Download The Federal Reserve

The Federal Reserve
And Monetary Policy
The Federal Reserve Act of 1913
The Federal Reserve System, often referred to
as “the Fed,” is a group of 12 regional,
independent banks.
Ben Bernanke
2006-?
The Pyramid Structure of the Federal Reserve
Federal Open Market Committee
12 District
Reserve Banks
4,000 member banks
and 25,000 other
depository institutions
40 percent of all
US banks belong
These members
hold about 75
percent of all
bank deposit.
Board of Governors
Structure of the Federal Reserve System
Structure of the Fed
Serving Government
• Federal Government’s Banker
– Maintains a checking account for the
Treasury Department and processes
payments such as social security
checks and IRS refunds.
• Government Securities Auctions
– The Fed sells, transfers, and redeems
government securities.
T-bills, T-notes, and Treasury bonds.
• Issuing Currency
– The district Federal Reserve Banks are
responsible for issuing paper currency,
while the Department of the Treasury
issues coins.
Serving Banks
• Check Clearing
– Check clearing is the process by which banks record whose
account gives up money, and whose accounts receives money
when a customer writes a check.
• Supervising Lending Practices
– Act as a supervisor for banks who lend $ to their customers.
• Lender of Last Resort
– In case of economic emergency, commercial banks can borrow
funds from the Federal Reserve.
The Journey of a Check
• After you write a
check, the recipient
presents it at his or
her bank.
The Path of a Check
Check writer
Recipient
• The check is then sent
to a Federal Reserve
Bank.
• The reserve bank
collects the necessary
funds from your bank
and transfers them to
the recipient’s bank.
• Your processed check is
returned to you by your
bank.
Check
writer’s bank
Federal
Reserve Bank
The Money Creation Process
To determine how much money is actually created by a deposit, we use the money
multiplier formula. The money multiplier formula is calculated as 1/RRR.
Money Creation
You deposit $1,000
into your checking
account.
Your $1,000 deposit
minus $100 in reserves
is loaned to Elaine, who
gives it to Joshua.
$100 held in reserve
$900 available for loans
Joshua’s $900 deposit
minus $90 in reserves is
loaned to another
customer.
At this point, the money
supply has increased by
$2,710.
$90 held in reserve
$810 available for loans
Reserve
Requirements
The Fed has three tools available to adjust the money supply of the nation.
The first tool is adjusting the required reserve ratio.
Reducing Reserve
Requirements
• A reduction of the RRR
would allow banks to make
more loans.
• This would lead to a
substantial increase in the
money supply.
Increasing Reserve
Requirements
• Hold more money in reserve,
• shrinking the money supply.
Discount Rate
The discount rate is the interest rate that banks pay to borrow money
from the Fed.
Reducing the Discount Rate Increasing the Discount Rate
This causes banks to lend out • This causes banks to lend
more money, which leads to
out less money, which leads
an increase in the money
to a decrease in the money
supply.
supply.
Open Market Operations
The most important monetary tool is open market operations.
Open market operations are the buying and selling of government
securities to alter the money supply.
Bond Purchases
• In order to increase money
in circulation, the Fed buys
bonds and securities from
citizens to put $ in their
pockets.
Bond Sales
• When the Fed sells bonds,
it takes $ out of the
citizen’s pocket and
replaces it with a piece of
paper.
How Monetary Policy Works
Monetarism is the belief that the money supply is the
most important factor in macroeconomic performance.
The Money Supply and Interest
Rates
• The market for money is like
any other, and therefore the
price for money — the
interest rate – is high when
the money supply is low and
is low when the money
supply is large.
Interest Rates and Spending
• If the Fed adopts an easy
money policy, it will
increase the money
supply. This will lower
interest rates and increase
spending. This causes the
economy to expand.
• If the Fed adopts a tight
money policy, it will
decrease the money
supply. This will push
interest rates up and will
decrease spending.
The Problem of Timing
Good Timing
• Properly timed economic policy will
minimize inflation at the peak of the
business cycle and the effects of
recessions in the troughs.
Bad Timing
• If stabilization policy is
not timed properly, it can
actually make the
business cycle worse.
Business cycle
Business cycle with
properly timed
stabilization policy
Real GDP
Real GDP
Business Cycles and Stabilization Policy
Business cycle with
poorly timed
stabilization policy
Business
cycle
Time
Time
Fiscal and Monetary Policy Tools
The federal government and the Federal Reserve both
have tools to influence the nation’s economy.
Fiscal and Monetary Policy Tools
Fiscal policy tools
Expansionary
tools
Contractionary
tools
1. increasing government
spending
2. cutting taxes
1. decreasing government
spending
2. raising taxes
Monetary policy tools
1. open market operations:
bond purchases
2. decreasing the discount
rate
3. decreasing reserve
requirements
1. open market operations:
bond sales
2. increasing the discount
rate
3. increasing reserve
requirements