1. The Federal Reserve In Action

2. SSEMA2 The student will explain the role and functions of the Federal Reserve System.
Describe the organization of the Federal Reserve System.
Define monetary policy.
Describe how the Federal Reserve uses the tools of monetary policy to promote price stability, full employment, and economic growth.

3. KEY MACROECONOMIC GOALS
Economic growth measured by GDP
Price Stability measured by INFLATION
Full employment measured by UNEMPLOYMENT

4. What is the Federal Reserve?
The Central bank of the United States
Established in 1913
Purpose is to ensure a stable economy for the nation
What is the Fed?
The Federal Reserve is the central bank of the United States and its purpose is to help ensure a stable economy for the nation.
Established as a result of the Federal Reserve Act, signed in 1913.
Receives no congressionally appropriated funds. Its operations are financed primarily from the interest earned on the U.S. government securities it acquires in the course of its monetary policy actions.
Another major source of income is derived from the fees received for certain services provided to depository institutions.
After payment of certain expenses, all the net earnings of the Federal Reserve Banks are transferred to the U.S. Treasury. In 2004, for example, the Fed paid approximately $18.1 billion to the U.S. Treasury.

5. The Department of Treasury is responsible for manufacturing (printing) money

6. The Federal Reserve (aka The FED) controls the MONEY SUPPLY

7. The Federal Reserve is responsible for putting and taking dollars unto or out of circulation

8. Roles & Responsibilities
Conduct the nation’s monetary policy
Supervise and regulate banking institutions
Operate a nationwide payments system
The responsibilities of the Federal Reserve System as a whole fall into the following three general areas:
Conducting the nation’s monetary policy
Supervising and regulating banking institutions
Operating a nationwide payment system.

9. Federal Reserve System Structure
Board of Governors
12 Reserve Banks
Federal Open Market Committee
The Board of Governors in Washington, D.C. oversees the activities of the twelve independently operated District Reserve Banks across the country.
Each of the 12 Federal Reserve Banks is separately incorporated with a Board of Directors. The District Federal Reserve Banks, along with their 25 branches, are located in major cities across the country, giving the System a strong grass-roots foundation.
The Federal Open Market Committee (FOMC) is the chief policymaking body of the Federal Reserve System.

10. Board of Governors Seven members Work includes:
Appointed by the president
Confirmed by the Senate
Serve staggered 14-year terms
Work includes:
Analyzing economic developments
Supervising and regulating the operations of Federal Reserve Banks
Exercising responsibility in the nation’s payments system
Seven members (governors) of the Federal Reserve Board are appointed by the President and subject to approval by the Senate.
Structure provides for public accountability in the System, but because these governors serve staggered 14-year terms, the Board is insulated somewhat from short-term political pressure. Not one president can load the Board with candidates who will further a political agenda.
The work of the Board includes:
coordinating the activities of the regional Reserve Banks,
analyzing domestic and international economic issues,
exercising broad responsibility in the nation’s payments system, and
administering laws regarding consumer credit protection.

11. Board of Governors (cont’d)
Work includes (cont’d):
Administering consumer credit protection laws
Authorizing changes in banks’ reserve requirements
Supervising Fed member banks and other financial entities
Authorizing changes in the Fed’s discount rate
Seven members (governors) of the Federal Reserve Board are appointed by the President and subject to approval by the Senate.
Structure provides for public accountability in the System, but because these governors serve staggered 14-year terms, the Board is insulated somewhat from short-term political pressure. Not one president can load the Board with candidates who will further a political agenda.
The work of the Board includes:
coordinating the activities of the regional Reserve Banks,
analyzing domestic and international economic issues,
exercising broad responsibility in the nation’s payments system, and
administering laws regarding consumer credit protection.

12. Where is my Fed?
Reserve Banks are the decentralized components that carry out the Fed’s policies and activities at the regional level.
Each bank is identified with a corresponding letter and number to identify Districts.
There are several Divisions within the Fed that carry out its mandated responsibilities: Supervision & Regulation, Financial Services and Research.

13. 12 Federal Reserve Banks:
Operate a nationwide payments system
Distribute the nation’s currency and coin
Supervise/regulate member banks/bank holding companies
Act as banker for the U.S. Treasury
Contribute to monetary policymaking through Bank presidents’ participation in the FOMC
The Supervision & Regulation Division exists to promote the safety and soundness of the banking system, foster stability in financial markets, and ensure compliance with applicable laws and regulations.
One of four federal regulatory agencies:
Office of the Comptroller of the Currency (OCC)
Federal Deposit Insurance Corporation (FDIC),
Office of Thrift Supervision (OTS)
Has oversight of bank holding companies and state-chartered banks that are members of the Federal Reserve System; examines the health of banks; analyzes proposed mergers and acquisitions of banks; and monitors banks’ management, capital levels, and quality of assets.
Plays a major role in international banking activities
overseeing U.S. banking organizations that conduct operations abroad;
authorizing the establishment of foreign bank branches in the U.S.;
establishing supervisory policy and practices regarding foreign lending of member banks.
Responsible for implementing consumer protection laws, which cover almost all financial transactions involving consumers, including ATMs, credit cards, checking and savings accounts, and loans.

14. Supervision & Regulation
Promote safety and soundness of banking system along with other regulatory bodies
FDIC, OCC, OTS, state banking regulators
Ensure compliance with laws and regulations
Oversee international banking interests
Administer consumer credit protection laws
The Supervision & Regulation Division exists to promote the safety and soundness of the banking system, foster stability in financial markets, and ensure compliance with applicable laws and regulations.
One of four federal regulatory agencies:
Office of the Comptroller of the Currency (OCC)
Federal Deposit Insurance Corporation (FDIC),
Office of Thrift Supervision (OTS)
Has oversight of bank holding companies and state-chartered banks that are members of the Federal Reserve System; examines the health of banks; analyzes proposed mergers and acquisitions of banks; and monitors banks’ management, capital levels, and quality of assets.
Plays a major role in international banking activities
overseeing U.S. banking organizations that conduct operations abroad;
authorizing the establishment of foreign bank branches in the U.S.;
establishing supervisory policy and practices regarding foreign lending of member banks.
Responsible for implementing consumer protection laws, which cover almost all financial transactions involving consumers, including ATMs, credit cards, checking and savings accounts, and loans.

15. Financial Services Supply currency and coin to banking institutions
Clear more than one-third of nation’s checks
Transfer funds electronically (ACH, Fedwire)
Serve as bank for the U.S. Treasury
The Financial Services Division is the operational area of the Bank.
Responsible for supplying currency and coin to financial institutions. The Fed orders new currency from the Bureau of Engraving & Printing, and coin from the U.S. Mint, and is responsible for destroying unfit currency.
As a provider of check clearing services, the Fed processes about 1/3 of all of the checks written in the U.S.
The Automated Clearinghouse (or ACH) is an electronic form of payments processing, which you may be familiar with if you work and get your pay deposited directly into your account.
Another example of electronic payments processing is FedWire, which is utilized primarily by financial institutions to transfer very large sums of money electronically.
The Fed acts as the fiscal agent (bank) for the United States Treasury.

16. Research Gather, analyze and disseminate economic data
Focus on all aspects of the economy (regional to international levels)
Analyze regional and national markets and economic data
Design and test econometric models used to produce hard data that factor into policymaking decisions
The Research Division is comprised of economists at the Reserve Banks and the Board of Governors. The primary responsibility of the research economists is to prepare the Reserve Bank presidents for his or her participation in FOMC meetings.
Members of the research staff gather, analyze and disseminate information about the economy.
Focus on every aspect of the economy, from the regional level to the international level, and studies range from analyzing regional banking markets to designing and testing econometric forecasting models to predict the outcome of various economic scenarios.
The economists are looking for key pieces of information that will contribute to better monetary policymaking.

17. Monetary Policy
Policy changes affect the nation’s supply of money and credit.
Actions have real short- and long-term effects on the economy.
What is monetary policy?
The Fed manages the nation’s money supply to keep inflation low and the economy growing at a sustainable rate.
The actions that the Fed takes today influence the economy and the inflation rate for some time to come. Consequently, policymakers must be forward-looking and must take pre-emptive action to head off inflation before it gathers momentum

18. Federal Open Market Committee
Sets and directs U.S. monetary policy
Seven governors
Five presidents (New York and four others on a rotating basis)
Nonvoting presidents participate fully
Final interest rate decision is made by the 12-member Federal Open Market Committee (FOMC)
The Federal Open Market Committee (FOMC) is the primary group responsible for formulating and implementing monetary policy.
Seven Fed governors and the twelve Bank Presidents participate in the economic discussions at each meeting, with the Reserve Bank Presidents bringing to the table regional economic news gleaned from their local boards of directors and staff economists.
Every president and each of the governors are given an opportunity to present their opinions.
Twelve of the 19 members vote at the meetings—all seven governors and five of the Reserve Bank Presidents, with the president of the New York Fed always a voting member, because Open Market Operations are carried out at the trading desk of the New York Fed. The other four voting positions rotate yearly among the remaining eleven Reserve Bank presidents.
Policy changes are decided by consensus and are announced immediately following each meeting.

19. Goals of Monetary Policy
Stable Prices
Sustainable Economic Growth
Full
Employment
Monetary policy is designed to effectively promote the goals of maximum employment, stable prices, and sustainable economic growth.
The Fed is consistently striving for a balance between oftentimes conflicting goals of monetary policy
For example, if the economy is growing at too rapid a pace, the Fed may dampen that growth by influencing interest rates to rise, which may have the effect of putting some people out of work—a direct challenge to the goal of maximum employment.

20. Key Tools of Monetary Policy
Discount Rate
The interest rate charged by the Federal Reserve to banks that borrow on a short-term (usually overnight) basis
Reserve Requirement
The amount of money banks must keep on reserve at the Fed
Open Market Operations
Buying and selling Treasury securities between the Fed and selected financial institutions in the open market
Most important tool; directed by the FOMC – least disruptive to the banking system
The tools the Fed utilizes to influence the economy (or affect the amount of funds in the banking system) are:
Discount Rate:
Rate of interest charged to banks that need to borrow from the Fed to cover temporary deposit drains (short-term “discount window” loans).
Reserve Requirements:
Portions of deposits that banks must hold in reserve, either in their vaults or on deposit at a Reserve bank.
Federal Open Market Operations:
The most frequently used and most flexible tool is that of Open Market Operations, which involves the buying and selling of U.S. government securities. This tool is directed by the FOMC and carried out at the domestic trading desk at the Federal Reserve Bank of New York

21. Key Federal Reserve Interest Rates
Federal Funds Rate
market-based interest rate which banks charge each other on overnight loans of their reserve balances held at the Fed.
The Fed achieves this rate through Open Market Operations.
A target rate
Discount Rate
Interest rate on short-term loans made directly to commercial banks from the Federal Reserve System.
Typically set at 1 percentage point above the Federal Funds Rate.
Discount Rate
Applies to loans made directly to commercial banks from the Federal Reserve System
Typically set at one percentage point above the Federal Funds Rate – incentive not to borrow from the Lender of Last Resort
Federal Funds Rate
The lowest of short-term market interest rates which banks charge each other on overnight loans. The Fed achieves this rate through Open Market Operations.

22. Monetary Policy at the Grassroots
Each head office and branch of the Federal Reserve System has a local Board of Directors.
7–9 individuals
Board members provide various perspectives and economic data from different regions and industries.
Boards of directors vote on the discount rate.
Boards of directors influence policymaking at the national level through “real-world” input.
The Federal Reserve Bank Boards of Directors have 9 members, and each Branch’s Board consists of 7 members.
Directors are chosen because of their contributions as a member of their industry and because they provide a diverse economic and cultural picture of the region.
Various sectors of business are represented such as agriculture, commerce, labor, and banking.
Directors also make a recommendation on the Discount (the rate that the Fed charges banks that borrow money to cover individual bank reserves).
The minutes of the meeting and their votes are sent to the Bank’s president and is combined with key economic information collected by the District economists for the Federal Open Market committee meeting.
Directors provide grassroots intelligence for policy decisions made at the national level.

23. Monetary policy alters the supply of money

24. The supply of money affects interest rates

25. The money supply affects interest rates Too much money rates are low…Too little and rates are high Remember supply and demand?

26. Interest rates affect the level of investment and spending in the economy

27. Effects of Low Interest Rates
Generally, low interest rates stimulate the economy because there is more money available to lend.
Consumers buy cars and houses.
Businesses expand, buy equipment, etc.
Why does the Fed lower interest rates?
If inflation is in check, lower rates stimulate economic activity, thus boosting economic growth.
Impact of Lowering Rates:
The cost of borrowing money goes down.
Induced consumer spending increases economic activity.
Low interest rates cut the cost of capital for businesses and improve profit margins and encourages expansion.

28. Effects of High Interest Rates
The Fed raises interest rates as an effective way to fight inflation.
Inflation—a sustained rise in the general price level; that is, all prices are rising together.
Consumers pay more to borrow money which discourages spending and slows the economy.
Businesses have difficulty borrowing; unemployment rises.
The Fed generally raises rates as an effective way to quell inflation (a sustained rise in the general price level).
Inflation means that your money is worth less
Impact of Raising Rates:
Businesses have difficulty in obtaining loans for expansion; unemployment rises
Consumers will pay higher interest rates on credit cards and mortgages, which can cool spending.

29. YOUR GUIDED NOTES STOP HERE. You need to take notes on separate paper.

30. MONETARY POLICY
The FED can influence the economy by controlling the nation’s money supply

31. Is the problem unemployment, or is the problem inflation???

32. Expand?
Contract?

33. Easy Money Policy Purpose is to Speed up the economy Used in periods of contraction and recession

34. Easy money policy Monetary policy that increases the money supply

35. The Fed may follow an easy money policy when the macroeconomy is experiencing a contraction

36. Increase the money supply:
Decrease the Required Reserve Ratio (RRR)
Decrease the Discount Rate
Buy Back Federal Securities on the Open Market

37. Tight Money Policy purpose is to slow the economy Used in period of expansion and inflation

38. Tight money policy Monetary policy that reduces the money supply

39. The Fed may follow a tight money policy when the macroeconomy is experiencing TOO rapid rate of growth

40. Decrease the money supply:
Increase the Required Reserve Ratio – RRR
Increase the Discount Rate
Sell federal Securities on the Open Market

41. Three tools the Fed uses to adjust the money supply
Reserve requirement
Discount Rate
Open Market Operations

43. Reserve requirements

44. Reserve Requirement
Banks must keep a certain percentage of their deposits on “reserve”
That money cannot be loaned out
“Required reserve”

45. Reserve requirement
Formula used to compute the amount of reserves an institution must have
Set by the Fed
To ensure that banks have enough funds to meet customers’ withdrawal needs

46. Legal reserves
Coins, currency, and deposits used to fulfill the Fed’s reserve requirement
Vault cash

47. Excess reserves
Bank money available for loans
Lending ability depends on excess reserves

48. The more money in excess reserves…the more banks can loan out
The more money in excess reserves…the more banks can loan out. If the Fed lowers the reserve requirement…banks have more excess reserves and can loan more out.

49. When a bank loans more out…the money supply increases

50. HIGH MONEY SUPPLY = LOW INTEREST RATES
which means Money is cheap….. Businesses and People borrow more
People may buy a new house or car
Businesses may expand

51. Creates jobs
Encourages consumer spending
Helps the economy to grow
Speed up the economy and lower unemployment
Remember C+I+G+(X-M)?

52. If the Fed increases the reserve requirement… banks have less excess reserves and can loan less out. The money supply decreases

53. SMALL $ SUPPLY = HIGH INTEREST RATES Used to slow down the economy – slow down inflation

54. Changing the reserve requirement is Simplest way to adjust money supply BUT The Fed rarely changes the reserve requirement It can be disruptive to the whole banking system

55. Reserve requirements,the discount rate,and open market operations
3 TOOLS
Reserve requirements,the discount rate,and open market operations

56. The discount rate
The interest rate that the Fed charges on loans to banks
If the Fed lowers the discount rate, banks pay less to borrow so they will borrow money from the Fed
Banks will have more excess reserves and will loan that money out
Money supply goes up

57. DISCOUNT
RATE
SUPPLY
MONEY

58. If the Fed raises the discount rate…
It will cost more for banks to borrow so they are less likely to borrow from the Fed.
Banks must meet Reserve Requirement.
So, banks have fewer reserves to loan. Money Supply decreases and the economy slows down.

59. DISCOUNT
RATE
SUPPLY
MONEY

60. Reserve requirement,the discount rate, and open market operations
3 TOOLS
Reserve requirement,the discount rate, and open market operations

61. OPEN MARKET OPERATIONS
Refers to the buying and selling of government securities by the Fed
Most often used tool by the Fed because easy to implement/not disruptive to the banking system.

62. The Federal Open Market Committee (FOMC)
Looks at the state of the economy
Decides what to do with the money supply

64. Includes all of the following:
Government securities
Savings bonds
Treasury bonds
Treasury notes
Treasury bills

65. If the Fed PURCHASES securities, it is giving people money…
Money Supply goes up
People have money to spend.
Stimulates the economy

66. BUYS
GOVERNMENT
SECURITIES
SUPPLY
MONEY

67. If the Fed SELLS securities, it is taking money from people…
Takes money out of circulation .
Money Supply decreases.
People have less to spend.
Economy slows down.

68. SELLS
GOVERNMENT
SECURITIES
SUPPLY
MONEY

69. MONETARY POLICY RESERVE REQUIREMENT DISCOUNT RATE
EASY
TIGHT
RESERVE REQUIREMENT
DISCOUNT RATE
OPEN MARKET OPERATIONS
BUY
SELL

71. Review What are the three main roles of the Federal Reserve System?
Where is your Fed?
What are the goals of monetary policy?
What happens when the Fed lowers interest rates? Raises interest rates?
What is inflation? Why should it concern you?
What is the name of the Fed’s monetary policymaking body?
What is the discount rate? Federal funds rate?
What is the difference between easy and tight monetary policy? When is each used?
Explain the 3 tools that the Fed uses to affect the economy.
Answers:
Conducting the nation’s monetary policy, Supervising and regulating banking institutions, and operating a nationwide payment system.
Results will vary
Maximum employment, price stability, sustainable economic growth
Lower rates induce economic activity; higher rates calm inflation, slows down spending
Inflation is a sustained increase in the general price level; inflation is a concern because it means your money is worth less over time.
The Federal Open Market Committee (FOMC)
Discount Rate – the rate of interest charged to banks who borrow money from the Federal Reserve; Fed Funds Rate – the rate of interest banks charge each other to borrow money.