
The Federal Reserve System Chapter 14
Objectives • How did the Panic of 1907 affect U.S. banking? • What is the purpose of the Federal Reserve System? • How is the Fed organized? • What services does the Fed provide to banks? • How do economist measure the money supply? • Easy-money policy v. tight-money policy • How is monetary policy made?
Central Bank • Many of the founders were distrustful of a central bank • The Second Bank of the United States had its charter expire under Andrew Jackson. • No central bank was proposed again until the Panic of 1907
Panic of 1907 • Causes • No ability to expand the nation’s money supply • The system of pyramided reserves failed
Money Supply • Businesses and individuals competed for a fixed supply of funds available as loans • When these were not available, withdrawals were made from savings accounts • “Runs” on banks would occur.
Pyramided Reserves • Smaller banks deposit with larger banks who deposit with large commercial banks in New York, Chicago or San Francisco • Even small financial panics could cause serious “runs” on even the commercial banking houses.
Federal Reserve • 1908 – establishment of the National Monetary Commission • Federal Proposed the establishment of a new central bank • Reserve Act passed in 1913
Role of the Federal Reserve • Fed supervises member banks • Holds cash reserves • Moves money in and out of circulation
Characteristics of the Fed • There is no central bank. District banks carry on the policies • The government owns no shares in the Fed—Congress does have oversight • Only nationally chartered banks are required to join the Federal Reserve System.
Organization • National Level • Decisions made by the Board of Governors and Federal Open Market Committee • District Level • 12 separate federal reserve banks
National Level • The Board of Governors supervises policy and controls the supply of money • There are 7 members on the board. They are nominated by the president and confirmed by the senate and serve a term of 14 years. • The 7 members of the board and the president of the Federal Reserve Bank of New York are permanent members of the FOMC. • The remaining 4 members are district federal reserve bank presidents who serve one rotating terms
District Level • 12 District Federal Reserve Banks each serving a particular geographic region. • There are 25 branch offices located throughout the country • All commercial banks are nationally chartered and belong to the Feds • Each district has a board of 9. • The federal reserve district elect 6 members (3 may be bankers). The Board of Governors appoint the remaining 3 members.
Federal Reserve Services to Banks • Services offered by Fed Reserve Banks making your banking easier • The Fed clears checks • 1. Mrs. Pacheco writes a check to Macy’s • 2. Macy’s deposits the check in their account with Bank of New York • 3. Bank of New York credits Macy’s account for the amount of the check and sends the check to the District Fed Reserve Bank of New York • 4. The Fed Reserve Bank of New York credits the Bank of New York and sends the check to Federal Reserve Bank in San Francisco • 5. The Federal Reserve Bank in San Francisco credits the Federal Reserve Bank of New York for the value of the check and sends the check on to Mrs. Pacheco’s bank • 6. Mrs. Pacheco’s bank credit the Federal Reserve Bank in San Francisco and debits the amount of the check from her account
Loans to Banks • Federal Reserve Banks make loans to state or regional banks for the short term • Often small banks need loans to cover short term increases in withdrawals • Sometimes the Fed make loans to help in times of national emergencies
Services to Government • Serves as the Government’s Bank • Depository of Revenues • Provide a government checking account • Keeps records of deposits and withdrawals and conducts purchase and sales of T-Bills • Acts as advisor to the executive and legislative branches
The Federal Reserve acts as a “watchdog” over the 12 District Federal Reserve Banks • The District Banks have bank examiners who audit member banks to ensure proper procedures and an adequate amount of cash is available to depositors • Regulate bank mergers and charters of bank holding companies
The Fed’s regulate the nation’s money supply • Paper money is printed by the Treasury Department’s Bureau of Engraving and Printing • Coins are minted at the U.S. mints • New Currency is placed in circulation to: • Replace worn out notes • Increase the amount of money in circulation • The Fed’s increase or decrease the money supply by trading in U.S. Securities
Money Supply • Economist determine how much money is in circulation by several means: • M1 • M2 • M3 and L
M1 • The simplest of the measures • Considered in the measure are • All of the currency in circulation • All deposits in checking accounts • All Traveler’s checks
M2 • Is a broader and more encompassing measure of money • It includes everything in M1 and • Money market accounts • Money market mutual fund shares • Savings accounts • Certificates of Deposit that are less than $100,000.
M3 and L • These are the most inclusive of the measures • M3 include all aspects of M1 and M2 and • CDs over $100,00 • L include M1, M2 and M3 and • Savings bonds • Short-term treasury securities
Monetary Policy and Aggregate Demand • Fed regulates the amount of money and credit available. • Monetary policy effects the cost of credit via money supply • Aggregate demand is the demand for all goods and services
Easy Money Policy • Designed to expand the money supply. This will • Increase jobs, aggregate demand • This policy is used to aid the economy during a recession
Tight Money Policy • Slows business growth and stabilizes the economy • Inflation may develop if there is too much money in circulation • Higher interest rates, reduced aggregate demand, decreased money supply
Components of Monetary Policy • Open Market Operations • The buying and selling of government securities • FOMC makes the decision to buy or sell securities • The Federal Reserve Bank of New York handles the transactions • Selling – contracts money supply • Buying – expands money supply
Discount Rate is the interest rate that the Fed charges member banks • Adjustments are done to encourage or discourage borrowing • The prime rate is the interest rate that commercial banks charge their best customers
Reserve Requirement is the money that must be held by banks • It is a percentage of a bank’s total net transaction accounts • This percentage is on fluid accounts • The Fed can increase or decrease the money supply by adjusting the reserve requirement
The SEC can adjust the margin requirement to increase or decrease the money supply and investment • As the margin increases, investment decreases
Credit Regulation is the power to regulate consumer credit during times of nation emergency • This power was revoked in 1952.
Moral Suasion • The indirect method of the Fed exerting pressure on the economy • Done through direct appeal to banking, congress and the public • The Fed can change the lending policies of banks.
Policy Limitations • Economic forecasting • Used to develop monetary policy based on educated guesses • Time Lags • Period of time between forecast and implementation of policy • Priorities and Trade Offs • Monetary policy can fight inflation or recession • Lack of Coordination • Government agencies sometimes have agendas that differ from those of the Fed • Conflicting Opinion • Economists and government agencies often have different ideas about what will positively effect the economy