Chapter 15 – The Fed and Monetary Policy

Section One – The Federal Reserve System Structure of the Fed i. Main organizational structure has not changed since the 1930’s a. Private Ownership i. It’s privately owned by it’s member banks ii. All national banks are required to be members and own shares b. Board of Governors i. A seven member board of governors was established in 1935, each serving 14 year terms

c. Federal Reserve District Banks i. 12 District Reserve Banks located throughout the country ii. Each has it’s own president and board of directors d. Federal Reserve Open Market Committee i. Makes decisions about the growth of the money supply ii. There are 12 voting members on the committee iii. The committee meets eight times a year to meet and make decisions about the monetary policy e. Advisory Committees i. Three advisory committees advise the board directly - health of the economy - consumer credit laws - savings institutions

Regulatory Responsibilities a. State Member Banks i. Bank reserves are monitored by the Fed - serves to clear checks - control the size of the money supply b. Bank Holding Companies – Corporations that own one or more banks i. They do not accept deposits or make loans ii. Originally created to sidestep regulations they now are subject to more regulations than before

c. International Operations i. Foreign banks can operate in the U.S. ii. Some own stock in U.S. banks iii. The Fed can terminate foreign bank operations inside the U.S. iv. The Fed also supervises U.S. banks oversees. d. Member Bank Mergers i. If a state member bank is merged with another the Fed must approve the merger

Other Federal Reserve Services i. Clearing checks ii. Consumer legislation – Truth in Lending iii. Maintaining currency and coins iv. Provides financial services for the federal government v. Maintains accounts for the IRS

Section Two – Monetary Policy Fractional Bank Reserves i. One of the most important roles they have is in managing the money supply ii. Fractional reserve banking - Banks only required to keep a fraction of their reserves on hand - Subject to a reserve requirement, where a certain percentage of each deposit has to be set aside in reserve (12%) a. How Banks Operate i. Examine the banks balance sheet and net worth

b. Organizing a Bank i. Bank is organized as a corporation ii. Owners supply cash in return for stock in the bank d. Accepting Deposits i. The bank must set aside what is required for it’s reserve requirement ii. The rest is shown as an asset that can be loaned out. e. Making Loans i. It’s free to loan out $90 f. Reaching Maturity i. liquidity is desirable for banks. It means they can convert assets to cash quickly. ii. Once banks diversify their assets they achieve a high degree of liquidity iii. Can offer more products like savings accounts

Fractional Reserves and Monetary Expansion a. Loans and Monetary Growth i. Excess reserves can continually be lent out - If loaned money is deposited in the bank, the bank can loan the excess money out again to a new customer b. Reserves and the Money Supply i. The money supply will stop growing at some point because each deposit is smaller than the one before. ii. As deposits are withdrawn bank reserves will fall

Tools of Monetary Policy i. Easy money policy – Allows the money supply to grow and interest rates to fall ii. Tight money policy – Allows the money supply to fall and interest rates will rise a. Reserve Requirement i. The Fed can change what the reserve requirement for banks b. Open Market Operations i. Buying and selling of government securities in financial markets - When it buys government securities it increases the money supply - When it sells government securities it decreases the money supply

c. Discount Rate i. The interest rate the Fed charges on loans to financial institutions ii. If the interest rate goes up, banks borrow less and vice versa d. Margin Requirements i. The total amount of money needed to buy stocks (Now 50%) - decreases the amount of speculation e. Other Tools i. Press releases that banks use as signals to what future policy will be ii. Credit controls – ex. Minimum down payments

Section Three – Monetary Policy, Banking and the Economy Short-Run Impact i. Cost of credit goes down when the money supply is expanded ii. Cost of credit goes up when the money supply is restricted iii. No matter the policy the Fed chooses, it does have enormous impact on the economy, especially the financial sector.

Long-Run Impact i. In the long run, changes in the supply of money affects the general price level. a. Monetizing the Debt i. Create enough extra money to offset deficit spending to keep interest rates from changing ii. Inflation can become worse with this policy if used too much b. Taming Inflation i. Inflation distorts our economic statistics ii. Real rate of interest can be used (interest rate – rate of inflation)

Other Monetary Policy Issues a. Timing and Burden i. Results of policy changes aren’t always realized right away ii. Each choice will affect different industries differently b. Present vs. Future Allocation i. Decisions affect how people consume either now or in the future ii. The rate of inflation changes how people invest c. Defining Money i. M1 – Component of money supply that match money’s role as a medium of exchange (coins, currency,) ii. M2 – Component of money supply that match money’s role as a store of value (time deposits, savings deposits, money market funds)

IV. The Policies of Interest Rates i. Fed operates under political pressure ii. Threaten changes in policy over the Fed iii. Can appoint members of the Board with certain goals iv. People often think the economy is healthy if interest rates are low - Can make policy changes in election years difficult