Federal Reserve Bank ucation/federal-reserve-and- you/chapter-1

Multiple Roles Federal Reserve System serves as the central bank of the United States The Federal Reserve Act of 1913 created the Federal Reserve System federal-reserve-act/ federal-reserve-act/ The Fed regulates banks and carries out the nation’s economic policies The Fed’s major economic goals are to create ongoing economic growth, encourage full employment, and promote price stability The Fed uses monetary policy in order to achieve these goals © 2010 Pearson Education, Inc. All rights reserved 0-2

Price Stability Price level stability means making sure that we don’t have inflation (or deflation) Inflation is defined as a sustained increase in the general level of prices The main goal of Fed policy is price level stability Inflation means the prices of goods and services are going up Inflation is considered problematic to the government and the Fed because it harms businesses and individuals in our economy © 2010 Pearson Education, Inc. All rights reserved 0-3

Monetary Policy Monetary policy involves the raising or lowering of the money supply to achieve some goal Fiat money has value not because the coins and bills have some value in their own right, but because the government orders that it be accepted as payment The Fed uses monetary policy as its primary tool to fight inflation and promote a healthy economy The money we currently use in the United States is known as fiat money With fiat money, a five-dollar bill is worth five dollars because the government says it is © 2010 Pearson Education, Inc. All rights reserved 0-4

Monetary Policy The government must control how much of that paper and coin is circulating in the economy The United States Treasury is in charge of printing money and minting coins The Fed is the agency in charge of determining how much money is in circulation © 2010 Pearson Education, Inc. All rights reserved 0-5

Monetary Policy Physical money in circulation is the most visible part of the money supply There is a lot of electronic money that we never see As the economy grows and more people need money to make purchases, the Fed expands the money supply This includes more electronic money, paper money, and coins (see figure 12.3) © 2010 Pearson Education, Inc. All rights reserved 0-6

Figure 12.3 © 2010 Pearson Education, Inc. All rights reserved 0-7

Monetary Policy The Fed uses monetary policy to change interest rates and impact buying behavior If the Fed wants to encourage people to spend more money, it increases the money supply When more money is available, it drives interest rates down and encourages spending When the Fed reduces the money supply, interest rates go up © 2010 Pearson Education, Inc. All rights reserved 0-8

Monetary Policy If the Fed shrinks the money supply, people will compete for an item (money) that’s in limited supply The price of that money (interest rates) will go up If the Fed is concerned about inflation, it will shrink the money supply This will drive up the price of money and discourage spending, which should slow inflation © 2010 Pearson Education, Inc. All rights reserved 0-9

Monetary Policy A Discount rate occurs when the Fed changes the interest rate it charges to the banks when it loans them money The Fed uses the money supply to impact interest rates Banks use the option of borrowing money from the Fed only on occasion Either of these actions are designed to slow the economy or stimulate the economy o/play/federal-funds-rate/ o/play/federal-funds-rate/ © 2010 Pearson Education, Inc. All rights reserved 0-10

Monetary Policy The Fed has to maintain a balance It wants enough money in the economy to encourage economic growth, but not too much because to cause inflation Keep the Fed’s overall goals in mind: stable prices, economic growth, and full employment ederal-reserve-and-you/chapter-1 ederal-reserve-and-you/chapter-1 © 2010 Pearson Education, Inc. All rights reserved 0-11

Are you as good as Yellen?? Chair the Fed! education.org/chairthefed/WebGameYourJob. html education.org/chairthefed/WebGameYourJob. html