1. The Federal Reserve and The Supply and Cost of Credit
Chapter 3
The Federal Reserve and The Supply and Cost of Credit

2. The Federal Reserve (the Fed)
The nation's central bank
Purpose: to control the supply of money in order to achieve
Stable prices
Full employment
Economic growth

3. The Assets of the Fed Gold certificates Cash items in process
The float
U.S. government securities
Foreign currencies

4. The Liabilities of the Fed
Federal Reserve Notes
Deposits by
Banks (reserves)
Federal government
Foreign depositor

5. Structure of the Federal Reserve
Board of Governors
The twelve district banks
Federal Open Market Committee

6. Structure of the Federal Reserve

7. Expansion of Money and Credit
Fractional reserve banking
Expansion (and contraction) of the money supply
Importance of excess reserves

8. Multiple Expansion Reserves are either The process of loan credition
Required or
Excess
The process of loan credition

9. Multiple Epansion of the Supply of Money
Initial Dep: $100
Reserve Req: 10%
New
Demand
Deposits
Cumulative
Credit
Required
Reserves
Excess
1st bank
$100.00
$0.00
$10.00
$90.00
2nd bank
90.00
19.00
81.00
3rd bank
171.00
27.10
72.90 .
Final round
$900.00

10. Multiple Expansion
Change in the money supply = change in excess reserves / reserve requirement

11. Multiple Expansion Reserve requirement = 10% Reserves increase by $100
Possible increase in the money supply: $100/0.1 = $1,000

12. Impact of Cash Withdrawals
Multiple expansion in reverse
Money supply contracts

13. Importance of the Federal Funds Market
Market for reserves
The lending of reserves between banks
The federal funds rate

14. The Tools of Monetary Policy
The discount rate
Rate the Fed charges banks to borrow reserves

15. The Discount Rate

16. The Reserve Requirement
Percentage banks must hold against deposit liabilities
Changing commercial banks' reserves leads to:
Multiple expansion or
Multiple contraction

17. The Tools of Monetary Policy
Open market operations
The buying and selling of Federal government securities
By far the most important tool of monetary policy

18. Impact of The Federal Reserve
The Fed affects interest rates through its impact on the ability of the banking system to lend

19. Monetary Expansion
To expand the money supply, the Fed buys government securities
Paying for the securities puts reserves into the banking system
The purchases reduce interest rates

20. Monetary Contraction
To contract the money supply, the Fed sells government securities
Receiving payment for the securities removes reserves from the banking system
The sales increase interest rates

21. Fiscal Policy The federal government's taxation spending
debt management

22. Deficit Spending Government spending exceeds revenues
Sources of funds to finance the deficit
commercial banks
non-bank public
Federal Reserve

23. Surplus Government revenues exceed revenues
Question of how to use any surplus

24. Fiscal Policy The possible impact of deficit spending or a surplus on
the money supply
the reserves of the banking system
security prices

25. Inflation General increase in prices
CPI - measures the rate of inflation
Excessive expansion of money

26. Changes in Inflation Affect firms with natural resources
Oil
Precious metals (e.g., gold)
Some firms are better able to pass on price increases

27. Fight Inflation by Contracting the money supply Raising interest rates
Raising taxes

28. Deflation A general decline in prices Opposite impact of inflation
Unexpected deflation hurts debtors and helps creditors

29. Impact of Monetary and Fiscal Policy on the Firm
Cost of funds
Demand for firm’s products and services
Ability to anticipate changes in economic policy

30. Foreign Exchange Foreign currencies Exchange rate
Value of one currency in terms of another

31. Foreign Exchange Devaluation - depreciation of a currency
Revaluation - appreciation of a currency

32. Fluctuations in the British Pound

33. Balance of Payments Current account
merchandise trade deficit or surplus
Capital account
Official reserve account - The IMF

34. Balance of Trade

35. International Monetary Fund (IMF)
Bretton Woods agreements
Loans to less-developed countries