The Federal Reserve System the Fed

The Federal Reserve System the Fed

12 Federal Reserve Districts Commercial banks banker

Board of Governors

Board of Governors 7 members appointed by president approved by Senate 14 yr. term chairman Janet Yellen Formerly Ben Bernanke Janet Yellen, the first woman to hold the position. Yellen was nominated on October 9, 2013, by President Obama and, confirmed by the United States Senate on January 6, 2014.

6 Major Jobs of the Fed Supply the economy with paper money and coins. Hold bank reserves. Provide check-clearing services Supervise member banks Serve as lender of last resort. Control the money supply

1.Supply the economy with paper money and coins. U.S. Mint Bureau of Engraving and Printing

2. Hold bank reserves reserves at the Fed + vault cash =total reserves

3.Provide check-clearing services Facilitates check-cashing between commercial banks. for example, Wells-Fargo and Bank of America

Between banks, cities EXAMPLE: Pete pays Sue for a used car. He gives her a check for $2,000. Sue deposits the check in her bank and is credited with $2,000 in her account. Sue s bank sends the check to FRB who increases the bank s reserve account by $2,000. FRB decreases Pete s bank s reserve by $2,000 FRB notifies Pete s bank to reduce Pete s account by $2,000.

4. Supervise member banks 5. Serve as lender of last resort Fed may audit a bank check that the loans it made are good be sure it has followed banking rules verify the accuracy of its accounting. Fed can lend funds to struggling banks. Glass-Steagall Act (1933) establishes FDIC

6. Control the money supply. I kept the most important for last! Tools for changing the money supply Reserve Requirement Discount Rate Open Market Operations Why is changing the money supply important? TO CONTROL INFLATION and/or UNEMPLOYMENT Monetary Policy

Review Answers 1. Federal Open Market committee: major decision maker in the FRB. 2. Federal Reserve System : US Central Bank 3. Board of Governor s : controls and coordinates fed activities (7 members) 4. Reserve account: funds required to be held in the FRB

Review Describe the structure of the Federal Reserve System. 7 member Board of Governors appointed by president, ratified by Senate 14 year term, chairman 12 districts In what year was it founded? 1913

Review 1. 6 major jobs? Supply the economy with paper money and coins. Hold bank reserves. Provide check-clearing services Supervise member banks Serve as lender of last resort. Control the money supply

Review Why would a bank choose to join the Federal Reserve System? FRB helps maintain bank stability Consumers want their accounts to be covered by FDIC

Review Describe the check-clearing process. Pete pays Sue for a used car. He gives her a check for $2,000. Sue deposits the check in her bank and is credited with $2,000 in her account. Sue s bank sends the check to FRB who increases the bank s reserve account by $2,000. FRB decreases Pete s bank s reserve by $2,000 FRB notifies Pete s bank to reduce Pete s account by $2,000.

The Money Creation Process Think of our banking simulation for fractional reserve banking

The Money Creation Process

Fed Tools for Changing the Money Supply

These tools are used to implement MONETARY POLICY Monetary policy has two basic goals: to promote "maximum" sustainable output and employment to promote "stable" prices

Why would the Fed want to change the money supply? Slow INFLATION (too much money chasing too few goods) Lower UNEMPLOYMENT (too many people out of work) Promote Growth in the Economy Slow down an over-heated economy Adjusting for the normal business cycle

Typical Business Cycle

Long Term Growth

Monetary Policy Fed is responsible for maintaining price stability and employment Expansionary Monetary Policy goal is to increase money supply to reduce unemployment to avoid deflation Contractionary Monetary Policy goal is to decrease the money supply to reduce inflation To prevent bubbles

3 Important Tools 1. Changing the Reserve Requirement 2. Changing the Discount Rate 3. Conducting Open Market Operations The three tools are interactive

1. Reserve Requirement currently: 3-10% Raise the reserve requirement = Less money in circulation slows the economy eventually brings price stability (lowers inflation) Lower the reserve requirement = More money in circulation More money to buy goods and services requiring more jobs to produce them (lowers unemployment)

2. Changing the discount rate discount rate = interest rate on fed to bank loans (set by Fed) federal funds rate = interest rate on bank to bank loans (set by fed funds market) Raising the interest rate influences how much banks will decide to borrow from the fed (who will lend them money out of thin air, increasing money supply) Keeping the discount rate low encourages borrowing

federal funds rate=interest rate on bank to bank loans discount rate=interest rate on fed to bank Another loans bank When the federal funds rate is lower than the discount rate, who would you borrow from? When the discount rate is lower than the federal funds rate, who would you borrow from? The fed The Fed can encourage borrowing by keeping rates low

currently: discount rate -.75% federal funds rate - 0-.25% 2006 discount rate - 6.25% federal funds rate - 5.25% What is the Fed trying to do?

Federal Open Market Committee (FOMC) controls Open Market Operations Open Market Purchases buys government securities = increases money supply Open Market Sales sells government securities = reduces the money supply 1

Important Background Information U.S. Department of the Treasury the agency of government responsible for paying for government and its actions collects taxes borrows money if needed It borrows from the public by offering securities» securities: promises to repay with interest at some future time

Open Market Purchases Fed offers to buy your government security. Thin air money is given to you. Money supply increases

Open Market Sales Fed offers to sell government securities it holds. You pay for it. Your money disappears into the Fed Decreases the money supply.

Review What are three ways the Fed can control the money supply? Reserve Requirement Discount Rate Open Market Operations

Review Why does the Fed want to control the money supply? Monetary Policy: maintain employment control inflation

Review What is the reserve requirement? If the Fed wants to reduce the money supply, what does it do to the reserve requirement? What is the discount rate? What is the federal funds rate? If the Fed wants to increase the money supply, what does it do to the discount rate?

Review What is the difference between an Open Market Sale and an Open Market Purchase? action? goal?