16-1: THE FEDERAL RESERVE SYSTEM

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1 16-1: THE FEDERAL RESERVE SYSTEM

2 Learning Objective 1. I will demonstrate my understanding of the role of the Federal Reserve, our nation s central bank.

3 What is the Federal Reserve System? It is the central bank of the U.S. that directs the nation s monetary policy Created in 1913 with the passage of the Federal Reserve Act Known as the banker's bank

4 The Duties of the Fed Supervises banks in the U.S. by providing regulation and oversight Maintains cash reserves

5 The Duties of the Fed Transfers funds between banks Distributes currency, coin and paper money, and regulates the supply of money

6 Structure of the Fed Board of Governors: 7 appointed members (with Senate approval) who serve a single 14-year term Supervise the operations of the Fed and guide monetary policy Analyze domestic and international economic and financial conditions

7 Structure of the Fed The Board's most important responsibility is participating in the Federal Open Market Committee (FOMC), which conducts our nation's monetary policy

8 Structure of the Fed The chairman of the BOG is the most influential member Currently, this position is held by Janet Yellen

9 Structure of the Fed The Federal Reserve System is organized into 12 district banks All nationally chartered banks are automatically members of the Fed Each of the 12 Reserve Banks serves its region of the country (our branch is located in Detroit and we are part of the Chicago region)

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12 Structure of the Fed The Federal Open Market Committee (FOMC) is the Fed's monetary policymaking body It is responsible for formulation of a policy designed to promote stable prices and economic growth

13 Structure of the Fed The FOMC typically meets eight times a year in Washington, D.C. At each meeting, the committee discusses the outlook for the U.S. economy and monetary policy options

14 16-2: FUNCTIONS OF THE FEDERAL RESERVE

15 Serving the Banking System 1. Check clearing: records receipts and expenditures of bank clients 2. Lending money: the Fed can loan money to banks for a fee The Fed is the lender of last resort to prevent a banking crisis

16 Serving the Banking System 3. Regulating and supervising banks: Each Federal Reserve Bank supervises the practices of statechartered member banks in the district

17 The Fed is also the federal government s banker Serving the Federal Government Paying government bills: payments for Social Security and Medicare come out of the government s account at the Fed Likewise when the IRS collects tax revenues they are deposited within the Fed

18 Serving the Federal Government Selling government securities: selling of stocks and bonds to raise money

19 Serving the Federal Government Distributing currency: the Fed issues a standard currency Federal reserve notes are the official paper currency Fed makes sure bills are distributed to banks in the amount needed

20 The Markings on a Dollar Bill

21 There are twelve different Federal Reserve Banks responsible for printing paper money in the United States. On the one dollar bill, the bank can be quickly identified by a letter code in the Federal Reserve Seal to the left of the portrait of George Washington. The letter code is also found in the prefix of the serial number. A corresponding Federal Reserve District Number code is found in four locations. The following table is a handy reference for the bank codes: Reserve Bank Letter Designation Boston A 1 New York B 2 Philadelphia C 3 Cleveland D 4 Richmond E 5 Atlanta F 6 Chicago G 7 St. Louis H 8 Minneapolis I 9 Kansas City J 10 Dallas K 11 San Francisco L 12

22 Creating Money Creating money refers to the way money gets into circulation through deposits and loans at banks

23 Creating Money Banks are NOT allowed to loan out all of the money they have in deposits This is due to a required reserve ratio (RRR) this states the fraction of the bank s deposits that it must keep in reserve

24 Creating Money Money in excess of the RRR can be loaned out Or, it can be stored as cash in the bank s vault

25 Example #1: Money Creation The RRR is 20% Bank A has $10,000 in deposits How much must Bank A have on reserve? Answer: $2,000

26 Example #2: Money Creation What happens to Bank A if the Fed changes the RRR to 10%? Answer: Bank A has to keep $1,000 in reserve and can lend out the other $9,000

27 Factors Affecting Demand for Money The Fed monitors 2 major indicators of the money supply M1=cash and checkable deposits M2 =M1 plus savings deposits and certain time deposits

28 Factors Affecting Demand for Money Cash on hand: sometimes cash is needed to complete a financial transaction The Fed makes sure it is available especially during peak times of the year

29 Factors Affecting Demand for Money Interest rates: when interest rates are high, people place excess cash in bonds, stocks, and/or savings accounts (they want a high rate of return on their money whenever possible) When interest rates are low, more money is demanded (think loans)

30 Factors Affecting Demand for Money Cost of consumer goods and services: as the costs of goods/service increase so does the demand for money Level of income: as income increases, people tend to hold more cash