Download Economics: Today and Tomorrow

Chapter Introduction
Section 1: Organization and
Functions of the Fed
Section 2: Money Supply and
the Economy
Section 3: Regulating the
Money Supply
Visual Summary
Governments strive for a balance
between the costs and benefits of
their economic policies to
promote economic stability and
growth.
In this chapter, read to learn
about who is in charge of the
U.S. money supply and how
they decide how much currency
to put into circulation.
Section Preview
In this section, you will learn about how the
Federal Reserve System, or Fed, is
organized, and its role in determining the
nation’s monetary policy.
Organization of the Federal Reserve
System
The Federal Open Market Committee of
the Federal Reserve is responsible for
implementing monetary policy.
Organization of the Federal Reserve
System (cont.)
• The Federal Reserve System, or Fed, is a
system, or network, of banks that share
power.
• The Fed is responsible for monetary
policy in the United States.
View: Organization of the Fed
Organization of the Federal Reserve
System (cont.)
• The Board of Governors, consisting of 7
full-time members appointed by the
president, directs the operation of the Fed.
• They are assisted by the Federal Advisory
Council (FAC)—12 members elected by
the directors of each Federal Reserve
district bank.
Organization of the Federal Reserve
System (cont.)
• The Federal Open Market Committee
(FOMC) has 12-voting members that meet
8 times a year to decide the course of
action that the Fed should take to control
the money supply.
• The nation is divided into 12 Federal Reserve
districts, with each district having a Fed
district bank.
View: The Federal Reserve System
Organization of the Federal Reserve
System (cont.)
• Each district bank is set up as a
corporation owned by its member banks.
• The system also includes 25 Federal
Reserve branch banks.
• All national banks are required to become
members of the Federal Reserve System.
Functions of the Fed
The primary function of the Federal
Reserve is to control the money supply.
Functions of the Fed (cont.)
• Functions of the Federal Reserve:
– Check clearing
– Acting as the federal government’s fiscal
agent
– Supervising banks
– Holding reserves and setting reserve
requirements
View: How a Check Clears
Functions of the Fed (cont.)
– Supplying paper currency
– Regulating the money supply
– Sets standards for certain types of
consumer legislation
View: Functions of the Fed
Section Preview
In this section, you will learn how the Fed
controls the money supply and interest
rates.
Content Vocabulary
• loose money policy
• tight money policy
• fractional reserve banking
• reserve requirements
Academic Vocabulary
• function
• portion
Loose and Tight Money Policies
The goal of monetary policy is to
promote economic growth and
employment without causing inflation.
Loose and Tight Money Policies (cont.)
• Credit, like any good or service, has a
cost—the interest that is paid to obtain it.
• If the Fed implements a loose money
policy (often called expansionary) credit is
abundant and inexpensive to obtain,
possibly leading to inflation.
View: Balancing Monetary Policy
Loose and Tight Money Policies (cont.)
• If the Fed implements a tight money
policy (also called “contractionary”), credit
is in short supply and is expensive to
obtain, which slows the economy.
If more people are employed, borrowing
is easy, and people spend more, which
type of policy is in effect?
A. Loose
B. Tight
A. A
B. B
0%
A
0%
B
Fractional Reserve Banking
Banks are not required to keep 100
percent reserves to back their deposits.
Fractional Reserve Banking (cont.)
• The banking system is based on
fractional reserve banking.
• Many banks have reserve requirements.
• A larger portion of the money supply
consists of funds that the Feds and
customers deposit in banks.
• Banks may only keep 10% of the deposits
in reserve, so they use the remaining 90%
in reserves to create new money.
Fractional Reserve Banking (cont.)
• When each bank uses the non-required
reserve portion of money deposits to make
loans to businesses and individuals, the
process is known as the multiple
expansion of the money supply.
View: Expanding the Money Supply
Section Preview
In this section, you will learn about several
tools that the Fed uses to control the size
of the U.S. money supply
Do you feel that the
actions of the Fed
impact your daily life?
A. Yes
B. Somewhat
C. Not at all
0%
A
A. A
B. B
C.0%C
B
0%
C
Changing Reserve Requirements
The Fed can change the growth rate of
the money supply by changing reserve
requirements on bank deposits.
Changing Reserve Requirements (cont.)
• The Federal Reserve can choose to control
the money supply by changing the reserve
requirements of financial institutions.
– If the Fed raises the reserve requirements, it
would decrease the amount of money in the
economy.
– If the Fed lowers the reserve requirements, it
would increase the amount of money in the
economy.
View: Raising and Lowering Reserve
Requirements
Changing the Discount Rate
The Fed can change the growth rate of
the money supply by changing shortterm interest rates.
Changing the Discount Rate (cont.)
• If a bank does not have enough reserves
to meet its reserve requirement, it can ask
the Federal Reserve district bank for a
loan.
• If the discount rate is high, the bank
passes its increased costs on to
customers in the form of higher interest
rates on loans.
Changing the Discount Rate (cont.)
• Banks might raise their prime rate.
– High interest rates discourage borrowers and
may keep down the growth of the money
supply.
– Low interest rates encourage borrowers and
may lead to growth of the money supply.
Changing the Discount Rate (cont.)
• Changing the reserve requirement or the
discount rate is now rarely used by the
Fed.
• Rather, the Fed states periodically that it is
going to change the federal funds rate.
• If the Fed causes the federal funds rate to
drop, banks will borrow more and, thus,
lend more—and vice versa.
View: Federal Funds Rate
Open-Market Operations
The Fed controls the money supply
primarily through the purchase and
sale of government securities.
Open-Market Operations (cont.)
• The major tool the Fed uses to control the
money supply is a practice known as
open-market operations.
• When the Fed buys securities—such as
Treasury bills, notes, and bonds—it pays
for them by making a deposit in the
dealer’s bank.
• This increases the bank’s reserves, thus
increasing the money supply.
Open-Market Operations (cont.)
• When the Fed sells Treasury bills to a
dealer, the dealer’s bank must use its
deposits to purchase securities.
• This decreases the bank’s reserves, thus
decreasing the money supply.
• Some people feel that the Fed should not
engage in monetary policy due to
misjudgments in the past.
Open-Market Operations (cont.)
• The spending and taxing policies of the
federal government also affect the economy.
The primary function of the Federal
Reserve System is to control the money
supply, but it has other responsibilities as
well.
The Fed can implement either a loose or
tight money policy to try to promote
economic growth and employment.
The Fed has several tools at its disposal to
use to regulate the money supply.
Economic Concepts
Transparencies
Transparency 18 Monetary Policy
Select a transparency to view.
Fed: the Federal Reserve System
created by Congress in 1913 as the
nation’s central banking organization
monetary policy: policy that involves
changing the rate of growth of the
supply of money in circulation in order
to affect the cost and availability of
credit
Federal Open Market Committee
(FOMC): 12-member committee in
the Federal Reserve System that
meets 8 times a year to decide the
course of action that the Fed should
take to control the money supply
check clearing: method by which a
check that has been deposited in one
institution is transferred to the issuer’s
depository institution
loose money policy: monetary
policy that makes credit inexpensive
and abundant, possibly leading to
inflation
tight money policy: monetary policy
that makes credit expensive and in
short supply in an effort to slow the
economy
fractional reserve banking: system
in which only a fraction of the
deposits in a bank is kept on hand, or
in reserve; the remainder is available
to lend
reserve requirements: regulations
set by the Fed requiring banks to
keep a certain percentage of their
checkable deposits as cash in their
own vaults or as deposits in their
Federal Reserve district bank
discount rate: interest rate that the
Fed charges on loans to commercial
banks and other depository
institutions
prime rate: rate of interest that banks
charge on loans to their best business
customers
federal funds rate: interest rate that
banks charge each other on loans
(usually overnight)
open-market operations: buying
and selling of United States securities
by the Fed to affect the money supply
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