Federal Reserve
The Fed Term used to refer to the Federal Reserve System/Bank. They are the government s fiscal agent Hold and set reserve requirements Clear checks Supervise member banks Supply paper currency Regulate the money supply
The Fed Board of Governors Seven members appointed by the President Federal Open Market Committee Twelve members Meets approximately eight times a year to decide monetary policy
Reserve Requirement This is the percentage of all deposits that each bank in the Federal Reserve System must keep in their vaults, or HOLD. This money is not available to be loaned to anyone, it MUST stay in the bank. Example: If the reserve requirement is 20%, and the total amount of money that people have deposited in the bank is 10,000,000 then $2 mil must be HELD in the banks vault. This leaves $8 million to be loaned to individuals.
Changing the Reserve Requirement Fractional Reserve Banking: requiring all member banks to keep a certain percentage of their deposits. If the Fed were to change the reserve requirement from 20% to 30%, how would that change the following? The amount of money the bank must hold The amount of money available for loans
Changing the Reserve Requirement Where s the money? Does our change make more money available to individuals or put more money in the banks? Change from 20%-30% Change on the amount held by bank from $2 million to $3 million (more in bank) Change on the amount available for loans from $8 million to $7 million (less available to individuals)
Discount Rate The interest rate that the Fed charges its member banks. This determines how much banks are charged when they borrow money from the Fed It in return changes the interest rates banks charge individuals Example: If the discount rate is 5% and a bank borrows $100,000 from the Fed The bank must pay back the $100,000 it borrowed PLUS $5,000 in interest.
Changing the Discount Rate If the Fed were to change the discount rate, what would happen to the cost of borrowing money? Would it become MORE expensive to borrow money, or LESS expensive to borrow money? Remember the Law of Demand: the more something costs, the fewer people that will be willing or able to purchase it. If the discount rate increases, so does the cost of borrowing money.
Government Securities Buying and selling government securities is called open-market operations This is the tool the Fed most often uses to change the money supply. Government Securities (such as treasury bills) are bought and sold on the open market.
Buying and Selling Securities What happens to money when the Fed SELLS government securities? Where is the money? With individuals? In the banks? If the government sells you a Treasury bill, then your money is now HELD by the Fed
Loose Monetary Policy Increase the money supply (Inflation) Speed Up the economy Individuals will have MORE money when we are done What do we need to do? Raise or Lower Reserve Requirements? Raise or Lower the Discount Rate? Buy or Sell Government Securities?
Loose Monetary Policy Lower reserve requirements MORE money banks can loan out Lower discount rate Credit is cheaper (people will buy MORE) Buy Government Securities If the Fed buys back government securities, it will pay you for them (more money to individuals)
Tight Monetary Policy Decrease the money supply (Recession) Slow Down the economy Individuals will have LESS money when we are done What do we need to do? Raise or Lower Reserve Requirements? Raise or Lower the Discount Rate? Buy or Sell Government Securities?
Tight Monetary Policy Raise reserve requirements LESS money banks can loan out Raise discount rate Credit is more expensive (people will buy LESS) Sell Government Securities If the Fed sells you government securities, you pay for them (they have your money)