The Banks Bank: Federal Reserve and the Banking System

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The Banks Bank: Federal Reserve and the Banking System

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Central Bank of the United States, established in 1913 as 'lender ... district bank is in ... is 10%, and Wachovia Bank has $10 million deposited ... – PowerPoint PPT presentation

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Title: The Banks Bank: Federal Reserve and the Banking System


1
The Banks Bank Federal Reserve and the Banking
System
ECON 1101 Economics for Non-Majors
  • Chapter 15

I guess I should warn you, if I turn out to be
particularly clear, you have probably
misunderstood what I said. Alan Greenspan Fed
Chairman, 1987 - 2006
2
A Bank for All Reasons
  • The Federal Reserve (Fed)
  • Central Bank of the United States, established in
    1913 as lender of last resort to maintain
    liquidity
  • Banks Bank
  • Governments Bank
  • Four Main Responsibilities
  • Formulate and implement nations monetary policy
  • Supervise and regulate banking institutions and
    protect the rights of consumers who use credit
  • Maintain stability of the financial system
  • Provide financial services to US government, the
    public, financial institutions, and foreign
    government institutions

Ch 15 The Banks Bank Federal Reserve
3
A Bank for All Reasons
  • Three Primary Components of Fed
  • Twelve District Banks
  • Charlottes district bank is in Richmond
  • Check-clearing services (now use ACH auto
    clearing house)
  • Maintain accounts for commercial banks in
    district
  • Issue currency to commercial banks
  • Board of Governors
  • Seven members, appointed by President, confirmed
    by Congress
  • Serve 14-year terms to ensure non-partisanship
  • Establish banking regulations, oversee banking
    operations, economy in general.
  • One member is appointed as chair, another as vice
    chair (who is the current chair??)
  • Federal Open Market Committee (FOMC)
  • Consists of Board of Governors, NY bank
    president, and five other district bank
    presidents.
  • Conduct open market operations as tool of
    monetary policy.

Ch 15 The Banks Bank Federal Reserve
4
(No Transcript)
5
A Bit of Background on Banking
  • Fractional Reserve Banking (How Money Supply
    Increase or Decrease)
  • Banks are required to keep a certain percentage
    of checking account balances on hand in their
    vault or in their account at the Federal Reserve
    Bank.
  • The reserve requirement is a percentage
    established by the Federal Reserve.
  • For example, if the reserve requirement is 10,
    and Wachovia Bank has 10 million deposited into
    checking accounts at their banks, Wachovia must
    always have at least 1 million (10 million x
    10) on hand in vault cash or in their cash
    account at the Fed.
  • Banks can then make loans to consumers and
    businesses with the other 90 of their checking
    deposits, thereby creating money in the money
    supply.

Ch 15 The Banks Bank Federal Reserve
6
Monetary Moves
  • Monetary Policy
  • We often refer to the Fed as controlling the
    money supply, though they do not actually
    CONTROL it.
  • The Fed influences the demand for and supply of
    money and loanable funds, influencing interest
    rates, the availability of money and credit, and
    ultimately the economy (through consumption,
    investment, etc).
  • The Fed does not SET the economys interest
    rates, it only influences them in the direction
    they need them to move.

Ch 15 The Banks Bank Federal Reserve
7
Monetary Moves
  • The Federal Reserve
  • The Feds most important function is to engage in
    monetary policy to achieve certain goals for the
    United States economy.
  • Two Types of Monetary Policy
  • Expansionary Policy
  • Designed to expand (speed up, boost, jumpstart)
    the economy.
  • Increase in money supply, increase in
    consumption, increase in output
  • Contractionary Policy
  • Designed to contract (shrink, slow down) the
    economy.
  • Decrease in money supply, decrease in
    consumption, decrease in output.

Ch 15 The Banks Bank Federal Reserve
8
  • Three Tools of Monetary Policy
  • Reserve Requirement
  • Percentage of deposits that banks are required to
    hold in reserve.
  • Expansionary lower reserve requirement
  • Contractionary raise reserve requirement
  • Discount Rate
  • Interest Rate that the Federal Reserve Bank
    charges commercial banks for borrowing money.
  • Expansionary lower discount rate
  • Contractionary raise discount rate
  • Open Market Operations
  • Buying and selling government bonds and
    securities in the bond market.
  • Expansionary buy bonds
  • Contractionary sell bonds

A Bank for All Reasons
Ch 15 The Banks Bank Federal Reserve
9
How Money is Created
How Does Money Supply Increase or
Decrease? Assume banks loan all excess reserves,
and borrowers deposit entire amount back into a
bank.
Injection into the money supply by the Federal
Reserve Bank.
Ch 15 The Banks Bank Federal Reserve
10
How Money is Created
  • With fractional reserve banking, the initial
    injection into the banking system has a
    multiplier effect on the money supply. Amount of
    the impact depends on the reserve requirement.
  • Money (deposit) multiplier reciprocal of
    reserve requirement
  • If reserve requirement is 10, money multiplier
    1/.10 10.
  • Deposit of 100,000 can impact the money supply
    by
  • 10 x 100,000 1 million.
  • In order to increase the impact a deposit would
    have on the money supply, would we raise or lower
    the reserve requirement?
  • If reserve requirement is 5, money multiplier
    1/.05 20.
  • Deposit of 100,000 can impact the money supply
    by
  • 20 x 100,000 2 million.

Ch 15 The Banks Bank Federal Reserve
11
Monetary Policy Stepping in the Gas, Hitting the
Brakes
ECON 1101 Economics for Non-Majors
  • Chapter 16

The business cycle is doomed, thanks chiefly to
the government. Paul Samuelson Nobel-winning
Economist
12
Monetary Policy in Action
  • Goal To maintain a stable, growing economy with
    low inflation and unemployment.
  • During expansion, Fed should hit the brakes.
  • Aka tightening, or tight policy
    (contractionary)
  • Target higher interest rates
  • Slow growth of money supply
  • Take away the punch bowl just when the party
    gets good.
  • During recession, Fed should step on the gas.
  • Aka loosening or loose policy
  • Give the economy a soft landing
  • Target lower interest rates
  • Increase growth of money supply

Ch 16 Stepping in the Gas, Hitting the Brake
13
Monetary Policy in Action
  • Factors that complicate the process
  • Time lags
  • Recognition lag
  • Action lag
  • Response lag
  • Lags require Fed to anticipate changes in the
    economy, and implement proper policies for those
    anticipated changes (ie, cant wait for inflation
    to hit the brakes)
  • Other factors, outside of Feds purview, affect
    inflation and unemployment
  • Fiscal Policy (taxes and govt spending)
  • Developments overseas
  • Conditions in financial markets
  • Technological changes

Ch 16 Stepping in the Gas, Hitting the Brake
14
Monetary Policy in Action
  • How the Fed Gets the Word Out
  • Monetary Policy report to Congress
  • Twice a year, mandated by law
  • Statement delivered by chairman, usually Feb and
    July
  • Includes report on key economic variables
    (unemployment, inflation, GDP, productivity,
    wages, exchange rates, etc)
  • Ends with Fed forecast of economic growth
  • Commentary on Current Economic Conditions
  • Informal survey of all 12 banks, published 8
    times a year.
  • Called The Beige Book
  • Info summarized by district and industrial sector
    (ag, manufacturing, etc)
  • Interviews with economists, business execs, etc)
  • Statements after FOMC Meetings
  • Released at 215 on last day of FOMC meetings.
  • Includes target for fed funds rate, explanation,
    clues about what Fed thinks of economy, and votes
    of all members.

Ch 16 Stepping in the Gas, Hitting the Brake
15
Monetary Policy in Action
  • Release Date June 25, 2008
  • The Federal Open Market Committee decided today
    to keep its target for the federal funds rate at
    2 percent.
  • Recent information indicates that overall
    economic activity continues to expand, partly
    reflecting some firming in household spending. 
    However, labor markets have softened further and
    financial markets remain under considerable
    stress.  Tight credit conditions, the ongoing
    housing contraction, and the rise in energy
    prices are likely to weigh on economic growth
    over the next few quarters.
  • The Committee expects inflation to moderate later
    this year and next year.  However, in light of
    the continued increases in the prices of energy
    and some other commodities and the elevated state
    of some indicators of inflation expectations,
    uncertainty about the inflation outlook remains
    high.
  • The substantial easing of monetary policy to
    date, combined with ongoing measures to foster
    market liquidity, should help to promote moderate
    growth over time.  Although downside risks to
    growth remain, they appear to have diminished
    somewhat, and the upside risks to inflation and
    inflation expectations have increased.  The
    Committee will continue to monitor economic and
    financial developments and will act as needed to
    promote sustainable economic growth and price
    stability.
  • Voting for the FOMC monetary policy action were
    Ben S. Bernanke, Chairman Timothy F. Geithner,
    Vice Chairman Donald L. Kohn Randall S.
    Kroszner Frederic S. Mishkin Sandra Pianalto
    Charles I. Plosser Gary H. Stern and Kevin M.
    Warsh.  Voting against was Richard W. Fisher, who
    preferred an increase in the target for the
    federal funds rate at this meeting.

Ch 16 Stepping in the Gas, Hitting the Brake
16
Monetary Policy in Action
Ch 16 Stepping in the Gas, Hitting the Brake
RECESSION
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