Economics Unit 14. The Federal Reserve and Monetary Policy

Transcription

1 Economics Unit 14 The Federal Reserve and Monetary Policy These documents are being distributed for educational discussion purposes only. They do not reflect any attempt by the North East Independent School District, its trustees, administrators, or teachers, to promote any particular viewpoints or opinions expressed in the documents over any others, nor do the viewpoints or opinions expressed in the documents necessarily reflect those of the NEISD, its trustees, administrators or teachers.

2 Sect. 1: The Federal Reserve System The first two attempts at establishing a central banking system for the US failed mainly because too many people felt it placed too much power at the federal government level The 1800 s ended without a central banking system being established

3 Panic of 1907 Because no central bank existed, there was no way for the money supply to grow Businesses and individuals had to compete for a fixed amount of loanable money Since they were unable to borrow money they began to withdraw savings which caused a series of runs on banks Banks had nowhere to go for emergency cash and panic took over when banks could not allow customers to withdraw their savings

4 Panic of 1907 Another reason for the panic was that the system of pyramided reserves failed With pyramided reserves, smaller banks deposited their reserve cash with a larger bank, that bank then deposited their reserve cash into yet larger banks, then those banks into even larger banks The largest banks made loans and held the rest as their own reserve

5 Pyramided Reserves

6 Financial Panic Drains Reserves During the 1907 financial panic the smaller banks rapidly began to withdraw their reserves from the bigger banks Those large banks did not have enough cash to cover the reserve withdrawals and banks at all levels to go bankrupt Businesses and individuals went bankrupt as a result and many depositors lost all or part of their deposits Let s look at a panic 10:29-13:30

7 Ours Is Not The Only One The Federal Reserve (the Fed) is not the worlds only central bank The United Kingdom, Japan, and Canada and many more countries have a central bank

8 What makes our central bank different? Our central bank is different in three distinct ways We don t just have one central bank Our central bank is not owned by the US government Membership in the central bank is optional in some cases

9 Not just one central bank Our central banking system is made up of 12 banks called district Federal Reserve banks Each district bank carries out the banking policies developed at the national level, but each district bank can develop policies that are unique to the needs of their districts

10 Who owns the Federal Reserve banks? In every other country with a central banking system the government owns most or all of their central banks The US government does not own any of our Federal Reserve bank All of the stock in the Fed is owned by banks who are members of the Fed system Gives the Fed independence

11 Whose membership is optional? All banks with federal charters must be members of the Fed State chartered banks have the option to join the Fed today virtually all do (more info later)

12 The 12 district banks Texas is in the 11th district and is headquartered in Dallas. It has 3 branches located in Houston, San Antonio, & El Paso. The district covers northern Louisiana, southern New Mexico, and all of Texas.

13 Federal Reserve Bank of SA

14 Organization of the Fed Because so many people were afraid that a central bank would hold too much power over the nation as a whole, the Fed was organized with part of it at the national level and other parts spread among the 12 districts

15 What s at the national level? The national level has two parts The Board of Governors Federal Open Market Committee (FOMC) The Board of Governors has seven members all appointed by the President and confirmed by the Senate Their duty is to supervise banking services and make policy to control the money supply Janet Yellen: Chairman of the Board of Governors

16 More about the Board of Governors The seven governors are appointed for 14 year terms with the chairman serving a 4- year term Their service is staggered with only 1 governor being appointed every 2 years The 14 year appointments give each governor autonomy and shelters them from political influence since 2-4 Presidents, 7 congresses, and 3 senatorial terms span their 1 appointment

17 Now for the FOMC The Federal Open Market Committee has 12 members the 7 governors and the President of the Federal Reserve Bank of New York are permanent members the other 4 are Presidents of the remaining 11 district banks who serve on rotating 1 year terms

18 Who runs the district banks? Each district bank has a 9 member board 6 board members are elected by the stock owning member banks in the district 3 can be bankers, but 3 must be nonbankers with business or academic experience 3 more are elected by the Board of Governors in Washington

19 Sect. 2: The Federal Reserve at Work The Fed does not serve the public directly It does provide services to member banks the federal government That serves the public indirectly

20 Services to Banks The Fed oversees the flow of money between member banks and the Fed s district banks by check clearing, the process of crediting and debiting bank reserve accounts to process the billions of checks written every year by customers of commercial banks providing coin and currency service (v) making loans to member banks Fed Video 2:35-4:25

21 Basics of Check Clearing

22 Why do banks need loans? Banks do keep cash in reserve to meet normal customer cash demands but sometimes demands are unusual causing banks to go to the Fed to borrow money to meet large or unexpected withdrawals made by a banks customers to provide seasonal cash needs during harvest/ planting times or heavy withdrawals around Christmas to provide cash to meet withdrawal needs following emergencies like hurricanes or floods Fed Video: 5:00-10:04 Banks must provide collateral to the Fed when borrowing money much like we do

23 Services to the Government The Fed s role in managing the governments financial activities consists of serving as the governments bank supervising the Fed s member banks regulating the nations money supply

24 Serving as the Government s Bank The Fed accepts deposits of federal money from all sources Income Tax, SS Tax, Fees Maintains government treasury checking accounts on which the government writes checks for things like tax refunds, social security payments, and all other government payments Oversees sales and purchases of government securities such as T-Bills

25 Supervising Member Banks The 12 Federal Reserve banks supervise the financial activities of member banks in their regions monitor loans and investments conduct reviews/audits of banks records monitor banks cash reserve requirements regulate bank mergers charter banks and bank holding companies Fed Video: 16:33-20:15

26 Regulating the Money Supply The Fed also regulates the nation s money supply, (the amount of money circulating in the US economy) by distributing currency produced by the Bureau of Engraving and Printing distributing coin produced by the US Mint Constantly exchanging worn out notes and coin for new ones

27 Regulating the Money Supply The Fed also expands or decreases the pool of cash that the Federal Reserve banks can loan by buying or selling US government securities on the open market all securities sales or purchasing is handled by the Federal Reserve Bank of New York (might explain why the President of this district bank is a permanent member of the FOMC while others rotate on and off the FOMC)

28 Measures of the Money Supply Three measures used are, the M1, M2, & M3 The M1 measure consists of money that is easily accessible and in circulation currency travelers checks checking account deposits

29 Measures of the Money Supply The M2 measure consists of all of the elements of the M1 plus money market accounts money market mutual funds all other savings (like CD s) in amounts under $100,000

30 Measures of the Money Supply The M3 measure consists of all money counted in M2 plus large time deposits (CD s over $100,000) US dollars deposited by US residents in US dollar bank accounts overseas (Eurodollars) repurchase agreements (sales of securities to be used as collateral with an up front agreement to buy them back)

31 Sect. 3: Monetary Policy Strategies The Fed regulates the amount of money and credit available in the economy Monetary policy is the plan to expand or contract the money supply in order to influence the cost and availability of credit By controlling the money supply, the Fed also controls aggregate (total) demand for goods and services

32 Easy-Money An easy-money policy is a design to expand the money supply, increase aggregate demand, create jobs, reduce unemployment & promote economic growth The Fed does this by lowering interest rates which makes loans easier to get (quantitative easing) That causes more demand in the marketplace

33 Tight-Money The opposite of easy-money, tight-money slows business activity, stabilizes prices, reduces the supply of money, makes loans harder to get, reduces aggregate demand and contracts the money supply The Fed does this by raising interest rates This causes less demand in the marketplace

34 Components of Monetary Policy The Fed influences the money supply, the availability of credit, and aggregate demand through open-market operations the discount rate the reserve requirement margin requirements moral suasion

35 Open Market Operations The Federal Open Market Committee (FOMC) buys and sells government securities through the Federal Reserve Bank of New York To expand the money supply the FOMC buys government securities (puts dollars back in circulation) To contract the money supply the FOMC sells government securities (then takes the money from the sales out of circulation)

36 Discount Rate / Prime Rate The discount rate is the interest rate that member banks are charged when they borrow money from the Fed Lowering the rate encourages banks to borrow from the Fed and in turn fund loans to consumers Increasing the rate discourages banks from borrowing from the Fed and makes loans harder to get through the economy Banks set their own prime rate which is the rate they charge to their most reliable business customers

37 Reserve Requirement The Fed requires member banks to meet a reserve requirement, which is money held in the banks own vaults or on deposit at the Fed (this money gives the bank cash to use to meet customer demands and to fund loans) Current reserve requirements are between 4% & 12% of transaction account totals (checking/money markets) There is no reserve requirement on time deposits and other savings accounts

38 Margin Requirements The Board of Governors sets margin requirements, the percentage of cash an investor must have to buy stocks, options, and other investments A higher requirement discourages investments in the stock market A lower requirement encourages investment in the stock market Ex. A 60% margin would mean an investor could purchase stock with 60% cash and 40% borrowed money

39 Moral Suasion Moral suasion refers to unofficial pressures Fed policy puts on banks to channel lending policies of banks in directions the Fed wants them to go This is done through letters, conferences, press releases, testifying before congress, etc. They can do this without imposing formal regulations

40 Challenges Faced by the Fed Some challenges that the Fed must deal with are economic forecasting time lags in developing and carrying out monetary policy priorities and trade-offs lack of coordination among government agencies in formulating economic policies conflicting opinions about monetary policy

41 Challenges Faced by the Fed Economic forecasting, or predicting future business activity and consumer spending; this is difficult because the US economy contains millions of economic actors, products and markets Time lags, the time between when policies are developed and put into place, disrupt the effectiveness of the Fed s monetary policy (sometimes can take months)

42 Challenges Faced by the Fed Monetary policy is designed to fight off either inflation or recessions Sometime creating a policy to fix one problem creates new problems elsewhere in the economy Ex. A tight-money policy intended to combat inflation also contributes to decreased business activity and recession The Fed must weigh the trade-offs of each decision it makes

43 Challenges Faced by the Fed Sometimes different levels of government lack coordination Fed policy, congressional decisions, and presidential mandates conflict sometimes Not everyone agrees about the ways to steer the economy Maybe economics is not a science

44 References Economics: Texas Edition: McGraw Hill Education Holt Economics; Texas Edition: 2003, Holt, Rinehart and Winston