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1. Created in 1913 2. Responsible for: a. overseeing the money supply b. coordinating commercial bank operations c. regulating depository institutions • The Board of Governors is at the center of the banking system in the U.S. • The seven members of the Board of Governors also serve on the Federal Open Market Committee • The FOMC is a 12member board that establishes Fed policy regarding the buying and selling of government securities. Federal Reserve Board of Governors 7 members appointed by the president, with the consent of the U.S. Senate Open Market Committee Board of Governors & 5 Federal Reserve Bank Presidents (alternating terms, New York Bank always represented). 12 Federal Reserve District Banks (25 branches) Commercial Banks Savings & Loans Credit Unions Mutual Savings Banks The Public: Households & businesses 1. Board of Governors – 7 members appointed by President - 14 yr terms at 2 yr intervals for continuity & independence -not more than one from each district http://www.federalreserve.gov/ • Each district bank monitors the commercial banks in their region and assists them with the clearing of checks. • The Board of Governors of the Federal Reserve System is located in Washington D.C. 1 9 2 7 12 10 11 4 8 3 5 6 . (Board of Governors) 1 9 2 7 12 10 11 4 8 3 5 6 1.____________________ 2.____________________, ____________________ 3.____________________ 4._________________, _________________, _________________ 5.________________, _________________, _________________, 6._________________, ________________, _________________, _________________, _________________, _________________ 7._________________, _________________ 8._________________, ________________, _________________, _________________ 9._________________, _________________ 10._________________, ________________, ________________, __________________ 11._________________, _________________, _______________, 12._________________, ________________, _________________, _________________, _________________, _________________ . 1 Boston 2 New York City, Buffalo 3 Philadelphia 4 Cleveland, Pittsburgh, Cincinnati 5 Richmond, Baltimore, Charlotte 6 Atlanta, Nashville, Birmingham, Miami, Jacksonville, New Orleans 7 Chicago, Detroit 8 St. Louis, Louisville, Memphis, Little Rock 9 Minneapolis, Helena 10 KC, Denver, Omaha, Oklahoma City 11 Dallas, San Antonio, El Paso 12 SF, Salt Lake City, LA, Port., Seattle, Honolulu 2. Federal Open Market Committee -12 members = 7 Governors (for majority) plus 5 Pres or VP from 1 NY 2 Bost, Phila, or Richmond, 3 Atl, Dallas, or StL 4 Minn, KC, or SF, LA 5 Clev, or Chicago set policy on buying & selling bonds on open mkt 3. Federal Advisory Council outsiders 12 members - 1 each selected by Board of each Region Make sure they are following the rules Makes clearing check easier Replace money or increase or decrease money in circulation Moves checks from region to region Borrows, writes checks, takes deposits 1. Price stability 2. High employment 3. Stability of financial markets and institutions 4. Economic growth 1. Monetary Policy Tools: a. The Reserve Requirement -reducing it encourages loans and increases the money supply -increasing it discourages loans and decreases the money supply Type of Deposit Current Requirement Checkable Deposits $0 - $14.5 million $14.5 - $130.6 million Over 130.6 million savings 0 % 3 Limits 3% 3 10 8-14 0 0-9 b. The Discount Rate 3 rates 1. Discount Rate 2. Federal Funds Rate 3. Prime Rate federal reserve to member banks bank to bank banks to best customers b. The Discount Rate Raising Discount Rate discourages bank borrowing decreases money supply Lowering Discount Rate encourages bank borrowing increases money supply c. Open Market Operations Buying and Selling Securities (Bonds) -selling bonds puts bonds out and take money out of circulation What effect will this have on the economy?? -buying bonds puts money back in circulation and takes bonds in What effect will this have on the economy?? Fed Buys Fed Sells Changing the Interest Rate • The original equilibrium occurs at E0. • Expansionary monetary policy shifts supply to the right. • reduces the interest rate from 8% to 6%. • Contractionary monetary policy shifts supply to the left. • raises the interest rate from 8% to 10%. a. The Reserve Requirement Increase or decrease? b. The Discount Rate Raise or Lower? c. Open Market Operations Buy or Sell? a. The Reserve Requirement Increase or decrease? b. The Discount Rate Raise or Lower? c. Open Market Operations Buy or Sell? Fed’s Past Policies Episode 1 1979 and 1980, high inflation (over 10%), the Fed raised interest rates 5.5% in 1977 to 16.4% in 1981. By 1983, inflation was down to 3.2%, (may have caused back-to-back recessions in 1980 and in 1981–1982) Episode 2 In early 1980s, the Fed felt inflation was declining, Fed reduced the federal funds rate from 16.4% in 1981 to 6.8% in 1986. Episode 3 From 1986 to 1989, inflation rose from 2% to 5%. the Fed raised the federal funds rates from 6.6% to 9.2%. Inflation fell from above 5% in 1990 to under 3% in 1992 (but it helped to cause the recession of 1990–1991, and the unemployment rate rose from 5.3% in 1989 to 7.5% by 1992.) Episode 4 In the early 1990s, the Fed reduced interest rates 8.1% 3.5%. The unemployment rate declined from 7.5% in 1992 to less than 5% by 1997. Fed’s Past Policies Episodes 5 and 6 With a risk of inflation the federal funds rate was raised from 3% to 5.8% from 1993 to 1995. No Inflation. In 1999 and 2000, the Fed was concerned that inflation seemed to be creeping up so it raised the federal funds rate from 4.6% in 12/98 to 6.5% in 6/00. By early 2001, inflation was declining again, but a recession occurred in 2001. Between 2000 and 2002, the unemployment rate rose from 4.0% to 5.8%. Episodes 7 and 8 the Fed slashed the federal funds rate from 6.2% in 2000 to 1.7% in 2002, and to 1% in 2003. In 2004, the unemployment rate declined and the Federal Reserve began to raise the federal funds rate until it reached 5% by 2007. Episode 9 Great Recession in 2008, the Fed slashed interest rates 2% to nearly 0%. the economy was still deep in recession Consumption. Lower interest rates lower the cost of durable goods and reduce the return to saving, leading households to save less and spend more. Investment. Lower interest rates increase the demand for stocks and make it less expensive for firms and households to borrow, thereby increasing investment. Net exports. If interest rates in the United States decline relative to interest rates in other countries, the value of the dollar will fall and net exports will rise. Price Level LRAS SRAS1 P2 P1 E2 e1 AD1 Y1 YF AD2 Goods & Services (real GDP) • If the increase in AD is when the economy is below capacity, the policy will help direct the economy toward long-run full-employment equilibrium YF. Price Level LRAS SRAS1 P2 P1 e2 E1 AD2 AD1 YF Y2 Goods & Services (real GDP) If the increase is at full-employment YF, they will lead to excess demand, higher product prices, and temporarily higher output Y2. Price Level LRAS SRAS2 SRAS1 P3 E3 P2 P1 e2 E1 AD2 AD1 Y F Y2 Goods & Services (real GDP) In the long-run, the strong demand pushes up resource prices, shifting short run aggregate supply (from SRAS1 to SRAS2). The price level rises (from P2 to P3) and output falls back to YF from its temporary high,Y2. Too Low for Zero: The Fed Tries “Quantitative Easing” and “Operation Twist” Quantitative easing - purchasing securities—including certain mortgagebacked securities—beyond the short-term Treasury securities that are usually involved in open market operations. (Nov. 2008 and June 2011) The economic recovery remained weak Operation Twist - the Fed announced it would purchase $400 billion in long-term Treasury securities while it would sell an equal amount of shorter-term Treasury securities. (Sept 2011) Both tried to reduce interest rates on long-term Treasury securities, which typically move closely with those on home mortgage loans, in order to increase aggregate demand. The Federal Reserve can provide reserves for banks to loan. They can’t make them loan them out. Becoming unpredictable. M * V = P *Y M one My Velocity V Output P rice P Y - the amount of money in circulation - the number of times each $ is spent in a year (considered to be stable) - the level of prices - the actual output of goods and services M * V = P *Y Money • P Velocity *Y = Y =output Price Total Sales (GDP) • If V and P are constant, then an increase in M will lead to a proportional increase in Y GDP increases. • but if V and Y are constant (at full employment), then an increase in M will lead to a proportional increase in P =Inflation. Which to target? 1.It would draw the public’s attention to the fact that the Fed can affect inflation but not real GDP in the long run., 2. The Fed would make it easier for households and firms to form accurate expectations of future inflation, improving their planning and the efficiency of the economy. 3. It get would help institutionalize good U.S. monetary policy that is subject to fewer abrupt changes as members join and leave the FOMC. 4. It would promote accountability for the Fed by providing a yardstick against which Congress and the public could measure the Fed’s performance. 1.A numeric target reduces the flexibility of monetary policy to address other policy goals. 2.It assumes that the Fed can accurately forecast future inflation rates, which is not always the case. 3.Holding the Fed accountable only for an inflation goal may make it less likely that the Fed will achieve other important policy goals.