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The Federal Reserve and the Supply and Cost of Credit

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  1. Chapter 3 The Federal Reserve and The Supply and Cost of Credit

  2. The Federal Reserve(the Fed) • The nation's central bank • Purpose: to control the supply of money in order to achieve • Stable prices • Full employment • Economic growth

  3. The Assets of the Fed • Gold certificates • Cash items in process • The float • U.S. government securities • Foreign currencies

  4. The Liabilities of the Fed • Federal Reserve Notes • Deposits by • Banks (reserves) • Federal government • Foreign depositor

  5. Structure of the Federal Reserve • Board of Governors • The twelve district banks • Federal Open Market Committee

  6. Structure of the Federal Reserve

  7. Expansion of Money and Credit • Fractional reserve banking • Expansion (and contraction) of the money supply • Importance of excess reserves

  8. Multiple Expansion • Reserves are either • Required or • Excess • The process of loan credition

  9. Multiple Epansion of the Supply of Money Initial Dep: $100 Reserve Req: 10%

  10. Multiple Expansion • Change in the money supply = change in excess reserves / reserve requirement

  11. Multiple Expansion • Reserve requirement = 10% • Reserves increase by $100 • Possible increase in the money supply: $100/0.1 = $1,000

  12. Impact of Cash Withdrawals • Multiple expansion in reverse • Money supply contracts

  13. Importance of the Federal Funds Market • Market for reserves • The lending of reserves between banks • The federal funds rate

  14. The Tools of Monetary Policy • The discount rate • Rate the Fed charges banks to borrow reserves

  15. The Discount Rate

  16. The Reserve Requirement • Percentage banks must hold against deposit liabilities • Changing commercial banks' reserves leads to: • Multiple expansion or • Multiple contraction

  17. The Tools of Monetary Policy • Open market operations • The buying and selling of Federal government securities • By far the most important tool of monetary policy

  18. Impact of The Federal Reserve • The Fed affects interest rates through its impact on the ability of the banking system to lend

  19. Monetary Expansion • To expand the money supply, the Fed buys government securities • Paying for the securities puts reserves into the banking system • The purchases reduce interest rates

  20. Monetary Contraction • To contract the money supply, the Fed sells government securities • Receiving payment for the securities removes reserves from the banking system • The sales increase interest rates

  21. Fiscal Policy • The federal government's • taxation • spending • debt management

  22. Deficit Spending • Government spending exceeds revenues • Sources of funds to finance the deficit • commercial banks • non-bank public • Federal Reserve

  23. Surplus • Government revenues exceed revenues • Question of how to use any surplus

  24. Fiscal Policy • The possible impact of deficit spending or a surplus on • the money supply • the reserves of the banking system • security prices

  25. Inflation • General increase in prices • CPI - measures the rate of inflation • Excessive expansion of money

  26. Changes in Inflation • Affect firms with natural resources • Oil • Precious metals (e.g., gold) • Some firms are better able to pass on price increases

  27. Fight Inflation by • Contracting the money supply • Raising interest rates • Raising taxes

  28. Deflation • A general decline in prices • Opposite impact of inflation • Unexpected deflation hurts debtors and helps creditors

  29. Impact of Monetary and Fiscal Policy on the Firm • Cost of funds • Demand for firm’s products and services • Ability to anticipate changes in economic policy

  30. Foreign Exchange • Foreign currencies • Exchange rate • Value of one currency in terms of another

  31. Foreign Exchange • Devaluation - depreciation of a currency • Revaluation - appreciation of a currency

  32. Fluctuations in the British Pound

  33. Balance of Payments • Current account • merchandise trade deficit or surplus • Capital account • Official reserve account - The IMF

  34. Balance of Trade

  35. International Monetary Fund (IMF) • Bretton Woods agreements • Loans to less-developed countries

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