1. Government Policy: Monetary & Fiscal Policy
Adapted from James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts University ©2005 Thomson Business & Professional Publishing, A Division of Thomson Learning

3. Monetary Policy - Policy that involves changing the rate of growth of the money supply in circulation in order to affect the cost and availability of credit.
Fiscal Policy - Using taxes and spending to help the economy grow.

8. The Federal Reserve System: Definitions
Federal Reserve System: the central bank of the United States
Board of Governors: the governing body of the Fed
Federal Open Market Committee (FOMC): the 12 member policymaking group within the Fed. It has the authority to conduct open market operations

9. The Federal Reserve System: Definitions
Open Market Operations: the buying and selling of government securities (bonds) by the Fed
Monetary Policy: changes in the money supply, or in the rate of change of the money supply, to achieve particular macroeconomic goals

10. Federal Reserve Districts and Federal Reserve Bank Locations

11. Structure of the Federal Reserve
Each of the 12 districts has one main branch, other branches. Allocation of regional banks reflects conditions around 1913.
NY, Chicago, and SF are the 3 largest district banks in terms of assets. (50%)
FRBs are quasi-public, technically owned by member banks. (just technically).
9 directors (6 elected by Banks, 3 by BOG); 3 A directors are professional bankers; 3 B directors are leaders from industry, labor agriculture; 3 C directors are appointed by BOG as public reps.
What is the function of the regional reserve banks?
Functions:
Payments: clear checks, issue new currency, withdraw damaged currency,
BS&R: evaluate bank consolidation, make discount loans, BS&R,
Monetary Policy: collect data on local business conditions, conduct economic research.
Monetary Policy: decide who gets discount loans, select banker for Federal Advisory Council, serve on the FOMC, votes on policy rotate through 4/11 banks and NY.
Special role of FRB NY: 1) Contains the largest banks for BS&R; 2) Conducts OMO and FX operations, (ensures smooth functioning of financial markets); 3) Only FRB to be a member of BIS. (close contact with foreign central bankers); 4) NY President is only permanent member of the FOMC.
Political genius to stress regional representation over HQ in NY or DC.
National banks are required to be members of the Federal Reserve System. State banks are not required to be members. 1/3 of banks are members, down from 1/2 in Banks used to leave Fed system b/c they were required to keep deposits there. This hurt the conduct of monetary policy. Depository Institutions Deregulation and Monetary Control Act of 1980 required all banks to keep same required reserves with the Fed. All banks given discount window privileges.
F. Mishkin, THE ECONOMICS OF MONEY AND THE ECONOMIC POLICY REVIEW. (c) 1998 Frederic S. Mishkin. Reproduced by Addison Wesley Longman. All rights reserved.

12. The Board of Governors of The Federal Reserve
Coordinates and controls the activities of the Federal Reserve System
7 Members
14 Year Terms
Appointed by the President with Senate approval
A governor is appointed every other year
President designates one member as President for a 4 year term

13. The Federal Open Market Committee of the Federal Reserve
The major policy making group within the Fed is the Federal Open Market Committee
Authority to Conduct Open Market Operations (Buying and Selling of Federal Securities)
12 Members
7 Board of Governors
5 District Bank Presidents (including New York)

14. Functions of the Federal Reserve System
Control the Money Supply
Supply the economy with paper money
Provide check-clearing services
Hold depository institutions’ reserves

15. Functions of The Federal Reserve System
Supervise Member Banks
Serve as the government’s banker
Serve as the lender of last resort
Serve as a fiscal agent for the Treasury

17. The Check-Clearing Process

18. Fed Tools For Controlling the Money Supply: Open Market Operations
Open Market Operations: Buying and Selling U.S. Government Securities in the Financial Markets
U.S. Securities: bonds and bond-like securities issued by the U.S. Treasury
Open Market Purchase: The buying of government securities by the Fed
Open Market Sale: The selling of government securities by the Fed

19. Open Market Purchases Assume Fed purchases securities from a bank.
The Fed receives the securities from a bank, and the bank’s reserves increase by the amount of the purchase (Reserves = Bank deposits at the Fed + Vault Cash).
When the banks have a reserve increase and no other bank has a similar decline, the money supply expands through a process of increased loans and checkable deposits.

20. Open Market Sales Assume the Fed sells securities to a bank.
To pay for the securities, the Fed takes reserves from the bank.
Because of the decrease in the bank’s reserves, the bank reduces total loans outstanding, which reduces the total volume of checkable deposits and the money supply.

21. Open Market Operations

22. The Required-Reserve Ratio
The Fed can also influence the money supply by changing the required-reserve ratio.
An increase in the required-reserve ratio leads to a decrease in the money supply
A decrease in the required-reserve ratio leads to an increase in the money supply.

23. The Discount Rate
A bank can borrow from the federal funds market or from the Fed.
Federal Funds Rate: The interest rate a bank pays for a loan in the federal funds market.
Discount Rate: The interest rate a bank pays for a loan from the Fed.
When a bank borrows money from the Fed, the money supply increases because its reserves increase while the reserves of no other bank decrease.

24. The Spread Between the Discount Rate and the Federal Funds Rate
Banks may believe that the Fed is hesitant to extend loans to take advantage of profit- making opportunities.
The bank may not want to deal with the Fed bureaucracy that regulates it.
The bank realizes that acquiring a loan from the Fed is a privilege and not a right, and doesn’t want to abuse the privilege.

25. Discount Rate Vs. Federal Funds Rate
If the discount rate is significantly lower than the federal funds rate, most banks will borrow from the Fed.
An increase in the discount rate relative to the federal funds rate reduces bank borrowings from the Fed.

26. Which Tool Does the Fed Prefer to Use?
Tools which can be used to influence the money supply:
open market operations
the required-reserve ratio
the discount rate
The Fed prefers Open Market Operations
Open market operations are flexible
Open market operations can be reversed
Open market operations can be implemented quickly

27. Fed Monetary Tools & Their Effects on the Money Supply