1. The Federal Reserve and Monetary Policy
Chapter 16

2. The Federal Reserve System
Chapter 16, Section 1

3. Federal Reserve Act of 1913 Created the Federal Reserve (FED)
System of federal banks
12 districts
Overseen by the Board of Governors
7 governors
14 year terms appointed by the President
Appoints a chair confirmed by the Senate
Chairs serve a four year term that can be renewed

4. FED Districts 12 districts
District bank reports on economic activity in the district to the central bank
Member banks... All nationally chartered banks are required to join the Fed. Member banks contribute funds to join the system, and receive stock in and dividends from the system in return. This ownership of the system by banks, not government, gives the Fed a high degree of political independence.
The FOMC (Federal Open Market Committee), which consists of The Board of Governors and 5 of the 12 district bank presidents, makes key decisions about interest rates and the growth of the United States money supply.

5. Structure of the Federal Reserve System
12 District Reserve Banks
Federal Open Market Committee
4,000 member banks and 25,000 other depository institutions
Board of Governors

6. Federal Reserve Functions
Chapter 16, Section 2

7. Functions of the FED Banking and fiscal services to the government
Banking and fiscal services to member and nonmember banks
Regulates the banking industry
Tracks and manages the money supply

8. Serving the Government
Acts as the Government’s bank
Maintains a checking account for the treasury
Sells securities
Issues currency
Coins are created at the US Mint
Currency is created by the Bureau of Engraving and Printing
The FED issues the currency

9. Serving Banks Check clearing Loans to member banks
Stock to member banks
Supervise lending practices
Lender of last resort
Banks loan money to each other and charge interest known as the Federal Funds Rate
The FED can lend funds to banks in times of need and charge interest
This is called the discount rate

10. Regulating the Banking System
The FED requires banks to report on their reserves
Examine banks to ensure they are following regulations
Examiners look at the banks Net Worth to determine if they are in trouble
Net Worth represents total assets minus total liabilities

11. Regulating the Money Supply
FED is best known for regulating the money supply
Factors that affect demand for money
Cash needed on hand
Interest rates
Price levels in the economy
General level of income
The laws of supply and demand work the same with the money supply

12. Monetary Policy Tools
Chapter 16, Section 3

13. Monetary Policy
Monetary policy refers to the action the FED takes to influence economic performance
The FED can use monetary policy in a number of ways
Money creation...not making it but putting it into circulation
Changing reserve requirements
Changing the discount (interest) rates
Purchasing bonds

14. Money Creation Banks keep a certain amount of funds on hand
The required reserve ratio (RRR) is the amount that must be kept by banks...this is established by the FED
After the RRR is kept, banks can loan money. This process, along with gained interest creates money...or adds it to the money supply
The money multiplier formula tells us how much money will be created through this process
However, banks may keep excess reserves on hand
More money than is required by the RRR

15. Reserve Requirements
The FED can influence the economy by changing the RRR
Raising the RRR will reduce the money in circulation
Lowering it will increase the money in circulation
FED does not do this today as it can be very disruptive to the loan process
Loans may have to be recalled

16. The Discount Rate
Banks borrow from the FED and the interest charged is known as the discount rate.
In turn, these banks loan to customers (you and me) and the interest rate charged is known as the prime rate.
By changing the discount rate, the prime rate changes and affects our spending behaviors
Raising the discount rate will slow borrowing, spending and the economy
Lowering the discount rate will increase borrowing, spending, and increase the economy
2nd most used form of Monetary Policy

17. Open Market Operations
The most used monetary tool is open market operations
The FED can purchase bonds to put money into circulation
They sell government bonds to take money out of circulation

18. Review 1. The required reserve ratio is
(a) the ratio of deposits to reserves required of banks by the Federal Reserve.
(b) the ratio of accounts to customers required of banks by the Federal Reserve .
(c) the ratio of reserves to deposits required of banks by the Federal Reserve.
(d) the ratio of paper currency to coins required of banks by the Federal Reserve.
2. All of the following will increase the money supply except
(a) increasing the required reserve ratio.
(b) bond purchases by the Fed.
(c) reducing the required reserve ratio.
(d) reducing the discount rate.

19. Monetary Policy and Macroeconomic Stabilization
Chapter 16, Section 4

20. Using Monetary Policy
Monetarism...the belief that the money supply is the most important factor in macroeconomic performance
Money supply and interest rates
In basic terms, the interest rate is the cost of money
Works under the principles of supply and demand
When money supply is high, interest rates are low
When money supply is low, interest rates are high

21. Easy Money vs. Tight Money Policy
When money is in low supply, the FED may follow an easy money policy...or follow policy that will increase the money supply
When money is in high supply, the FED will try to lower the money supply or use tight money policy

22. Timing of Monetary Policy
Policies of Monetary Policy need to be carefully enacted to have the desired effect...if they are not time accordingly, they may have a negative effect on the business cycle
Like with Fiscal Policy, Monetary Policy takes time to put in place and take effect...lags
Inside lag... Delay in implementing monetary policy
The government takes time to recognize the problem and create a solution
Outside lag...the time it takes for the policy to have an effect
Predictions of the business cycle is key in this process

23. Fiscal and Monetary Policy Tools
Fiscal policy tools
Monetary policy tools
Open market operations: bond purchases
Decreasing the discount rate
Decreasing reserve requirements
Increase government spending
Cutting taxes
Expansionary Tools
Open market sales: bond sales
Increasing the discount rate
Increasing reserve requirements
Decrease government spending
Raising taxes
Contractionary Tools

24. Remember
Fiscal Policy is how the government uses its taxing and spending to influence the economy
Monetary Policy is how the FED uses its control of the money supply to influence the economy

25. Review 1. Monetarism is 2. Tight money policies aim to
(a) the time it takes to enact monetary policy.
(b) the belief that the money supply means little to macroeconomic performance.
(c) the time it takes for monetary policy to take affect.
(d) the belief that the money supply is the most important factor in macroeconomic performance.
2. Tight money policies aim to
(a) increase the money supply and expand the economy.
(b) decrease the money supply and expand the economy.
(c) decrease the money supply and slow the economy.
(d) increase the money supply and slow the economy.