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Chapter 15 Sections 1 and 2
The Fed and Money Supply
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The Federal Reserve (AKA – The Fed)

The central bank of the United
States of America.
The Fed


The “Fed” is a system/network of
banks.
Responsible for Monetary Policy.
Cont.

Monetary Policy – Changing the
growth of money supply in
circulation.
Federal Open Market Committee

Board of Governors, head of NY Fed
Bank, and 4 rotating heads of the
other 11 district banks.


Meet 8 times a year to set MONETARY
POLICY
Extremely important decision making
body.
Banking System

12 District Banks – 25 branch banks
underneath it.

All national banks must become
members of the Federal Reserve
System.
Monetary Policy

Changing the growth of money
supply
Loose Money Policy “Expansionary”

Credit is abundant and inexpensive
to obtain.

Encourages economic growth
Tight Money Policy “Contractionary”

Credit is in short supply and
expensive to obtain.


Used to control inflation
Think money when money is “tight” it
is harder to get, not as much available.
Fractional Reserve Banking

Only a fraction of bank deposits
must be kept on hand or in reserves
the rest can be lent out.
Reserve Requirements

A requirement by the Fed – % of
Money that banks must keep on
reserve from deposits.

Example – Sam deposits $1000 into a
checking account. The reserve
requirement is 10%. The bank must
therefore hold $100 and may loan out
the remaining $900.
Multiple Expansion of the Money
Supply
Chapter 15 Section 3
Regulating the Money Supply
The Federal Reserve

The main goal of the Federal
Reserve is to keep the money
supply growing steadily and the
economy running smoothly
Tool #1 – Changing Reserve
Requirements

Reserve Requirements – The % of
money that banks must hold from a
deposit.


Increase Requirements – Less money
available to lend out
Decrease Requirements – More money
available to lend out
#2 – Discount Rate

Banks can borrow money from the
Fed (to meet reserve
requirements).

The interest charged by The Fed on
these loans is the Discount Rate
Cont.

Prime Rate – Interest rate banks
charge its best business customers.
Banks pass on discount rate
changes to customers.
Cont.


Decrease Interest Rate = Loans
become cheaper to obtain = Loans
INCREASE in Quantity Demanded
Increase interest rates – Loans
become more expensive –
discourages borrowing
#3 – Open Market Operations

Buying and selling government
securities (Most common tool Fed
uses to control money supply


Fed buys securities it is increasing
money supply
Fed sells securities it is decreasing
money supply
Federal Funds Rate


Interest rate that banks charge
each other for short-term loans.
Banks that cannot meet reserve
requirements must borrow or pay a
penalty.
Cont.

Fed tries to indirectly change this
rate through open market
operations.
Delays in Effects of Monetary
Supply

Full effects can take months,
sometimes up to a year
Criticisms of Fed Policies


Fed has increased money supply
during times of inflation (creating
worse inflation)
Fed has decreased money supply
during recessions (thereby making
the recession worse)
Cont.


Some Recommend – Money supply
increased at same rate each year
(no monetary policy)
Gov’t (spending and taxation) also
has a dramatic affect on the
economy.