Download The Federal Reserve System

The Fed and Monetary Policy
The Federal Reserve System
The Fed
• 1913 the Federal Reserve or the
Fed was setup to act as the
central bank of the US
• Provides financial services to the
US
• Regulates financial institutions
• Conducts monetary policy
Structure
Corporation
• The Fed is a
corporation owned by
banks that own shares
• National Banks
chartered by the US
government must
belong
Board of Governors
• 7 member board appointed by
the President approved by
Senate 14 year terms
• Regulates and supervises
member banks
• Reports directly to Congress
Federal Reserve District Banks
• 12 Federal Reserve and 25
District Banks act as Banks
for Banks.
• Provide deposit locations and
loan institutions for
commercial banks
• Strategically located to be
near the commercial banks
they serve
Federal Open Market Committee
• Decide growth of money
Supply and level of interest
rates
• 12 voting Members
– 7 from the board of Governors
– President of the New York
District
– 4 other district presidents serve
one year
– Other district presidents are
nonvoting members
Federal Open Market Committee
continued
• Meet 8 times a year to
make decisions about cost
and credit availability
• Primary monetary policy
making body
Advisory Committees
• Federal Advisory Counciladvice on the health of the
economy representatives from
all 12 district banks
• Consumer Advisory Councilconsumer credit law issues 30
members
– educators, legal specialists and
consumer and financial industry
group representatives
Advisory Committees
continued
• Thrift Institutions Advisory
Council
– Representatives from Savings
and loans, Banks and Credit
Unions
– Advise on matters dealing
with thrift industry
Regulatory Responsibility
• State Member Banksmonitors the reserves of
members
– How much money they must
have on hand
– Way the money supply is
controlled
Regulatory Responsibility
continued
• Bank Holding Companiescorporations that own one
more banks
• Holding companies were
ways to get around banking
laws
Regulatory Responsibility
continued
• International OperationsForeign Banks control
20% of US banks Fed has
ability regulate them
• Member Bank Mergersbank mergers require Fed
approval
Other Reserve Services
• Check Clearing
• Enforcing consumer
Legislation
• Maintaining Currency and
Coins(issues and destroys
money)
• Providing Financial services
to the government( Bonds,
IRS accounts)
Monetary Policy
Monetary Policy
• The expansion and
contraction of the
money supply in order
to influence the cost
and availability of
credit
Fractional Reserve System
• Requires banks and other institutions
to keep a fraction of their deposits in
legal reserves
• Legal reserves- coins and currency
that must be kept in the vault, and
deposits in the fed district banks.
• Reserve requirement rule stating the
percentage of total deposits that the
bank must have in legal reserves
Fractional Reserve System
continued
• Banks operate at 12 % rate
• For every $100 deposited the
bank must set aside $12
• The other $88 is excess
reserves that the bank can
lend to others
Making Loans
• Banks make loans on all
of its excess reserves
• If a bank charged 12%
interest on a loan of $100
it would earn $12 each
time it was compounded
• To make loans Banks
need to offer savings
accounts and time deposits
Tools of Monetary policy
• Reserve Requirement– Lowering- more money can be loaned
(more credit avail. and Interest rates
lower)
– Raising- less money can be loaned
(less credit avail. and interest rates
higher)
• Open Market Operations- buying and
selling government Securities
– Buying increases the supply of money forcing
interest rates down
– Selling decreases the money supply forcing
up interest rates
Discount Rate
• The interest the Fed charges
on loans to other financial
institutions
• If the discount rate is raised
then banks will be less likely
to borrow money, and less will
be loaned to customers
• Rates charged by banks will
follow the discount rate
The Evolution of Money
Banking and Monetary Standards
Money
• Any substance that serves
as a medium of exchange,
a measure and store of
value
• Without money we would
have a barter economy
based on trade alone
Functions of Money
• Medium of exchangeaccepted by all parties as
payment for goods or services
• Measure of Value- can be used
to express worth in terms that
all individuals can understand
• Store of Value- allows it to be
saved until needed
Characteristics of Money
• Portability- easy to transfer from
one person to another
• Durability- it has to last and be
able to be handled can not
deteriorate when being used as a
store of value
• Divisibility- easy to divide into
smaller units
• Limited Availability- loses value
when there is too much of it
Monetary Standard
• Mechanism designed to
keep the money supply
portable, durable, divisible
and limited in supply
• US has had a number of
monetary standards
Privately Issued Bank Notes
• Federal government did not issue paper money until the
Civil War
• State Banks Issued their own paper money which could be
exchanged for gold or silver at that bank
• Problems included hundreds of different notes all different,
counterfeiting, and not all accepted
Greenbacks
• 1861 Paper currency printed
by the Union Government
• Declared Legal Tender- must
be accepted as payment for
debts (printed with green ink)
• Became United States Notes
• Confederate Government did
the same
Greenbacks
National Currency
• System of national banks
established
• These banks issued new
National Bank Notes or
National Currency
• 1865 State banks forced to
join the system and
withdraw their privately
issued notes
Certificates and Coin
Notes
• Gold Certificates- paper
currency backed by gold
deposited in the US Treasury
• Silver Certificates- backed by
silver on deposit
• Treasury Coin Notes- backed
by both gold and silver
Modern Money
• Since 1968 US money is
no longer backed by gold
or silver
• Money is controlled by
the actions of the Federal
Reserve System
Government Taxes and Spending
Economic Impact of Taxes
• Tax placed on a good at the
factory increases production
costs
• Taxes can encourage or
discourage activities (sin
Tax)
• Incidence of the tax is the
person who eventually pays
for it. (consumer)
Criteria For Effective Taxes
• Equity- is the tax fair are
there exceptions, deductions
and exemptions
• Simplicity- are the laws easy
to understand
• Efficient- easy to administer
and generate revenue
Principles of Taxation
• Benefit principle- those who
benefit from government
services should pay in
proportion to those services
• Ability to pay principlepeople taxed according to
their ability to pay
Types of Taxes
• Proportional Tax- same
percentage is paid by everyone
• Progressive Tax- higher
percentage on higher incomes
• Regressive tax higher
percentage on lower incomes
•
Individual
Income
Taxes
45% taxes come from
individuals (Highest amount)
• Withheld from paychecks sent
by employers to the
Government
• Taxes filed by April 15th
refund -paid over what is
owed
• Income tax is progressive
until a certain level then
proportional
FICA Taxes
• Federal Insurance
Contributions Act- pays
Social Security and
Medicare
• Called payroll taxes
• Second largest amount of
tax
Corporate Income Taxes
• Corporation are
considered legal
entities and pay taxes
on their profits
• Third largest source of
government revenue
Other Federal Taxes
• Excise tax- regressive tax on
the manufacture and sale of
select items (gas liquor)
• Estate and Gift taxes- death or
as a gift
• Customs duties- charges for
bringing goods into the US
State and Local
Taxes
• Intergovernmental
revenues- collected by one
level of the government and
distributed to another
• Sales Tax- consumer
purchases for most products
(mostly state level)
• Property Taxes (local level)
• Fees, lotteries utilities
Two Kinds of Spending
• Goods and serviceseverything the government
buys guns to butter
• Transfer payments- from one
level of the government to
another (grant-in-aid) and
payments to individuals or
subsidies (welfare, social
security, unemployment)
Federal Budget
• President drafts budget-sent to
Congress treated like a
proposed law
• Budget has two parts
– Mandatory spending- interest
payments, Social Security and
Medicare
– Discretionary spendingprograms approved by
Congress
National Debt
• Deficits- spending more than is
collected in revenues
• Government sells bonds to raise
money results in debt
• Debt takes purchasing power
from the government
• Increasing taxes to pay debt takes
purchasing power from society
Taming the Deficit
• Congress has passed a
number of resolutions to
curb deficit spending and
reduce the debt
• All resolutions have failed
to work
• Government is currently
operating under record
deficits