Download The Federal Reserve System

The Federal Reserve
System
Chapter 14
Objectives
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How did the Panic of 1907 affect U.S.
banking?
What is the purpose of the Federal
Reserve System?
How is the Fed organized?
What services does the Fed provide to
banks?
How do economist measure the money
supply?
Easy-money policy v. tight-money policy
How is monetary policy made?
Central Bank
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Many of the founders were
distrustful of a central bank
The Second Bank of the United
States had its charter expire
under Andrew Jackson.
No central bank was proposed
again until the Panic of 1907
Panic of 1907
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Causes
No ability to expand the nation’s
money supply
 The system of pyramided reserves
failed
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Money Supply
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Businesses and individuals
competed for a fixed supply of
funds available as loans
When these were not available,
withdrawals were made from
savings accounts
“Runs” on banks would occur.
Pyramided Reserves
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Smaller banks deposit with
larger banks who deposit with
large commercial banks in New
York, Chicago or San Francisco
Even small financial panics
could cause serious “runs” on
even the commercial banking
houses.
Federal Reserve
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1908 – establishment of the
National Monetary Commission
Federal Proposed the
establishment of a new central
bank
 Reserve Act passed in 1913
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Role of the Federal Reserve
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Fed supervises member banks
Holds cash reserves
Moves money in and out of
circulation
Characteristics of the Fed
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There is no central bank.
District banks carry on the
policies
The government owns no
shares in the Fed—Congress
does have oversight
Only nationally chartered banks
are required to join the Federal
Reserve System.
Organization
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National Level
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Decisions made by the Board of
Governors and Federal Open
Market Committee
District Level
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12 separate federal reserve banks
National Level
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The Board of Governors supervises policy
and controls the supply of money
There are 7 members on the board. They
are nominated by the president and
confirmed by the senate and serve a term
of 14 years.
The 7 members of the board and the
president of the Federal Reserve Bank of
New York are permanent members of the
FOMC.
The remaining 4 members are district
federal reserve bank presidents who serve
one rotating terms
District Level
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12 District Federal Reserve Banks each
serving a particular geographic region.
There are 25 branch offices located
throughout the country
All commercial banks are nationally
chartered and belong to the Feds
Each district has a board of 9.
The federal reserve district elect 6
members (3 may be bankers). The Board
of Governors appoint the remaining 3
members.
Federal Reserve Services to
Banks
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Services offered by Fed Reserve Banks making your banking
easier
The Fed clears checks
 1. Mrs. Pacheco writes a check to Macy’s
 2. Macy’s deposits the check in their account with Bank of
New York
 3. Bank of New York credits Macy’s account for the amount
of the check and sends the check to the District Fed
Reserve Bank of New York
 4. The Fed Reserve Bank of New York credits the Bank of
New York and sends the check to Federal Reserve Bank in
San Francisco
 5. The Federal Reserve Bank in San Francisco credits the
Federal Reserve Bank of New York for the value of the
check and sends the check on to Mrs. Pacheco’s bank
 6. Mrs. Pacheco’s bank credit the Federal Reserve Bank in
San Francisco and debits the amount of the check from her
account
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Loans to Banks
Federal Reserve Banks make
loans to state or regional banks
for the short term
Often small banks need loans to
cover short term increases in
withdrawals
Sometimes the Fed make loans
to help in times of national
emergencies
Services to Government
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Serves as the Government’s
Bank
Depository of Revenues
 Provide a government checking
account
 Keeps records of deposits and
withdrawals and conducts
purchase and sales of T-Bills
 Acts as advisor to the executive
and legislative branches
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The Federal Reserve acts as a
“watchdog” over the 12 District
Federal Reserve Banks
The District Banks have bank
examiners who audit member
banks to ensure proper
procedures and an adequate
amount of cash is available to
depositors
Regulate bank mergers and
charters of bank holding
companies
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The Fed’s regulate the nation’s
money supply
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New Currency is placed in circulation
to:
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Paper money is printed by the Treasury
Department’s Bureau of Engraving and
Printing
Coins are minted at the U.S. mints
Replace worn out notes
Increase the amount of money in
circulation
The Fed’s increase or decrease the
money supply by trading in U.S.
Securities
Money Supply
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Economist determine how much
money is in circulation by
several means:
M1
M2
M3 and L
M1
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The simplest of the measures
Considered in the measure are
All of the currency in circulation
All deposits in checking
accounts
All Traveler’s checks
M2
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Is a broader and more
encompassing measure of money
It includes everything in M1 and
Money market accounts
Money market mutual fund shares
Savings accounts
Certificates of Deposit that are less
than $100,000.
M3 and L
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These are the most inclusive of
the measures
M3 include all aspects of M1
and M2 and
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CDs over $100,00
L include M1, M2 and M3 and
Savings bonds
 Short-term treasury securities
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Monetary Policy and
Aggregate Demand
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Fed regulates the amount of
money and credit available.
Monetary policy effects the cost
of credit via money supply
Aggregate demand is the
demand for all goods and
services
Easy Money Policy
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Designed to expand the money
supply. This will
Increase jobs, aggregate
demand
This policy is used to aid the
economy during a recession
Tight Money Policy
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Slows business growth and
stabilizes the economy
Inflation may develop if there is
too much money in circulation
Higher interest rates, reduced
aggregate demand, decreased
money supply
Components of Monetary Policy
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Open Market Operations
The buying and selling of
government securities
 FOMC makes the decision to buy
or sell securities
 The Federal Reserve Bank of New
York handles the transactions
 Selling – contracts money supply
 Buying – expands money supply
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Discount Rate is the interest
rate that the Fed charges
member banks
Adjustments are done to
encourage or discourage
borrowing
The prime rate is the interest
rate that commercial banks
charge their best customers
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Reserve Requirement is the
money that must be held by
banks
It is a percentage of a bank’s
total net transaction accounts
This percentage is on fluid
accounts
The Fed can increase or
decrease the money supply by
adjusting the reserve
requirement
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The SEC can adjust the margin
requirement to increase or
decrease the money supply and
investment
As the margin increases,
investment decreases
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Credit Regulation is the power
to regulate consumer credit
during times of nation
emergency
This power was revoked in
1952.
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Moral Suasion
The indirect method of the Fed
exerting pressure on the economy
 Done through direct appeal to
banking, congress and the public
 The Fed can change the lending
policies of banks.
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Policy Limitations
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Economic forecasting
Used to develop monetary policy based on
educated guesses
Time Lags
Period of time between forecast and implementation
of policy
Priorities and Trade Offs
Monetary policy can fight inflation or recession
Lack of Coordination
Government agencies sometimes have agendas
that differ from those of the Fed
Conflicting Opinion
Economists and government agencies often have
different ideas about what will positively effect the
economy