1. The Toolbox of the Federal Reserve
Mr. Mizak
Economics

2. Review
The Federal Reserve’s Purpose: Maintain financial stability through monetary policy
How does the Fed control monetary policy?
Through the use of multiple tools
There is no magic wand that creates desired outcome

3. Tool # 1- Change the Reserve Requirement
The Fed has the ability to change the reserve requirements for member banks.
The lower the reserve requirement, the more money that is available to loan.
The reverse is true as well
Very small changes in the RR can have drastic effects
Because of the drastic impact this tool is not often used

4. Tool # 2- Changing the Discount Rate
When banks need money they have two options
1) Borrow from the FED
The FED charges an interest rate known as the discount rate
Low discount rate= more money borrowed= more money in circulation
Reverse is true as well

5. Tool # 3- Changing the Federal Funds Rate
When banks don’t borrow from the Fed, they borrow from other banks
Charged an interest rate known as the Federal Funds Rate
This rate is often lower than the discount rate
The Federal Funds Rate is the rate that is most often changed
Low FFR = more money borrowed = more money in circulation

6. Current Data This Week Month Ago Year Ago WSJ Prime Rate 3.25
Federal Discount Rate
0.75
0.50
Fed Funds Rate
0.25
11th District Cost of Funds
1.786
1.828
2.455

7. FFR- Historical Year FFR 2007 5.02 2002 1.67 1981 16.39 1961 1.95
Source:

8. Tool # 4- Open- Market Operations
The Fed can buy and sell government securities (Treasury bills, notes, and bonds)
When the Fed purchases gov. securities, it deposits money into the selling bank.
This deposit increases the bank’s reserves
Bank can lend more money
When the Fed sells gov. securities, it withdrawals money from the purchasing bank
This withdrawals decreases the bank’s reserves
Bank can lend less money

9. Problems of Monetary Policy
No perfect solution
Despite availability of information, the Fed’s actions do not always have desired effect
The Fed has made bad economic situations worse
Has the Fed prevented more damage than it has caused?