Basic Finance. The Federal Reserve. An introduction to financial institutions, investments & Management Eleventh Edition.

Transcription

1 Basic Finance The Federal Reserve 5 An introduction to financial institutions, investments & Management Eleventh Edition 1

2 U.S. Treasury Federal Reserve 2

3 Economy 3

4 U.S. Treasury Prints money IRS...collects taxes Manages Govt Finances Finances Govt Debt 4

5 Government Deficit Surplus Balance Budget Treasury Bills Treasury Bonds Treasury Notes 5

6 The Role of The Federal Reserve The U.S. central bank Purpose: to control the supply of money to achieve > Stable prices > Full employment > Economic growth 6

7 Video Federal Reserve v=l0hqfaxyu8k 7

8 Structure of the Federal Reserve Board of Governors Twelve district banks Federal Open Market Committee (FOMC) 8

9 Structure of the Federal Reserve 9

10 Expansion of Money and Credit Fractional reserve banking Expansion (and contraction) of the money supply Importance of excess reserves 10

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12 Reserve Requirement Percentage banks must hold against deposit liabilities Changing commercial banks' reserves leads to: Multiple expansion or Multiple contraction 12

13 Fraction Banking System Explained Video 13

14 Fractional Banking System 14

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18 Multiple Expansion Reserves are either Required or Excess Process of loan credition 18

19 Multiple Epansion of the Supply of Money 19

20 Multiple Expansion Change in the money supply = change in excess reserves / reserve requirement 20

21 Multiple Expansion Reserve requirement = 10% Reserves increase by $100 Possible increase in the money supply: $100/0.1 = $1,000 21

22 Impact of Cash Withdrawals Multiple expansion in reverse Money supply contracts 22

23 Multiple Contraction in the Supply of Money 23

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26 Review of the Open Market Operations v=rcpekmstdek 26

27 3 Ways the Fed controls the Money Supply Reserve Requirements Discount Rate Open Market Operations 27

28 Importance of the Federal Funds Market Market for reserves Lending reserves between banks Federal funds rate 28

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31 Discount Rate Rate the Federal Reserve charges banks to borrow reserves 31

32 3 Ways the Fed controls the Money Supply Reserve Requirements Discount Rate Open Market Operations 32

33 Target Federal Funds Rate Fed establishes a target rate Fed uses open market operations to achieve target rate 33

34 Open Market Operations Buying and selling Federal government securities By far the most important tool of monetary policy 34

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39 Open Market Operations: Monetary Expansion To expand the money supply, the Fed buys government securities Paying for the securities puts reserves into the banking system Purchases reduce interest rates 39

40 Open Market Operations: Monetary Contraction To contract the money supply, the Fed sells government securities Receiving payment for the securities removes reserves from the banking system Sales increase interest rates 40

41 Monetary Policy Expansionary monetary policy Economy faces a recession Lower target for Federal funds rate Fed buys securities Expanded money supply Downward pressure on other interest rates LO

42 Monetary Policy Restrictive monetary policy Periods of rising inflation Increases Federal funds rate Increases money supply Increases other interest rates LO

43 Expansionary Monetary Policy Problem: Unemployment and Recession Fed buys bonds, lowers reserve ratio, lowers the discount rate, or increases reserve auctions Excess reserves increase Federal funds rate falls Money supply rises Interest rate falls Investment spending increases Aggregate demand increases LO4 CAUSE EFFECT CHAIN Real GDP rises

44 Restrictive Monetary Policy Problem: Inflation Fed sells bonds, increases reserve ratio, increases the discount rate, or decreases reserve auctions Excess reserves decrease Federal funds rate rises Money supply falls Interest rate rises Investment spending decreases Aggregate demand decreases CAUSE EFFECT CHAIN Inflation declines LO

45 Open Market Operations Video v=rcpekmstdek 45

46 Fiscal Policy The federal government's taxation spending debt management 46

47 Fiscal Policy The possible impact of deficit spending or a surplus on the money supply reserves of the banking system securities prices 47

48 Fiscal Policy Deficit: Government spending exceeds revenues Surplus: Government revenues exceeds spending 48

49 Deficit Spending Sources of funds to finance the deficit commercial banks non bank public Federal Reserve foreign credit markets 49

50 Inflation General increase in prices Consumer Price Index (CPI) measures the rate of inflation 50

51 Fight Inflation by Contracting the money supply Raising interest rates Raising taxes 51

52 Deflation A general decline in prices Opposite impact from inflation Unexpected deflation hurts > debtors and helps creditors Associated with higher levels of unemployment 52

53 Recession Increase in unemployment Reduction in the nation s level of output 53

54 Evaluation and Issues Advantages over fiscal policy Speed and flexibility Isolation from political pressure Monetary policy is more subtle than fiscal policy LO

55 Lags Recognition and operational Cyclical asymmetry Liquidity trap /student_view0/chapter32/ worked_problems.html LO