1. The Federal Reserve: Functions & Monetary Policy Tools

2. Why You Should Care About the Fed
Fed decisions affect how much it costs banks (and you) to borrow money
The Fed's federal funds rate directly affects yields on savings accounts and CDs.
Their actions determine the interest rates for most of the variable-rate credit cards in the U.S.
The rate of your next auto loan or home mortgage will be determined in part by the Fed's interest-rate moves.
Decisions by the Fed can have a major influence on how hard or easy it is to find a job.
The Fed influences inflation.
So if you don't plan on having an auto loan, a mortgage, interest-bearing deposits, a job, a single dollar of American currency, or pretty much any financial product at all, you can safely ignore the Fed. Everyone else, though, might want to check in every once in a while.

3. Functions of the Fed
Provides banking/financial services to the federal government
Provides banking services to other banks
Regulates the banking industry
Tracks & manages the national money supply

4. Monday, December 1 Announcements Agenda
Test on the Fed & Monetary Policy this FRIDAY (more info coming today & Wednesday)
Completed Stock Portfolios are due Wednesday, December 10
Warm-up: Stock Market Project wrap-up
Presentation: Monetary Policy Tools
Assignments: Case Study, Stock Market current events & reflection

5. Monetary Policy
The actions the Fed takes to influence the real GDP and inflation

8. Money Creation Does not mean simply printing money
Banks create money by loans.
The required reserve ratio (RRR) determines how much of a deposit a bank can lend out

9. Creating Money The bank could lend out $900 of your $1000 deposit.
Now, let’s say the bank loans out the $900 to someone else, who then deposits it. That customer has a $900 balance.
The bank has increased the money supply by $900.

10. Money Multiplier
The amount of new money created by this process is given by the money multiplier formula
Increase in money supply= Initial cash deposit X 1/RRR

11. Example
If the RRR is .1, how much money will an initial deposit of $1000 lead to?

12. Reserve Requirements
Changing the RRR is the tool most used by the Fed.
Reducing reserve requirements decreases reserves for banks, allowing them to loan out more money, increases the money multiplier and leads to an increase in the money supply.

13. Reserve Requirements
Increasing the RR forces banks to hold more money.
They lend less, which causes the money supply to shrink.
This tool is not used often because it disrupts the banking system.
Banks might have to call in loans, or require the borrower to pay the entire balance immediately.

14. Discount Rate
The discount rate is the interest rate the Fed charges on loans to member banks.
Banks borrow from the Fed to maintain reserves.
Changes in the discount rate affect the cost of borrowing from the Fed, which then affects the prime rate- the rate banks give their best customers.

15. Discount Rate
Reducing the discount rate encourage banks to lend their reserves because they can borrow from the Fed to maintain them.
Increasing the discount rate reduces the money supply because banks are less willing to borrow from the Fed.
They reduce loans to keep required reserves.

16. Open Market Operations
OMO are the buying and selling of government securities to alter the money supply.
When the FOMC choose to increase the money supply, it orders the Federal Reserve Bank to purchase government securities
Government securities are bonds issued by a government authority

17. Buying Securities
The bank buys the securities with a check from the Federal Reserve funds.
When the check is deposited by the seller, new funds enter the money supply.

18. Selling Securities
If the FOMC wants to reduce the money supply, they sell the securities back to the dealers and receive checks from their own banks.
This takes money out of circulation and results in a decrease in the money supply because banks reduce loans to keep reserves.

19. Easy Money v. Tight Money Fiscal Policy v. Monetary Policy
Chapter 16, Section 4

20. Easy Money Lower interest rates encourage MORE spending.
If the economy is contracting, the Fed will follow an easy money policy, which is an increase in the money supply.
The increase will reduce interest rates and encourage spending.

21. Tight Money
If the economy is rapidly expanding, the Fed will introduce a tight money policy.
They will reduce the money supply by pushing interest rates higher.
Spending will decrease.

23. Policy Type Interest Rates Spending Money Supply Easy Money
Tight Money

24. Fiscal Policy v. Monetary Policy
Contractionary Tools
Expansionary tools
Fiscal Policy 1. 2.
Monetary Policy 3.

25. Assignments
Complete Case Study on back page of notes. Notes due Friday.
Ensure you have 4 stock market current events.
Your completed portfolio is due on December 10.

26. Major Economic Indicators
Real GDP
M2- Money Supply
Consumer Price Index (CPI)
Consumer Confidence Surveys
Current Employment Statistics
Housing Starts
S&P 500