1. The Federal Reserve and Monetary Policy
Introduction to Economics
Johnstown High School
Mr. Cox

2. The Federal Reserve The “Fed”
Central bank of the United States, 12 Reserve Banks
Established in 1913
Fed and FDIC (Federal Deposit Insurance Corporation) were formed to reduce economic panics, and to lessen severity of economic cycle
Ensure a stable economy
Money Supply
No longer based on gold standard, just confidence of American people
Controlling money supply helps to control inflation

4. Board of Governors Seven members Work includes:
Appointed by the president
Confirmed by the Senate
Serve staggered 14-year terms
Run by Chairwoman Janet Yellen
Work includes:
Analyzing economic developments
Supervising and regulating the operations of Federal Reserve Banks
Exercising responsibility in the nation’s payments system
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.

5. Sustainable Economic Growth
Stable Prices
Sustainable Economic Growth
Full
Employment
Monetary Policy
Monetary policy: the Federal Reserve’s power to regulate the money supply and interest rates
The Federal Reserve uses monetary policy by managing the money supply and interest rates
Easy-money policy
Expansionary policy that speeds the growth of the money supply to prevent recession (decline in the GDP)
Tight-money policy
Contractionary policy that slows the growth of the money supply to prevent inflation
*Most common tool of Federal Reserve is open-market operations (buying and selling of government securities).

6. Fed Tools Open Market Tools – most used
Buying and selling of government “securities” in the bond market
Treasury bonds, notes, bills, or other government bonds (guaranteed by US gov. and tax exempt)
Recommendation by FOMC (Federal Open Market Committee), component of the Fed
Final interest rate decisions

7. Other Tools of the Fed The Reserve Requirement The Prime Rate:
Reserve requirement for banks to keep at the Fed –”required reserve ratio”
Minimum percent of deposit keep in reserve at all times
Lowering the ratio allows for more loans and thus more money in circulation vs. raising, which tightens money supply
Average reserve requirement, 3-10%
The Prime Rate:
Interest rate that banks charge their most credit-worthy customers
The prime rate is also important for retail customers, as the prime rate directly affects the lending rates which are available for mortgage, small business and personal loans.

8. 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.

9. 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. (Dollar is worth less)
Impacts
Consumers pay more to borrow money, dampening spending.
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.

10. Largest Concern: The National Debt
John Maynard Keynes = Deficit Spending
Emergencies only
Fear of Government Bankruptcy
Increase taxes, refinance debt
Sell new bonds to pay off old bonds
Burden on Future Generations
Individuals and Institutions pay interest
Holders of government bonds benefit
Foreign-owned Debt
Japan and China
Interest paid to foreign countries but they buy US goods with it
Offset by Americans buying foreign bonds
Crowding-out Effect
Crowding private borrowers out of the lending market
Interest rate so high, no one can afford a loan
Government borrowing raises interest rates but spend the money on creating jobs