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The Federal Reserve System Monetary Policy. Functions of the Federal Reserve System 1.Financial Services a.The “banker’s bank” 2.Supervise and Regulate.

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Presentation on theme: "The Federal Reserve System Monetary Policy. Functions of the Federal Reserve System 1.Financial Services a.The “banker’s bank” 2.Supervise and Regulate."— Presentation transcript:

1 The Federal Reserve System Monetary Policy

2 Functions of the Federal Reserve System 1.Financial Services a.The “banker’s bank” 2.Supervise and Regulate Banking Institutions a.Regulating commercial banks 3.Maintain Stability of the Financial System a.Think financial crisis of Conducting Monetary Policy a. Most common tool used by the government to “flatten out” macroeconomic fluctuations

3 Federal Reserve in Action 1.Reserve Requirement a.Large banks must maintain a minimum reserve requirement How would a change to the reserve requirement affect economic activity? b.Federal Funds Rate = the rate at which member banks can borrow from one another (banks short of reserves can borrow from banks with excess reserves) 2.The Discount Rate a.The rate at which banks can borrow directly from the Federal Reserve b.Usually 1% higher than the Federal Funds Rate Why? c.Can be manipulated to spur economic activity How so? 3.Open-Market Operations (OMO) a.The Federal Reserve buys/sells U.S. Treasury bills to commercial banks b.Most commonly-used tool in monetary policy

4 Open Market Operations: How they Work Assets Liabilities Open Market Purchase of $100 Million Treasury Bills+$100 million Monetary Base+$100 million Assets Liabilities Treasury Bills-$100 millionNo change Federal Reserve Commercial Banks Reserves+$100 million These transactions don’t inject money directly into the economy. So how do they affect economic activity?

5 Open Market Operations: How They Work Assets Liabilities Open Market Sale of $100 Million Treasury Bills- $100 million Monetary Base- $100 million Assets Liabilities Treasury Bills+$100 millionNo change Federal Reserve Commercial Banks Reserves- $100 million These transactions don’t inject money directly into the economy. So how do they affect economic activity?

6 If the Fed wants to The could ___________ the Reserve Requirement Or they could ____________ the Discount Rate Or they could conduct an OMO by _____________ T-Bills These actions would serve to _____________ bank reserves. Banks would therefore _________ the amount of reserves loaned to the public And ultimately the money multiplier process would __________ the money supply Increase the money supply Decrease the money supply


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