15.1 I.The Federal Reserve was created in 1913 by Congress: main function is to control the money supply. A.The Fed is owned by member banks B.The Board of Governors establishes policies for the Federal Reserve and member banks to follow - 7 Members appointed by president for 14 years - Chairman of the Board – leader of the Fed C.12 Federal Reserve district banks & 25 branch banks D.Federal Open Market Committee (FOMC) – establishes monetary policy - 7 Board Members + 5 District Bank Presidents (4 rotate through, New York President is permanent)

E. The Federal Advisory Council, the Consumer Advisory Council, and the Thrift Institutions Advisory Council advise the Board of Governors E. The Federal Advisory Council, the Consumer Advisory Council, and the Thrift Institutions Advisory Council advise the Board of Governors

II. Regulatory Responsibilities: the Fed is politically independent A. Monitors member banks’ reserves B. Oversees bank holding companies C. Oversees foreign banks operating in the US and international operations of US member banks and holding companies operating abroad D. Approves bank mergers Goal is to regulate and stabilize the nation’s $$ supply

III. Other Federal Reserve Services A. Check clearing B. Truth-in-lending disclosures C. Issues paper currency D. Provides financial services to the federal government

I. Fractional Bank Reserves A. The Federal Reserve requires that member banks keep a certain percentage of their deposits in the form of legal reserves B.A bank’s balance sheet shows its assets, liabilities, and net worth

C. Every time a bank customer makes a deposit, the bank must set aside a portion of the deposit as reserves D.Banks earn money by lending out that portion of their deposits that need not be held as reserves E. To earn its profits, a bank usually needs to charge 2-3 percent more for its loans than the rate of interest it pays for its saving accounts and time deposits D.Banks earn money by lending out that portion of their deposits that need not be held as reserves E. To earn its profits, a bank usually needs to charge 2-3 percent more for its loans than the rate of interest it pays for its saving accounts and time deposits

II. Three Major Tools of Monetary Policy: Goal is to strike a balance between tight and loose money to control inflation and keep purchasing power stable A. Reserve Requirement A. Reserve Requirement 1.Total Reserves ÷ Reserve Requirement = Money Supply: example $100 ÷.20 = $ A system of fractional reserve banking allows banks to make a large volume of loans 3. A change in the money supply is equal to the change in reserves divided by the reserve requirement (∆ Money Supply = ∆ Reserves ÷ Reserve Requirement) (∆ Money Supply = ∆ Reserves ÷ Reserve Requirement)

B. The Discount Rate = rate of interest banks must pay to the Fed for loans 1. The higher the rate, the less $ banks may borrow from the Fed, leading to “Tighter $” in circulation 2. Higher discount rates = higher Prime Rates (rates charged to business customers of banks), which discourages borrowing and decreases growth of the $$ supply. 3. The opposite is true when the discount rate is low.

C. Open Market Operations = The main instrument by which the Fed affects monetary policy C. Open Market Operations = The main instrument by which the Fed affects monetary policy 1.Buying and selling of government securities in financial markets (not government controlled) 2. Influences short-term interest rates 3. When the Fed buys securities on the Open Market, $$ supply increases 2. Influences short-term interest rates 3. When the Fed buys securities on the Open Market, $$ supply increases 4. When the Fed sells sells securities on the Open Market, $ supply decreases

Minor tools of the Federal Reserve III. Minor tools of the Federal Reserve A. The Fed can affect the money supply by changing margin requirements * Margin requirements rarely used by the Fed today B. Moral suasion C. Selective credit controls

Tight Money = Credit is expensive and in short supply  Borrowing difficult  Consumers buy less  Expansion delayed  Unemployment increases THEN recession begins Tight Money = Credit is expensive and in short supply  Borrowing difficult  Consumers buy less  Expansion delayed  Unemployment increases THEN recession begins Loose Money = Credit inexpensive and abundant  Easy Money  Spending increases  Businesses expand  Jobs created  prices increase THEN  purchasing power declines and INFLATION occurs Loose Money = Credit inexpensive and abundant  Easy Money  Spending increases  Businesses expand  Jobs created  prices increase THEN  purchasing power declines and INFLATION occurs IV. Tight $$ vs Loose $$ IV. Tight $$ vs Loose $$

V. Measuring the Money Supply A. Money supply is all the money available in the United States economy. V. Measuring the Money Supply A. Money supply is all the money available in the United States economy.

(market mutual fund balances, and savings deposits) also called near moneys (near moneys are assets that are almost, but not exactly like money and have high liquidity). 2. M2 = broader definition of the money supply and = all the M1 assets PLUS any assets that can be converted to cash fairly easily 2. M2 = broader definition of the money supply and = all the M1 assets PLUS any assets that can be converted to cash fairly easily

What is Monetary Policy?? The expansion or contraction of the $$ supply in order to influence the cost and the availability of credit. It is a structured process. What are the three major tools of Monetary Policy???

1.1. Reserve Requirement Reserve Requirement 2.2. The Discount Rate The Discount Rate 3.3. Open Market Operations Open Market Operations