Federal Reserve and Money Supply Mr. Odren
The Fed • Congress created Fed in 1913 as Central Banking organization. • Major purpose: End periodic financial panics that had occurred in 1800 and early 1900s • Other responsibilities: processing checks (why is this getting less important?), serving as the government’s banker. • 12 Federal Reserve banks that serve as the nation’s banks are distributed throughout the country. Trillions of dollars pass through the Fed • Closest Fed Bank to De: Philadelphia
Monetary Policy • Main role of Fed is Monetary Policy. • Monetary policy is the use of a government’s control over the supply of money to influence the economy. Current monetary policy involves setting interest rates. When interest rates are low, companies often borrow money to invest in new projects, and individuals often borrow money to finance purchases like homes and cars.
Credit • The Fed and banks use credit as part of Monetary Policy • Credit subject to supply and demand. • Credit has a cost: Interest that must be paid to obtain it. • As cost of credit increases, the quantity demanded decreases. If cost drops, quantity demanded rises.
Balancing Monetary Policy • Loose Money Strategy: means credit is inexpensive to borrow and abundant. • Loose Money strategy can lead to Inflation • Tight Money Strategy: credit is expensive to borrow and in short supply. • Tight Money strategy can lead to Recession
Monetary Policy Goal • Goal of Fed is to strike a balance between the two strategies. ECONOMIC STABILITY • Responsibility to ensure money and credit are plentiful enough to allow economic expansion • However, cannot let money supply become so plentiful that rapid inflation results.
Functions of the Fed • Serves as the bank for U.S. Government • Is a clearinghouse for checks • Distributes coins and currency • Regulates and supervises banks and enforces consumer legislation related to banking • Lends to banks as a last resort • Stabilizes the economy through control of the money supply
Tools of the Fed • Sets reserve requirements (percentage of deposits which must be kept as cash and cannot be loaned out) • Sets the discount rate (interest rate charged to banks and the federal funds rate which is the interest rate banks charge each other) • Performs Open Market Operations (buying and selling of government securities