1 © ©1999 South-Western College Publishing PowerPoint Slides prepared by Ken Long Principles of Economics 2nd edition by Fred M Gottheil Chapter 27, The Federal Reserve System and Monetary Policy

2 What is the Federal Reserve System? The central bank and monetary authority of the United States; known as “the Fed” © ©1999 South-Western College Publishing

3 When was our National Bank formed? After two unsuccessful starts in 1811 and 1816, our present central bank was established in 1864 and took its present form with the Federal Reserve Act 1913 © ©1999 South-Western College Publishing

Federal Reserve System Board of Governors Alan Greenspan, Chair, Federal Reserve Board

5 How long do most Board Members serve? 14 years, after which they cannot be redesignated © ©1999 South-Western College Publishing

6 How long does the Chairman of the Board serve? The Chairman serves 4 years, but can be redesignated up to a total of 14 years © ©1999 South-Western College Publishing

7 President appoints Senate confirms Open Market CommitteeAdvisory Committee Board of Governors 12 Federal Reserve Banks National Banking System Commercial banks, Savings & Loans, Mutual savings banks, Credit Unions The Federal Reserve System © ©1999 South-Western College Publishing 7

8 Who makes the decisions for the Federal Reserve? The Board of Governors and the Open Market Committee © ©1999 South-Western College Publishing

9 Who owns the Fed? Each of the 12 district Federal Reserve banks is owned by its member banks © ©1999 South-Western College Publishing

The 12 Federal Reserve Banks

11 What are the two types of banks? There are about 5,000 Nationally Chartered banks and about 6,000 State banks © ©1999 South-Western College Publishing

12 What is a Nationally Chartered Bank? A commercial bank that receives its charter from the comptroller of the currency and is subject to federal law as well as the laws of its state © ©1999 South-Western College Publishing

13 What is a State Chartered Bank? A commercial bank that receives its charter to function from a state government and is subject to state laws © ©1999 South-Western College Publishing

14 Are all banks members of the Federal Reserve? All nationally chartered banks and about 15% of state chartered banks are members of the Fed © ©1999 South-Western College Publishing

15 What percent of deposits reside in member banks? More than 50% of all deposits reside in member banks © ©1999 South-Western College Publishing

16 Why are some banks not members of the Federal Reserve? High minimum capital requirements Restrictions & regulations Can use Fed’s major facilities anyway © ©1999 South-Western College Publishing

17 What is the major function of the Fed? To control the growth of the money supply, in an effort to ensure the availability of enough money and credit in the banking system to support a growing and non- inflationary economy

18 What are the goals of the Federal Reserve? high level of employment economic growth price stability stability in markets © ©1999 South-Western College Publishing

19 What are the responsibilities of the Fed? Influence our money supply Issue and maintain our currency Act as a national clearing house for checks Serve as a bank for the federal government Serve as a “bankers bank” Replace old currency Act as a “lender of last resort”

20 How does the Fed influence the money supply? Open market operations Discount rate Reserve requirements © ©1999 South-Western College Publishing

21 Which monetary tool is most often used? Open-market operations © ©1999 South-Western College Publishing

22 What are Open Market Operations? Purchases and sales of government securities by the Federal Reserve in an effort to influence the money supply © ©1999 South-Western College Publishing

23 What are Government Securities? Bonds sold by the federal government © ©1999 South-Western College Publishing

24 What happens when the Fed purchases government securities? The money supply expands Don’t forget the multiplier effect also!

25 What happens when the Fed sells government securities? The money supply contracts Don’t forget the multiplier effect also!

26 What is the Discount Rate? The interest rate that banks are charged when they borrow money from the Fed © ©1999 South-Western College Publishing

27 What happens when the Fed lowers the discount rate? Banks tend to borrow more from the Fed, expanding the money supply

28 What happens when the Fed raises the discount rate? Banks tend to borrow less from the Fed, slowing the growth of the money supply

29 Does the Fed loan money to private companies? No, they only do business with financial institutions © ©1999 South-Western College Publishing

30 3rd tool of the Fed, changes in reserve requirements Lower reserve ratio raises the money multiplier, thus expanding the money supply

31 What happens if the Fed raises reserve requirements? Higher reserve ratio lowers the money multiplier, thus contracting the money supply

32 What is the role of the Federal Open Market Committee? The FOMC makes decisions as to the buying and selling of government securities © ©1999 South-Western College Publishing

33 Who makes up the Federal Open Market Committee? The FOMC is made up of the 7 board members and 5 presidents of Federal Reserve Banks © ©1999 South-Western College Publishing

34 What is the Federal Advisory Council? Committee of 12 members, one from each Federal Reserve district who advise but do not vote © ©1999 South-Western College Publishing

35 Why would the Fed want to decrease the money supply? To lower inflation or if they are worried the economy is growing too fast

36 Why would the Fed want to increase the money supply? To stimulate employment during recessions or sluggish economic times © ©1999 South-Western College Publishing

37 To fight inflation, what are possible policies of the Fed? Sell bonds on the open market Raise the discount rate Raise reserve requirements

38 To fight unemployment, what are possible policies of the Fed? Buy bonds on the open market Lower the discount rate Lower reserve requirements

39 Are these Fed policies really symmetrical? Probably not, perhaps easier to slow the economy rather than stimulate it

40 Why??? The Fed can drain reserves so that banks cannot loan, but they cannot force people to borrow

41 What are two ancillary tools of the Fed? Controlling stock market margin requirements Moral Suasion © ©1999 South-Western College Publishing

42 Note that Fed policies can affect interest rates, such as the Federal Funds Rate

43 What is the Federal Funds Rate? The interest rate that one bank will charge another bank to borrow money © ©1999 South-Western College Publishing

44 What will happen to the federal funds rate if the Fed buys more bonds? Banks have more reserves and the Federal Funds rate falls © ©1999 South-Western College Publishing

45 What will happen to the federal funds rate if the Fed sells bonds? Banks have less reserves and the Federal Funds rate rises © ©1999 South-Western College Publishing

46 What is the Prime Interest Rate? The interest rate that big banks charge their best and most credit worthy customers © ©1999 South-Western College Publishing

47 news/fed/ a.asp news/fed/ a.asp

48 48 © ©1999 South-Western College Publishing /12/38.shtml cator/fomcsim.html tem/monpol/tofc.html

49 What is a State Chartered Bank?What is a State Chartered Bank? What is a Nationally Chartered Bank?What is a Nationally Chartered Bank? What is the Federal Reserve System?What is the Federal Reserve System? What are the responsibilities of the Fed?What are the responsibilities of the Fed? Who makes the decisions for the Federal Reserve?Who makes the decisions for the Federal Reserve?

50 What is the role of the Federal Open Market Committee?What is the role of the Federal Open Market Committee? Why would the Fed want to decrease the money supply?Why would the Fed want to decrease the money supply? Why would the Fed want to increase the money supply?Why would the Fed want to increase the money supply? How does the Fed influence the money supply?How does the Fed influence the money supply? Which monetary tool is most often used?Which monetary tool is most often used?

51 ENDEND © ©1999 South-Western College Publishing