1. The Federal Reserve and Monetary Policy
Chapter 15

3. The Federal Reserve System:Topics
Structure and Functions
Monetary Policy (The Fed Knows Best)
Tools of Monetary Policy
Money Creation (Money Grows on T’s)
[see Ch 15, Fed, Money and Policy powerpoint]
Gov’t Debt
The Fed
Money
Financial Markets

4. The Federal Reserve System
Board of Governors (7)
Federal
Open Market
Committee
B of G (7) + BP (5)
Bank Presidents (5)
(always FRBNY)
12 FEDERAL RESERVE BANK PRESIDENTS A B C D E F G H I J K L

5. Functions of the Fed 1. Control the money supply (M1)
2. Regulate and Supervise banks
3. Process checks/Transfer funds (p. 331,14.3)
4. Banker for federal government (Treasury Dep’t)
5. Lender of last resort

6. The Fed Knows Best

7. 2 x 3 = 6.5
The Fed’s Mandate
To achieve sustainable economic growth with full employment and stable prices.
Goals of Fed Policy
1. Inflation (Target) of 2 %
2. Economic growth of 3 %
3.Unemployment Rate (Target) of 6.5 %
(2013 strategy to unwind its easy money policy)

8. The Fed Knows Best Tools of Monetary Policy (pp. 350- 354)
1. Reserve Requirement
Reserve assets of member banks
2008; Fed pays interest on bank reserves
2. Discount Rate
Loans to member banks
3. Open Market Operations
The Fed Funds Rate (Buy/sell T-Bills)
4. Term Auction Facility (since 12/07)
Short-term loans to member banks

9. The Fed Knows Best Traditional Tools Non-Traditional Tools
Reserve Requirement
Discount Rate
Open Market Operations (buy/sell T-Bills)
Non-Traditional Tools
Term Auction Facility
Fed pays interest on Commercial Bank Reserves
QE, QE 2, QE 3 (Fed buys long-term T-bonds, etc)

10. The Fed Knows Best Expansionary Policy Contractionary Policy
Easy Money…WHY?
lower lower buys
rr DR T-
Bills
Tight Money…WHY?
raises raises sells
rr DR T-
Bills
The Fed
The Fed
Increases Bank Reserves
Decreases Bank Reserves

11. The Fed Knows Best Easy Money Policy Tight Money Policy
Larger Money Supply
And
Lower Interest Rates
Smaller Money Supply
And Higher Interest Rates
More Investment Spending
And Increased AD
Less Investment Spending
And Decreased AD

12. The Fed Knows Best Easy Money Policy Tight Money Policy
Higher Employment
And Output
Lower Employment
And Output
Lower Prices… lead to deflation?
Higher Prices… lead to inflation?

13. Fed Policy Theory For the following Scenario 1
Where is the economy on the business cycle?
What should the Fed do?
Options:
Tight money or easy money policy?
Policy Tools
Reserve Requirement?
Discount Rate?
Open-market Operations?

14. Scenario 1 INDICATOR 1ST QUARTER 2ND QUARTER REAL GDP -1 .7% -1.0 %
CPI
0.5 %
1.6% UR
8.5 %
8.1 %

15. Fed Policy Theory For the following Scenario 2
Where is the economy on the business cycle?
What should the Fed do?
Options:
Tight money or easy money policy?
Policy Tools
Reserve Requirement?
Discount Rate?
Open-market Operations?

16. Scenario 2 INDICATOR 3RD QUARTER 4TH QUARTER REAL GDP 6.7% 7.0 % CPI
5.5 %
7.6% UR
4.5 %
3.9 %

17. Interest - ed. On loans…not savings!
To promote spending, output, higher GDP
Interest Rate sensitive spending
Consumers (PCE)
Credit Cards (short-term)
Durable Goods, Autos (medium term)
Home mortgages (long term)
Business Investment
Inventories
Equipment & Software
Structures

18. Most Powerful People?

19. Freedonia! Freedonia!
Long Live Freedonia!!

20. Background
Freedonia’s business cycle is similar to that of the United States’ economy
Factors of Freedonia’s economic growth:
Consumer Spending (PCE) = 70% of GDP
Business Investment (I) = 10%
Government Spending (G) = 18%
Net Exports (Xn = x-i) = usually negative

21. Goals for Growth
Freedonia Central Bank strives to meet these goals for a strong economy (as measured by):
Stable Prices, (Inflation, CPI of < 2%)
Full employment, (+/- 96%, UR of 6%)
Economic Growth (Real GDP of 3%)

22. Monetary Policy You have tried the Fiscal Policy solution,
Now try the Monetary Policy Prescription.
Yes. . . Here it is. . . It is time for. . .

24. Here is your Monetary Policy Problem . . .
Freedonia! Freedonia!
Here is your Monetary Policy Problem . . .

25. Hard Times for Freedonia
INDICATOR
1ST QUARTER
2ND QUARTER
Real GDP
1.9 %
2.1 %
CPI
11.3 %
15.9 %
Unemployment Rate
3.5 %
4.3 %

26. Homework (50 pts) for 4/30/13
1. Where is the economy on the business cycle? Explain. 2. What should the Fed do? (A) Its best option? Why? (B) Which tool (s) should the Fed use? Why? 3. How will your policy affect (A) Prices? (B) Interest rates ? 4. Draw and label an Aggregate Demand and Aggregate Supply diagram. Show Freedonia in recession and the effect of your policy. [Hint! See Ch. 15 for more details] 5. How will this affect Freedonia’s economy (Y,Q,E)?