1. The Federal Reserve and Monetary Policy

2. What is the Federal Reserve
The Federal Reserve is the central bank of the United States
Independent of the US government
Political independence
Oversees the banking system and is responsible for the amount of money and credit in the economy.
Known as “The Fed”

3. Why the Fed was created Created 1913 by the Federal Reserve Act
1935, reforms created the Fed as we know it today
Consumers and businesses needed access to increased sources of funds to encourage business expansion
Banks need a source of emergency cash to prevent panic

4. Structure of the Federal Reserve
Fed is owned by member banks
Overseen by Board of Governors
7 members appointed by the President for 14-year staggered terms (Senate consent)
President Also appoints the Chair
Can not be reappointed
US divided into 12 districts
One Federal Reserve Bank in each district
9 directors each
3 bankers, 3 industry leaders, 3 appointed by Fed
Janet Yellen
Chairman of Board of Governors of Federal Reserve System

6. 12 Districts

7. Federal Open Market Committee
Makes key decisions about interest rates and growth of US money supply
Committee members
All 7 Board of Governors members
Majority, control actions
5 of the 12 district bank presidents
President of NY FRB is permanent member
Others 4 serve one year rotating terms

8. Functions of the Fed
Provides banking and fiscal services to the federal government
Provides banking services to member and nonmember banks
Regulates the banking industry
Tracks and manages the national money supply to meet current demand and to stabilize the economy

9. Serving Banks The Federal Reserve monitors bank reserves
Banks lend to each other on a day-to-day basis, but banks can also borrow from the Fed
Last Resort
Unites States operates as a fractional reserve banking system
Banks hold in reserve only a fraction of their funds- enough to meet customers’ daily needs
Lend remaining reserves, charging interest
Fed uses reserves to control how much money is in circulation
Too much money in the economy can lead to a rise in prices

10. Money Creation
Money creation  process by which money enters into circulation
Every dollar added, creates a change of more than one dollar in the economy
Banks make money by charging interest on loans
Amount banks are allowed to lend is determined by Required Reserved Ratio (RRR)
Must keep a minimum reserve (10%)
Ex. You receive $1000 loan from bank to buy a car.
The person you pay puts the $1000 in the bank.
Bank loans $900 of the $1000 to someone else
Their bank loans $810 of the $900
Money supply is now $2,710

11. Money Multiplier Formula
To find Increase in money supply:
Initial cash deposit / RRR
Ex. Deposit of $1,000  $1,000/10%  $1,000/.1 = $10,000
A $1,000 deposit will increase the money supply by $10,000

13. Three Tools Monetary Policy tools Reserve Requirements Discount Rate
Open Market Operations

14. Reserve Requirements Change the minimum amount that banks must keep
Rarely used, not used today
Lowering the RRR would allow banks to loan more money
More money into the economy
Increasing the RRR would force banks to increase reserves
Force banks call in loans
Make borrowers pay balance of loans
Less money in the economy

15. Discount Rates
Discount Rate  interest rate that the Federal Reserve charges on loans to banks
Not used often
Banks borrow from the Fed to maintain RRR
Changes the cost of borrowing from the FED
Can affect interest rates to large companies
Reducing the discount rate will encourage banks to lend more of their reserves and add to reserves by borrowing from the Fed at a low rate
New loans will increase money supply
Increasing the discount rate will lead banks to be less likely to borrow from the fed  hold more reserves  reduce loans  decrease money supply

16. Open Market Operations
Open Market Operations  buying and selling of governments securities to alter the supply of money
Most important, most used
Fed buys securities with a check from the Fed funds
Enters the banking system, leading to money creation
To decrease money supply, Fed sells bonds back

17. Monetary Policy
Monetary policy affects supply of money  affects interest rates  affect investment and spending and aggregate demand  affects Real GDP
Cost of money  price that you pay to borrow money (interest rate)
Lower cost of money  greater investment
Easy Money increases money supply
Tight Money reduces money supply

18. Timing Could make business cycle worse if not timed correctly
Takes time to enact policies
Takes time to recognize problems or recovery
Interventionists  encourage action
Could make cycle worse if cycle fixes itself quickly
Laissez-faire Economists  economy will self-adjust quickly (no policies)