Download The Federal Reserve

UNit 4.3
THE FEDERAL RESERVE
and the Banking System
“The FED” is the central banking system of the U.S.
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Established – 1913
Governing Body – board of governors
Presidentially-appointed Chairman – JANET YELLEN
Functions
- Uses monetary policy to manage money market/economy
- Regulates public/private banks through money supply
- Maintains the stability of financial system
- Provides finances to depository institutions & government
clearing things up!
the fed and the Banking System
the federal reserve
open market
committee
This Committee
oversees the
buying & selling of
bonds through
Open Market
Operations
board of governors
The Board oversees
all operations of the
Fed, including the
Discount rate
& the
reserve ratio
12 regional
reserve banks
These banks oversee
distribution of funds
to all banks/
depository
institutions,
public & private
the different types of
monetary policy
Remember This?...
monetary policy
1. Setting the
reserve ratio
“Fractional Reserve Banking”
reserve requirements are portions or a percentage of
all deposits that banks must hold in reserve and cannot lend
Here’s the deal!
•
•
•
Say the Fed announces that the Reserve Ratio for all banks is 0.2
Banks are mandated to hold 20% of all new deposits in reserve to
manipulate the money supply
The other 80% will be taken and loaned out or withdrawn and will
become deposits in other banks or used for consumption
The Secret?...
The Reserve Ratio works just like the MPC and MPS!
The higher the Reserve Ratio...the lesser the money supply!
The lower the Reserve Ratio...the greater the money supply!
monetary policy
2. lending at the
discount rate
The discount rate is the interest rate that the Federal
Reserve charges commercial banks to borrow from the Treasury
The catch?...
The discount rate can influence...
interest rates
AND
money supply
Example
•
2% to ____
4%
The Fed increases the Discount Rate from ____
•
Several banks & depository institutions borrow from the Fed to cover affairs
•
7%
To ensure a profit on loans, banks offer their loans at a rate of _____
and the money supply DECREASES
______________ due to high opportunity costs
monetary policy
3.
open market operations
The Open market committee can vote to use one of two
options to influence the market money supply & interest
The Options?
buying
or
selling
TREASURY BONDS
Example
Example
•
The Fed announces it is selling
$10 million T-Bonds at 5% int.
•
The Fed announces it is buying
back T-bonds from the public
•
Investors who like the interest
buy up the bonds, handing over
•
Anxious investors hand over
their bonds and the Fed releases
$100B
_______ in M1, M2 & M3 per bond
$200B
_______ in M1, M2 & M3 per bond
Wait!
What is this...
federal funds rate
The federal funds rate is the interest rate at which
depository institutions loan federal funds and excess reserves to
other banks
The Federal reserve commonly influences the federal funds rate through
open market operations!
Example
•
•
A bank has over-lended and cannot meet it’s reserve ratio, so it requests a
loan from a bank that has excess reserves
To change the Federal Funds Rate, the Fed buys bonds in the open market,
INCREASING
______________ the money supply and DECREASING
______________ interest rates,
DECREASING the federal funds rate!
thus also ________________
Ok...Let’s break down
monetary policies
the different types of
monetary policies
expansionary monetary Policy
“easy monetary policy”
lowering the discount rate
lowering the reserve ratio
buying bonds in the open
market
lowering the federal funds
rate
contractionary
monetary Policy
“tight monetary policy”
raising the discount rate
raising the reserve ratio
selling bonds in the open
market
raising the federal funds
rate
ok, we’re good.
LET’S PRACTICE!
Nominal rate of interest, i
10
8
6
Dm
0
Nominal rate of interest, i
#1. MONEY
MARKET
Sm2 Sm1
Quantity of money demanded and supplied
Price level
LRAS
AS
P1
P2
AD
AD2
Real domestic output, GDP
#3.
AGGREGATE
ECONOMY
10
#2.
INVESTMENT
DEMAND
8
6
DI
0
Amount of investment, I
The Fed SELLS Treasury Bonds in
the open market…
+ Interest Rate Increases
+ Investment Decreases
+ AD & Real GDP Decreases
with slight deflation
#1. MONEY
MARKET
10
8
6
Dm
0
Nominal rate of interest, i
Nominal rate of interest, i
Sm1 Sm2
Quantity of money demanded and supplied
Price level
LRAS
AS
P2
P1
AD
AD2
Real domestic output, GDP
#3.
AGGREGATE
ECONOMY
10
#2.
INVESTMENT
DEMAND
8
6
DI
0
Amount of investment, I
The Fed BUYS Treasury Bonds in
the open market…
+ Interest Rate Decreases
+ Investment Increases
+ AD & Real GDP Increases
with slight inflation
#1. MONEY
MARKET
10
8
6
Dm
0
Nominal rate of interest, i
Nominal rate of interest, i
Sm1 Sm2
Quantity of money demanded and supplied
Price level
LRAS
AS
P2
P1
AD
AD2
Real domestic output, GDP
#3.
AGGREGATE
ECONOMY
10
#2.
INVESTMENT
DEMAND
8
6
DI
0
Amount of investment, I
The Fed lowers the Reserve
Ratio to 0.1...
+ Interest Rate Decreases
+ Investment Increases
+ AD & Real GDP Increases
with slight inflation
Nominal rate of interest, i
10
8
6
Dm
0
Nominal rate of interest, i
#1. MONEY
MARKET
Sm2 Sm1
Quantity of money demanded and supplied
Price level
LRAS
AS
P1
P2
AD
AD2
Real domestic output, GDP
#3.
AGGREGATE
ECONOMY
10
#2.
INVESTMENT
DEMAND
8
6
DI
0
Amount of investment, I
The Fed RAISES the discount rate
from 2.5% to 3.5%…
+ Interest Rate Increases
+ Investment Decreases
+ AD & Real GDP Decreases
with slight deflation
#1. MONEY
MARKET
10
8
6
Dm
0
Nominal rate of interest, i
Nominal rate of interest, i
Sm1 Sm2
Quantity of money demanded and supplied
Price level
LRAS
AS
P2
P1
AD
AD2
Real domestic output, GDP
#3.
AGGREGATE
ECONOMY
10
#2.
INVESTMENT
DEMAND
8
6
DI
0
Amount of investment, I
The Fed lowers the Federal Funds
Rate by BUYING Treasury Bonds
in the open market...
+ Interest Rate Decreases
+ Investment Increases
+ AD & Real GDP Increases
with slight inflation