Download HONORS ECONOMICS CHAPTER 16

HONORS ECONOMICS
CHAPTER 16: THE FEDERAL RESERVE AND MONETARY POLICY
I.
The Federal Reserve System (Federal Reserve Act 1913)
A. Structure of the Fed
1. The Federal Reserve System is owned by its member banks
2. The Board of Governors establishes policies for the Federal Reserve and member banks to
follow, regulates certain operations, and controls the money supply
3. 12 Federal Reserve district banks and 25 branch banks
4. The Federal Open Market Committee (FOMC) makes decisions about the growth of the
money supply and interest rates
II.
Federal Reserve Functions
III.
A.
Regulatory Responsibilities
1. The Fed monitors member banks’ reserves
2. The Fed oversees bank holding companies
a. corporations that own one or more banks
3. The Fed oversees foreign banks operating in the United States as well as the international
operation of U.S. member banks and holding companies operating abroad
4. The Fed approves bank mergers
5. The Federal Reserve examines banks periodically to make sure they are obeying laws and
regulations.
B.
Other Federal Reserve Services
1. Check clearing
2. Extending truth – in – lending disclosures to millions of individuals who purchase or borrow
from corporations, retail stores, automobile dealers, and lending institutions
3. Issuing paper currency
4. Providing financial services to the federal government
Monetary Policy
A. Federal government controlling the money supply to affect the business activities in our economy
1. Affects credit
a. credit is subject to laws of demand/supply
b. credit has cost
Loose Money Policy
Designed to stimulate the economy by making credit
inexpensive and abundant
People will borrow more
Correct a recession
Tight Money Policy
Designed to slow the economy by making credit
expensive and in short supply
People will borrow less
Correct inflation
2. Goals of the Fed
a. balance tight/loose money
b. create a money supply that will allow expansion of the economy but not cause rapid
inflation
B. How Banking Systems Create Money
1. Fractional Reserve Banking
a. only a fraction of the deposits in a bank are kept on hand in the form of cash deposits
2. Reserve Requirements
a. Fed requires banks to keep a certain percentage of their deposits as cash (or as
deposits with their District Federal Reserve)
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C. Money Expansion
How Bank’s Expand the Supply of Money
How a $100,000 Deposit Multiplies
New Deposits
First National Bank
Second National Bank
Third National Bank
Fourth National Bank
Fifth National Bank
Etc.
Total
$100,000
80,000
64,000
51,200
40,960
163,840
$500,000
Required Reserves
(20 Percent)
$20,000
16,000
12,800
10,240
8,192
32,768
$100,000
Available for Loans
(80 Percent)
$80,000
64,000
51,200
40,960
32,768
131,072
$400,000
Deposit Multiplier = 5
1. In checking on the banking system’s potential for expanding the money supply, economists use
the following formulas
Expansion multiple x Initial deposit = Money created
(Deposit multiplier/Money multiplier)
Deposit/Money (expansion) multiple = 1
or
100
Reserve Req.
Reserve Req. %
2. Expansion multiple may be reduced
a. when banks accumulate excess reserves
b. only half of the money borrowed was deposited
c. withdraw deposits
D. Techniques for controlling the Money Supply (See chart)
1. Reserve Requirement
a. Fed requires banks to keep a certain percentage of their deposits as cash on hand
2. Discount Rate
a. rate of interest the Fed charges member banks whenever they borrow money
3. Open Market Operations
a. Fed buys and sells securities (T –bills, bonds, etc.) in the open market
b. market open to all businesses
E. Difficulties of Monetary Policy
1. Difficult to gather information about M1 and M2
2. Fed’s Board of Governors often receive conflicting advice from many directions
3. Increased/decreased money supply at too fast a rate
F. Short – Run Impact
1. Changes in money supply affect interest rates
2. Sometimes the Fed’s long – term objectives force it to keep interest rates above or below the
desired level in the short run
G. Long – Run Impact
1. Changes in the money supply affect general level of prices
2. Monetizing the government’s debt means creating enough extra money to offset deficit
spending in order to prevent interest rates from changing
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