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The Federal Reserve System and the Monetary Policy

The Federal Reserve System and the Monetary Policy. Chapter 16. The FRS. History 1790: Bank of the USA 1811 charter ends 1816: restore Second Bank of USA 1836 charter ended 1907: Bank Panic - Congress acts 1913: Federal Reserve Act. Federal Reserve Act 1913.

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The Federal Reserve System and the Monetary Policy

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  1. The Federal Reserve System and the Monetary Policy Chapter 16

  2. The FRS • History • 1790: Bank of the USA • 1811 charter ends • 1816: restore Second Bank of USA • 1836 charter ended • 1907: Bank Panic - Congress acts • 1913: Federal Reserve Act

  3. Federal Reserve Act 1913 • The Fed recommended by National Monetary Commission 1908 • 1930 - 33: tight money policy --exactly wrong, except NY region • 12 regional banks acted independently • 1935 reforms for FRS; more centralized

  4. Structure of the FED • Board of Governors • Sets monetary policy • Headquarters in Washington DC • 7 member board serve 14 years • Appointed by President, approved by Senate • President appoints chairmen - serves 4 years • Alan Greenspan: 1987 - 2006 • Ben Bernake: 2006

  5. 12 Districts • One FR Bank in each district • Monitors reports on economic and banking conditions • Member banks in district elect 3 bankers and 3 leaders in industry, commerce, or other businesses to district boards

  6. Member Banks • All nationally chartered banks • State chartered banks join voluntarily • Approximately 4,000 Fed member banks • Federal Advisory Council collects information about each district and reports to each FRS

  7. Federal Open Market Committee • FOMC • Makes key decisions about interest rates and Ms • Meets 8 times a year • Committee members • Board of governors • All governors • 12 District banks • 5 of 12 district bank presidents

  8. Functions of the FRS • Serving Government • Serving Banks • Regulating Banks • Regulating Money Supply Ms

  9. FRS: Serves Government • Federal Governments Bank • Checking accounts for Treasury Dept. • Government securities auction • Sells, transfers, redeems government bonds, bills, notes • Issuing currency • Federal reserve notes

  10. FRS: Serving Banks • Clears checks • Supervising lending practices • Bank mergers (bank holding company) • Lender of last resort • Federal fund rate: interest banks pay when banks loan money to banks • Discount rate: interest rate when banks borrow from the FRS

  11. FRS: Regulating Banking System • Reserve requirement • Bank examination • Net worth

  12. FRS: Regulating Ms • Factors that affect demand for money • Cash needed on hand • Interest rates • Price levels in the economy • General level of economy • Stabilizing the economy • Recession • Inflation

  13. Ms, ir and I Ms ir ir Md I Q Q

  14. Dept. of Treasury & Money • Dept. of Treasury manufactures money • prints • Coins • 2013 $1.2 Trillion • Money gets into the economy • Money creation: process by which money enters the economy • Fractional banking • Required reserve ratio (RRR) • Money multiplier = 1/rrr • Excess reserves • Reserve shortage

  15. Federal Reserve Tools • Reserve Rate (reserve ratio) • Discount Rate • Open Market Operation • Quantitative Easing (2008)

  16. Policy Options • Reserve requirement =Ms • Reserve requirement=Ms • Discount Rate =Ms • Discount Rate =Ms • Buy Bonds = Ms • Federal Fund Rate • Sell bonds = Ms • Federal Fund Rate 

  17. Using Monetary Policy • Omo are the most used of FRS monetary policy tools • Today do not change RRR • Omo or discount rate do not disrupt financial institutions • Federal fund rates Greenspan used

  18. Monetary Policy and Macroeconomic Stabilization • Recessionary gap • Ms needs to increase • Easy monetary policy • Buy bonds • Fed fund rate down • Discount rate down • Reserve requirement down • Inflationary gap • Ms needs to decrease • Tight money policy • Sell Bonds • Fed fund rate up • Discount rate up • Reserve requirement up

  19. Problem of Timing • Good timing: smooths fluctuations • Bad timing: makes economy worse • Policy lags • Inside lags: delay in implementing policy • Outside lags: time it takes for monetary policy to have an effect

  20. Predict Business Cycle • Inflation • Recession

  21. Fiscal & Monetary Policy Tools: Congruent • Expansionary Tools • Fiscal policy • G increases • T decreases • Monetary policy • Omo purchase bonds • decrease fed fund rate • Decrease reserve requirements • Decrease discount rate • Contractionary Tools • Fiscal Policy • G decreases • T increase • Monetary Policy • Omo sale of bonds • Increase Fed fund rate • Increase reserve requirement • Increase discount rate

  22. Fiscal and Monetary Policy: Not Congruent • LBJ Presidency • Spending Vietnam • Great Society • Fiscal • Increase spending • Decrease taxes • Monetary • Tight monetary policy • Sell bonds in omo • Increase reserve ratio • Increase discount rate • Obama Presidency/Republican Congress • Cut deficit / cut debt • Fiscal • Decrease spending • Increse taxes • Monetary • Loose monetary policy • Buy bonds • Decrease reserve ratio • Decrease discount rate • Quantitative Easing (QE)

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