Chapter 15 The Federal Reserve System & Monetary Policy Section 1 Organization & Function of the Federal Reserve System Section 2 Money Supply & the Economy Section 3 Regulating the Money Supply

Organization & Functions of the Fed Created in 1913 as a central banking organization to end panics and recessions. Fed – Federal Reserve System Fed is responsible for monetary policy Monetary Policy – policy that involves changing the rate of growth of the supply of money in circulation in order to affect the cost and availability of credit

Organization & Functions of the Fed Board of Governors – directs the operation of the Fed 7 members appointed by the President with Senate approval for 14 years Alan Greenspan & Ben Bernanke – serve(d) as chairperson 12 District Banks 25 Branch Banks Member Banks

Organization & Functions of the Fed Federal Advisory Council – reports to the board of governors on general business conditions in the country Federal Open Market Committee – determines whether or not to change interest rates which impacts the financial world

Organization & Functions of the Fed 12 Federal Reserve districts with a bank (page 402) Set up as a corporation owned by member banks with a 9 member board of directors Services are available to all banks Decides truth-in-lending rules to protect consumers

Functions of the Federal Reserve Clearing Checks – see figure 15.3 Government’s Fiscal Agent – tracks govt. deposits, checking account for the Treasury, & advises federal government Supervises Member Banks – regulates state banks

Functions of the Federal Reserve Holding Reserves & Setting Reserve Requirements – controls money in circulation by setting % required for reserves Supplying Paper Currency – all paper money printed in D.C. by Bureau of Engraving & Printing to replace old money & meet demand Regulating the Money Supply – primary responsibility which affects the amount of credit & business activity

Money Supply & the Economy Fed’s most important function involves controlling the rate of growth of the money supply Loose money policy – monetary policy that makes credit inexpensive and abundant, possibly leading to inflation Tight money policy – monetary policy that makes credit expensive and in short supply in an effort to slow the economy

Money Supply & the Economy Loose Money Supply Borrowing is easy Consumers buy more Businesses expand More people are employed People spend more Inflation results

Money Supply & the Economy Tight Money Supply Borrowing is difficult Consumers buy less Businesses postpone expansion Unemployment increases Production is reduced

Money Supply & the Economy Fractional reserve banking – system in which only a fraction of the deposits in a bank is kept on hand, or in reserve; the remainder is available to lend Reserve requirements – regulations set by the Fed requiring banks to keep a certain percentage of their deposits as cash in their own vaults or as deposits in their Federal Reserve district bank

Money Supply & the Economy Expanding the money supply – see15.6 on page 409

Regulating the Money Supply The main goal of the Federal reserve is to keep the money supply growing steadily and the economy running smoothly without inflation.

Changing Reserve Requirements Control money supply through reserve requirements. Lower the % of deposits kept in reserve, the more $s available to loan Higher the % of deposits, the more $s available to loan Raising reserve requirements slows down the economy. Changing the reserve requirement is rarely used.

Changing the Discount Rate Banks my need to borrow money to meet their reserve requirements. Discount rate is the interest rate the Fed charges for loans to banks. Prime rate is the interest rate banks charge their best customers. Increase in these rates lowers the money supply and vice versa. Typically the Fed does not use the discount rate to regulate the economy.

Federal Funds Rate Federal funds rate is the interest rate that banks charge each other on loans (usually overnight). The federal funds market is active with billions of dollars exchanged each day. The lower the rate the more banks will borrow and business activity increases. The higher the rate the less will be borrowed and business activity decreases.

Open-Market Operations Open-market operations – buying and selling U.S. securities by the Fed to affect the money supply. When the Fed buys securities, money supply increases. Selling securities lowers reserves and money supply decreases.

Difficulties of Monetary Supply Keeping track of the money supply is difficult in trying to gauge the economy. Credit cards and electronic banking make tracking money supply difficult. Fed is criticized for decisions that may lead to inflation or recession. Fed receives conflicting advice from many directions. Other factors, such as federal taxing & spending also greatly affect the economy.