The Federal Reserve and Monetary Policy

1. The Federal Reserve and Monetary Policy Chapter 16

2. Banking History • Monetary Policy: the actions the FED takes to influence the level of real GDP and the rate of inflation in the economy

3. The Federal Reserve Act of 1913 • Passed by Congress to deal with problems of bank runs and panics. • Creates “the FED” • 12 independent regional banks that can lend to other banks in times of need.

4. The Great Depression • The FED fails during this period because the banks still acted independently

5. A Stronger Fed • 1935 the Fed’s structure was reorganized by Congress. • Allowed for better handling of crises.

6. Structure of the Federal Reserve • Oversee the Fed • 7 members, 14 year terms, staggered

7. Chairman • Chosen from the 7 members by the president. • Serves a 4 year term • Specialist in keeping crises from getting out of control.

8. Twelve Federal Reserve Banks

9. Twelve Federal Reserve Banks • Each bank has a board of nine directors. • Chicago Board of Directors

10. Member Banks • All nationally chartered banks are required to join the Federal Reserve System. • Some state chartered banks voluntarily join. • 2,600 total banks

11. Adjust interest rates and the money supply Consist of the Board of Governors (7) and then 5 of the twelve regional bank presidents. NY Permanent, others rotate 1 year terms The Federal Open Market Committee (FOMC)

12. The Federal Reserve Functions Chapter 16 Section 2

13. Handles their banking Medicare, social security, and veteran benefits. Banker and Agent Has treasury department checking account Agent by handling bonds, bills, notes and interest payments. Serving Government

14. Issuing Currency • Federal Reserve Notes • In charge of circulation • http://www.moneyfactory.gov/ • http://www.newmoney.gov/newmoney/flash/5Currency/unveil5new.html

15. Check Clearing Supervising Lending Practices Lender of Last Resort Expanded role due to financial crisis of 2008 Serving Banks

16. Regulating the Banking System • Each financial institution must report daily its reserves. • Must maintain 10% • Bank Examinations

17. Watch the Demand for Money and use this info to stabilize the economy. Prevent inflation and keep real GDP growing Regulating the Money Supply

18. Monetary Policy Tools Chapter 16 Section 3

19. Money Creation • Treasury manufactures money • FED puts it into circulation

20. How Banks Create Money • Fractional Reserve (RRR) Required Reserve Ration • Loans with interest payments • Money Multiplier Formula • Increase in money supply = initial deposit x 1/RRR

21. Reserve Requirements • Easiest way to change money supply is for FED to adjust reserve ratio. • RRR M1 • RRR M1

22. Discount Rate • The rate the FED charges banks on loans. • Also affects money supply • Rare to be used, instead use other banks and the federal funds rate.

23. Open Market Operations • The buying and selling of government securities in order to alter the supply of money. • Sell bonds to decrease money supply. • Buy bonds to increase money supply.

25. Monetary Policy and Macroeconomic Stabilization Chapter16 Section 4

26. How Monetary Policy Works • Monetary policy affects money supply which in turn affects interest rates, which then affects investment and spending. • A lot of money = low interest • No money = high interest

27. Good timing smoothes out the business cycle. Bad timing intensifies the cycles The Problem of Timing

28. Lags • Inside lag is the time it takes to implement monetary policy • Outside lag is the time it takes for monetary policy to have an effect.

29. How Quickly Does the Economy Self-Correct? • Economists Disagree • Estimates 2-6 years

30. Homework • Page 442 #1-5