The Federal Reserve & Monetary Policy

The Federal Reserve & Monetary Policy

Essential Standards SSEMA2B: Describe the organization of the Federal Reserve System (12 Districts, Federal Open Market Committee (FOMC), and Board of Governors. SSEMA2C: Define Monetary Policy. SSEMA2D: Define the tools of monetary policy including reserve requirement, discount rate, open market operations, & interest on reserves. SSEMA2E: Describe how the Federal Reserve uses the tools of monetary policy to promote its dual mandate of price stability and full employment, and how those affect economic growth.

The Federal Reserve Act of 1913 Created the Federal Reserve System Usually referred to as the Fed. It is composed of 12 regional banks Overseen by a board of governors (7 members). The Federal Open Market Committee (FOMC) Controls monetary policy.

The Role of the Fed The Fed is the bank of the United States It processes all government payments (social security, IRS refunds, etc.) It also makes interest payments on government bonds And is responsible for issuing currency.

The Banking System The Fed provides check clearing services for member banks The process by which banks record whose account gives up money And whose account receives it. It also supervises all lending practices And makes sure that customers receive accurate information from lenders terms, conditions, interest, etc.

Reserves Banks hold only a fraction of their funds in reserve The rest has been lent to its customers. The Fed ensures that each bank keeps the required amount in reserve. The amount the bank must keep on hand is called the Required Reserve Ratio (RRR).

Monetary Policy and the Money Supply The most important role of the Federal Reserve is in controlling the money supply The total amount of currency held by individuals, plus money in bank accounts. By controlling the money supply, the Fed influences 1. The growth of the GDP (Full Employment) 2. The rate of inflation (Stable Prices)

Influencing the Money Supply The Fed controls the amount of money in the economy by four methods: 1. Altering the Reserve requirement: Reducing the RRR Increases the money supply (bank loans are allowed to lend more money) Increasing the RRR Reduces the money supply (bank loans are limited).

Influencing the Money Supply 2. Open Market Operations When the Fed buys government bonds/securities, bond sellers receive money that enters the economy and the money supply Increases. When the Fed sells bonds/securities, the money supply Decreases.

Influencing the Money Supply 3. Setting interest rates. The discount rate the interest rate the Fed charges on loans to other banks. Lowering the discount rate makes loans cheaper Banks respond by lowering the Prime Rate The interest rate that banks charge their customers. When the discount rate is lowered, the money supply INCREASES.

Interest on Required or Excess Reserves. The Fed has to pay interest on banks excess reserves. If the Fed changes the interest rate on excess reserves, it will change the money supply An increase in the interest rate will decrease the money supply. A decrease in the interest rate will increase the money supply.

Which of the following is NOT a power held by the Federal Reserve? A.) setting tax rates. B.) controlling the RRR. C.) conducting monetary policy. D.) overseeing lending practices. E.) paying interest on government loans.

Which of the following would lead to an INCREASE in the money supply? A.) an increase in the RRR. B.) a reduction in tax rates. C.) the Fed s purchase of government securities. D.) the construction of a highway. E.) an increase in the discount rate.

Which of the following would lead to a DECREASE in the money supply? A.) the Fed s sale of government securities. B.) a decrease in the RRR. C.) a decrease in the discount rate. D.) an increase in marginal tax rates. E.) the construction of a new stadium.

Money Supply Philosophy: Tight Money Tight Money Policy usually introduced in periods of expansion and inflation. The Fed will DECREASE the money supply, which will slow down the economy. There are three methods: 1. The RRR increase it! 2. Government securities sell em! 3. The discount rate increase it! 4. Interest on Reserves increase it!

Money Supply Philosophy: Easy Money Easy money policy is usually introduced during times of contraction or recession Is it designed to pump money into the economy to get it moving again. There are three methods: 1. The RRR lower it! 2. Government securities buy em! 3. The discount rate lower it! 4. Interest on Reserves Decrease it!

In 2008, US GDP declined by more than 2%. In response, you might infer that the Federal Reserve... A.) instituted a period of tight money policy. B.) called for an increase in marginal tax rates. C.) raised the discount rate by 3%. D.) instituted a period of easy money policy.

In 2014, US GDP grows by more than 18%. This causes rates of inflation that exceed 7% and the Federal Reserve responds by... A.) raising the discount rate by eight points. B.) buying back billions of dollars in government securities. C.) lowering the RRR by 3% D.) instituting a period of easy money policy.