former chairman was Alan Greenspan 1987 – The chairman is appointed every 4 years. The chair can be reappointed. Current chairman is Ben S. Bernanke, on his second term. Reports to Congress and testifies to Congress about monetary policy objectives (Alan Greenspan) (Ben Bernanke)

And now… Create a graphic organizer illustrating the structure of the Federal Reserve. Please include the primary responsibilities of each layer. Feel free to use a pyramid, spoke diagram, or any other GO that works for you!

Homework Read Module 26 (Optional) Explore Lessons 9-11 for enrichment at federal-reserve-and-interest-rates/ to get a better grasp of how the Fed functions and controls the money supply in the U.S. federal-reserve-and-interest-rates/

The Tools & Functions of the Fed DAY 2

Where we came from…  In a previous lesson, we learned about the history, structure, and roles of the Federal Reserve System.

Where are we going? In this lesson, you’ll learn about the basic functions of the Fed, and how those functions are carried out, as well as how the Fed’s actions relate to the money creation process.

Functions of the Fed… Provide financial services to banks and other large institutions. Supervise and regulate banking institutions, and to ensure success of nation’s banking system. Maintain stability of the financial system by providing liquidity to financial institutions. Conduct monetary policy through use of its tools.

The Tools of the Fed… 1) Open market operations: the buying and selling of Treasury securities (this is the primary tool used). 2) Discount rate: the interest rate the Fed charges on loans. 3) Required reserve ratio: sets minimum standard rr for banks

More info., please? Like banks, the Fed has assets and liabilities. Assets consist of debt issued by the U.S. government, primarily short- term U.S. bonds with a maturity of less than 1 year (these are U.S. Treasury bills). Liabilities consist of currency in circulation and bank reserves. We use a T-account to understand the Fed’s normal assets and liabilities.

Basic Balance Sheets of the Fed Left Side: Assets (government debt) Right Side: Liabilities (Currency in circulation + bank reserves) Net worth of both sides = Assets - Liabilities

How can changes in reserves changes the money supply? Changes in bank reserves, caused by open-market operations, doesn’t directly affect the money supply. However, it sets off the money multiplier! For example, a $200 million increase in reserves would increase the Ms by $200 mil, and then some of that money would be re- deposited, increasing reserves again, and so on and so forth. ml

How does the Fed get the money for their Treasury bill? Remember, the U.S. dollar is fiat money, and is not backed by anything. The Fed, ultimately, can create additional monetary base (bank reserves + currency in circulation) as it wishes. What do you think about this?

The Basis of Monetary Policy According to Krugman (as well as other economists): “the Fed controls the money supply—checkable deposits plus currency in circulation. In fact, it controls only the monetary base—bank reserves plus currency in circulation. But by increasing or reducing the monetary base, the Fed can exert a powerful influence on both the money supply and interest rates.” (p. 266) This is the basis of MP…

Process it! Create a graphic organizer illustrating the tools and functions of the Fed.

And now… Some resources: For information on federal reserve banks, you can visit: anks.htm Morton workbook: NO ACTIVITY DUE AT THIS TIME Please complete Krugman Module 27 questions

Works Cited Economics of Seinfeld. Krugman, Paul, and Robin Wells. Krugman’s Economics for AP. New York: Worth Publishers. Morton, John S. and Rae Jean B. Goodman. Advanced Placement Economics: Teacher Resource Manual. 3 rd ed. New York: National Council on Economic Education, Print. Reffonomics.