the federal reserve and monetary policy - mr. tyler's · pdf filethe federal reserve act...
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The Federal Reserve
and Monetary Policy
Part I – The Federal Reserve
System
Banking History: A Central Bank?
• Debated since 1790
• Following the Panic of 1907, Congress decided that a central bank was needed.
The Federal Reserve Act of 1913
• The Federal Reserve System “the Fed,” is
a group of 12 regional, independent
banks.
• Initially did not work well because one
regional bank would counteract another.
• In 1935, Congress restructured the Federal
Reserve so that regional banks can work
together while still representing their own
concerns.
Structure of the Federal Reserve
The Board of Governors
– Seven-member board.
– Actions taken by the Federal Reserve are
called monetary policy.
Federal Reserve Districts
– The Federal Reserve Regional Banks
monitor and report on economic activity
in their districts.
Structure of the Federal Reserve
Member Banks
– All nationally chartered banks are required to join the Fed.
– Member banks contribute funds to join the system
– This ownership of the system by banks, not government, gives the Fed a high degree of political independence.
The Federal Open Market Committee (FOMC)
– Consists of The Board of Governors and 5 of the 12 district bank presidents, makes key decisions about interest rates and the growth of the United States money supply.
The Pyramid Structure of the Federal Reserve Structure of the Federal Reserve System
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Comprehension Check 1. How many Federal Reserve Districts are there?
2. How many members are on the Board of
Governors?
3. What does FOMC stand for?
4. What year was the Federal Reserve created?
5. What year did Congress restructure the Federal
Reserve?
Part II – Federal
Reserve Functions
1. Federal Government’s Banker
–maintains a checking account for the
Treasury Department
–Processes payments: social security
checks, IRS refunds.
Serving Government
2. Government Securities Auctions
–financial agent for the Treasury
Department
–Sells, transfers, and redeems
government securities.
–Handles funds raised from selling T-
bills, T-notes, and Treasury bonds.
3. Issuing Currency
–Responsible for issuing paper
currency (Department of the
Treasury issues coins.)
Serving Banks
Check Clearing
1. Process by which banks record
whose account gives up money,
and whose account receives
money
The Journey of a Check
- After you write a check, the recipient presents it at his or her bank.
The Path of a Check
Check writer
Recipient
- The check is then sent to a
Federal Reserve Bank.
Federal
Reserve Bank
- The reserve bank collects the
necessary funds from your
bank and transfers them to
the recipient’s bank. Check
writer’s bank • Your processed check used
to be returned to you by your
bank. Now due to digital age
a record is kept only online.
2. Supervising Lending Practices
–Ensures reserves are met
–Enforces truth-in-lending laws.
3. Lender of Last Resort
–In case of economic emergency,
commercial banks can borrow
funds from the Federal Reserve.
–The interest rate at which banks
can borrow money is called the
discount rate.
Regulating the Banking System
Reserves
• Financial Institutions
MUST repost its reserves
and activities daily.
Bank Examinations
• Ensures banks follow
laws and regulations.
Regulating the Money Supply
•Best known for its role in
regulating the money supply.
•monitors the levels of M1 and M2
and compares these measures of
the money supply with the current
demand for money.
Factors That Affect Demand for Money
1. Cash needed on hand (Cash makes transactions easier.)
2. Interest rates (Higher interest rates lead to a decrease in the demand for cash.)
3. Price levels in the economy (As prices rise, so does the demand for cash.)
4. General level of income (As income rises, so does the demand for cash.)
Stabilizing the Economy
• Monitors the supply of and the demand for money in an effort to keep inflation rates stable.
Part II – Comprehension Check
1. What is M1 ?
2. What are Truth in Lending Laws?
3. Check clearing is done by what institution?
4. Who issues paper currency?
5. What MUST financial institutions do EVERY day?
Part III – Monetary Policy Tools
The Money Creation Process
• Money Multiplier Formula. The money multiplier
formula is calculated as 1/RRR.
Money Creation
You deposit $1,000
into your checking
account.
Your $1,000 deposit
minus $100 in reserves
is loaned to Elaine, who
gives it to Joshua.
$100 held in reserve
$900 available for loans
Joshua’s $900 deposit
minus $90 in reserves is
loaned to another
customer.
At this point, the money
supply has increased by
$2,710.
$90 held in reserve
$810 available for loans
Federal Reserve
Monetary Tools
1. Reserve Requirements
Reducing Reserve Requirements
Increasing Reserve Requirements
2. Discount Rate
•The discount rate is the interest
rate that banks pay to borrow
money from the Fed.
•Reducing the Discount Rate vs.
Increasing the Discount Rate
3. Open Market
Operations
•The most important monetary tool
is open market operations. Open
market operations are the buying
and selling of government securities
to alter the money supply.
Part IV – Monetary Policy and
Macroeconomic Stabilization
How Monetary Policy Works
Interest Rates and Spending
• Easy money policy, it will increase the
money supply.
• Tight money policy, it will decrease the
money supply.
•Monetarism is the belief that the money supply
is the most important factor in macroeconomic
performance.
The Problem of Timing Good Timing
• Properly timed economic policy will minimize inflation at the peak of the business cycle and the effects of recessions in the troughs.
Bad Timing
• If stabilization policy is not
timed properly, it can actually
make the business cycle worse.
Business Cycles and Stabilization Policy
Rea
l G
DP
Time
Business cycle Business cycle with
properly timed
stabilization policy
Time
Re
al G
DP
Business
cycle
Business cycle with
poorly timed
stabilization policy
•Policy lags are problems experienced in the timing of macroeconomic policy. There are two types:
Policy Lags
Inside Lags • An inside lag is a delay
in implementing monetary policy.
• Inside lags are caused by the time it actually takes to identify a shift in the business cycle.
Outside Lags
• Outside lags are the time it takes for monetary policy to take affect once enacted.
Anticipating the Business Cycle
How Quickly Does the Economy Self-Correct?
• Estimates range from two to six years.
• Since the economy may take quite a long time to
recover on its own, there is time for policymakers to
guide the economy back to stable levels of output
and prices.
•The Federal Reserve must anticipate
changes in the economy.
Fiscal and Monetary Policy Tools • The federal government and the Federal
Reserve both have tools to influence the nation’s economy.
Fiscal and Monetary Policy Tools
Fiscal policy tools Monetary policy tools
1. increasing government
spending
2. cutting taxes
Expansionary
tools
1. open market operations:
bond purchases
2. decreasing the discount
rate
3. decreasing reserve
requirements
Contractionary
tools
1. decreasing government
spending
2. raising taxes
1. open market operations:
bond sales
2. increasing the discount
rate
3. increasing reserve
requirements