The Federal Reserve


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The Federal Reserve


Required reserves are the minimum amount of reserves a bank must hold against its deposits as mandated by the Fed. A reserve requirement is a Fed regulation, ... – PowerPoint PPT presentation

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Date added: 21 May 2019
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Title: The Federal Reserve

Monetary Policy
  • Monetary Policy
  • Is regulated by the Federal Reserve Board (FED),
    the central bank
  • Monetary policy monitors the money supply by
    moving interest rates and regulating the banks
  • The Chairman of the Fed is Ben Bernanke
    nominated by the President and confirmed by the
    SenateThe FED is controlled by a Board of
  • Is not supposed to be political!

Structure of the Federal Reserve
  • The Board of Governors
  • The Federal Reserve System is overseen by the
    seven-member Board of Governors of the Federal
    Reserve. Actions taken by the Federal Reserve are
    called monetary policy.
  • Federal Reserve Districts
  • The Federal Reserve System consists of 12 Federal
    Reserve Districts, with one Federal Reserve Bank
    per district. The Federal Reserve Banks monitor
    and report on economic activity in their
  • 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
  • The Federal Open Market Committee (FOMC)
  • The FOMC, 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

  • The Fed is the central bank because it is the
    chief monetary authority in the country
  • The Fed is responsible for supervising banks and
    controlling the money supply
  • The Fed conducts open market operations by buying
    or selling securities to a) change the money
    supply, b) affect the economy
  • Open market purchases increase the money supply
  • The Fed DOES NOT print Federal Reserve notes

Responsibilities of the Fed
  • The Fed has six major responsibilities
  • Control the money supply.
  • Supply the economy with paper money, or Federal
    Reserve notes. Federal Reserve notes are printed
    at the Bureau of Engraving and Printing in
    Washington, D.C.
  • Hold bank reserves. Each bank that is a member of
    the Federal Reserve System is required to keep a
    reserve account with its district bank. Reserve
    accounts are similar to checking accounts.

  • Provide check-clearing services.
  • Suppose that Harry writes a 1,000 check and
    sends it to Julie.
  • Julie receives the check, takes it to her local
    bank, and deposits it into her checking account.
    Her account rises by 1,000.
  • Julies bank sends the check to its Federal
    Reserve district bank. The reserve bank increases
    the reserve account of Juliess bank by 1,000
    and decreases the reserve account of Harrys bank
    by 1,000.
  • The reserve bank sends the check to Harrys bank,
    which then reduces the balance in Harrys
    checking account by 1,000.

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  1. Supervise member banks. If the Fed finds that a
    bank has not followed established banking
    standards, it can pressure the bank to do so.
  2. Serve as the lender of last resort for banks
    suffering cash management problems.

Increasing the Money Supply
  • Banks are not allowed to print currency. However,
    banks can create checking account deposits.
  • When a customer deposits money in a checking
    account, that deposit increases the amount of
    money that the bank has on hand in its vault.
  • If the bank pays out less in withdrawals than it
    accepts in deposits during the day, the bank will
    have excess reserves at the end of the day. These
    excess reserves can then be lent out in the form
    of loans.

Changing the Money Supply
  • The Fed has three tools that it can use to raise
    or lower the money supply.
  • 1. the reserve requirement
  • 2. open market operations
  • 3. the discount rate

Creation of Money
  • Different Types of Reserves
  • Banks have three types of reserves total,
    required, and excess.
  • total reserves are the sum of the banks deposits
    in its reserve account at the Fed plus its vault
    cash. Eg. if a bank has 10 million in its
    reserve account and 5 million cash in its vault,
    its total reserves are 15 million.
  • Total reserves can be divided into two types
    required and excess.

  • Required reserves are the minimum amount of
    reserves a bank must hold against its deposits as
    mandated by the Fed.
  • A reserve requirement is a Fed regulation,
    requiring a bank to keep a certain percentage of
    its deposits in its reserve account with the Fed
    or in its vault as vault cash. For example, if
    the Fed requires a bank to hold 20 percent of its
    deposits in reserve, and the bank has 50 million
    in deposits, the required reserves are 10
  • Excess reserves are any reserves held beyond the
    required amount. For example, if a bank has 15
    million in total reserves and the Fed requires
    that it keep 10 million in required reserves,
    the bank has 5 million in excess reserves.

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  • The Federal Open Market Committee (FOMC) conducts
    open market operations by buying and selling
    government securities.
  • When the FOMC makes an open market purchase, it
    increases the money supply. When an open market
    sale is made, the money supply falls.
  • If the Fed purchases bonds (quantitative easing)
    it would lower the interest rate for long-term
    loans and could lead to inflation

  • Changing the Discount Rate
  • Federal funds rate is the interest rate one bank
    charges another for a loan.
  • Discount rate is the interest rate the Fed
    charges a bank for a loan.
  • When the discount rate is decreased, the money
    supply rises. When the discount rate is
    increased, the money supply falls.

Monetary Policy Strategies
  • Goals of Monetary Policy- the Fed wants to
    control inflation and try to achieve low
  • Monetary Policy- a governments plan for
    regulating a nations money supply and
    availability of credit in order to accomplish
    certain economic goals.
  • Easy-money policy- expands the supply of money
    and increases aggregate demand? creating jobs and
    reducing unemployment to promote economic growth.
  • Tight money policy- used to contract or restrict
    the money supply and limit credit. Interest rates
    are increased and the money supply would contract
    causing a reduction in aggregate demand.

The Pyramid Structure of the Federal Reserve
  • About 40 percent of all United States banks
    belong to the Federal Reserve. These members
    hold about 75 percent of all bank deposits in the
    United States.

Serving Government
  • Federal Governments Banker
  • The Fed maintains a checking account for the
    Treasury Department and processes payments such
    as social security checks and IRS refunds.
  • Government Securities Auctions
  • The Fed serves as a financial agent for the
    Treasury Department and other government
    agencies. The Fed sells, transfers, and redeems
    government securities. Also, the Fed handles
    funds raised from selling T-bills, T-notes, and
    Treasury bonds.
  • Issuing Currency
  • The district Federal Reserve Banks are
    responsible for issuing paper currency, while the
    Department of the Treasury issues coins.

Serving Banks
  • Check Clearing
  • Check clearing is the process by which banks
    record whose account gives up money, and whose
    account receives money when a customer writes a
  • Supervising Lending Practices
  • To ensure stability in the banking system, the
    Fed monitors bank reserves throughout the system.
    The Fed also protects consumers by enforcing
    truth-in-lending laws.
  • Lender of Last Resort
  • In case of economic emergency, commercial banks
    can borrow funds from the Federal Reserve. The
    interest rate at which banks can borrow money
    from the Fed is called the discount rate.

Regulating the Banking System
The Fed generally coordinates all banking
regulatory activities.
  • Reserves
  • Each financial institution that holds deposits
    for its customers must report daily to the Fed
    about its reserves and activities.
  • The Fed uses these reserves to control how much
    money is in circulation at any one time.
  • Bank Examinations
  • The Federal Reserve examines banks periodically
    to ensure that each institution is obeying laws
    and regulations.
  • Examiners may also force banks to sell risky
    investments if their net worth, or total assets
    minus total liabilities, falls too low.

Money Supply
  • money supply is the total supply of money in
    circulation. It is composed of currency, checking
    accounts, and travelers checks. The most basic
    money supply is known as M1.
  • In 9/2013 2,552.5 B

  • Is a Savings Account Money?
  • A savings account is an interest-earning account.
    A savings account that allows for check-writing
    privileges is considered a checking account.
  • A nonchecking savings account is not considered
    money because it is not widely accepted for
    purposes of exchange.

  • Are Credit Cards Money?
  • A credit card is not considered money. Money must
    be acceptable as a form of payment and
    repayment.A credit card cannot be used to repay
    debt but to incur debt. The use of a credit card
    places a person in debt, which he or she then has
    to repay with often with interest, which makes
    them a liability
  • Gold is not considered money because it is not

Regulating the Money Supply
The Federal Reserve is best known for its role in
regulating the money supply. The Fed monitors
the levels of M1 and M2 and compares these
measures of the money supply with the current
demand for money.
  • Factors That Affect Demand for Money
  • 1. Cash needed on hand (Cash makes transactions
  • 2. Interest rates (Higher interest rates lead to
    a decrease in demand for cash.)
  • 3. Price levels in the economy (As prices rise,
    so does the demand for cash.)
  • 4. General level of income (As income rises, so
    does the demand for cash.)
  • Stabilizing the Economy
  • The Fed monitors the supply of and the demand for
    money in an effort to keep inflation rates stable.

Stabilizing the Economy
  • FED policies to stabilize the economy
  • Easy Policy
  • Used during a contraction to prevent/limit a
  • Increase money in circulation make easier to
  • Tight Policy
  • Used during an expansion to limit inflation
  • Decrease in circulation make it harder to get
  • The FED uses 3 tools to keep our economy
    stabilized RRR, Interest Rates, and Open Market

Reserve Requirements
The Fed has three tools available to adjust the
money supply of the nation. The first tool is
adjusting the required reserve ratio.
  • Reducing Reserve Requirements
  • A reduction of the RRR would free up reserves for
    banks, allowing them to make more loans.
  • A RRR reduction would also increase the money
    multiplier. Both of these effects would lead to
    a substantial increase in the money supply.
  • Increasing Reserve Requirements
  • Even a slight increase in the RRR would require
    banks to hold more money in reserve, shrinking
    the money supply.
  • This method is not used often because it would
    cause too much disruption in the banking system.

Interest Rates
The discount rate is the interest rate that banks
pay to borrow money from the Fed.
  • Reducing the Discount Rate
  • If the Fed wants to encourage banks to loan out
    more of their money, it may reduce the discount
    rate, making it easier or cheaper for banks to
    borrow money if their reserves fall too low.
  • Reducing the discount rate causes banks to lend
    out more money, which leads to an increase in the
    money supply.
  • Increasing the Discount Rate
  • If the Fed wants to discourage banks from loaning
    out more of their money, it may make it more
    expensive to borrow money if their reserves fall
    too low.
  • Increasing the discount rate causes banks to lend
    out less money, which leads to a decrease in the
    money supply.

Open Market Operations
The most important monetary tool is open market
operations. Open market operations are the
buying and selling of government securities to
alter the money supply.
  • Bond Purchases
  • In order to increase the money supply, the
    Federal Reserve Bank of New York buys government
    securities on the open market.
  • The bonds are purchased with money drawn from Fed
    funds. When this money is deposited in the bank
    of the bond seller, the money supply increases.
  • Bond Sales
  • When the Fed sells bonds, it takes money out of
    the money supply.
  • When bond dealers buy bonds they write a check
    and give it to the Fed. The Fed processes the
    check, and the money is taken out of circulation.

How Monetary Policy Works
Monetarism is the belief that the money supply is
the most important factor in macroeconomic
  • Interest Rates and Spending
  • If the Fed adopts an easy money policy, it will
    increase the money supply. This will lower
    interest rates and increase spending. This
    causes the economy to expand.
  • If the Fed adopts a tight money policy, it will
    decrease the money supply. This will push
    interest rates up and will decrease spending.
  • The Money Supply and Interest Rates
  • The market for money is like any other, and
    therefore the price for money the interest rate
    is high when the money supply is low and is low
    when the money supply is large.

The Problem of Timing
  • Good Timing
  • Properly timed economic policy will minimize
    inflation at the peak of the business cycle and
    the effects of recessions in the troughs.
  • Bad Timing
  • If stabilization policy is not timed properly, it
    can actually make the business cycle worse.

Policy Lags
Policy lags are problems experienced in the
timing of macroeconomic policy. There are two
  • Inside Lags
  • An inside lag is a delay in implementing monetary
  • Inside lags are caused by the time it actually
    takes to identify a shift in the business cycle.
  • Outside Lags
  • Outside lags are the time it takes for monetary
    policy to take affect once enacted.

Anticipating the Business Cycle
The Federal Reserve must not only react to
current trends, but also must anticipate changes
in the economy.
  • Monetary Policy and Inflation
  • Expansionary policies enacted at the wrong time
    can push inflation even higher.
  • If the current phase of the business cycle is
    anticipated to be short, policymakers may choose
    to let the cycle fix itself. If a recession is
    expected to last for years, most economists will
    favor a more active monetary policy.
  • How Quickly Does the Economy Self-Correct?
  • Economists disagree about how quickly an economy
    can self-correct. Estimates range from two to
    six years.
  • Since the economy may take quite a long time to
    recover on its own, there is time for
    policymakers to guide the economy back to stable
    levels of output and prices.