1. Monetary Policy

2. Role of the Federal Reserve
Est. by President Wilson in 1913
Supervises member banks
Holds Cash Reserves
funds available for short-term borrowing by commercial banks or government
guarantees that money is available in the economy when needed
Moves money into and out of circulation

3. Characteristics of the Federal Reserve (independent of elected officials)
Lack of a Single Central Bank
most countries have single central bank
Fed relies on district banks to carry out national policies
Ownership and Control by the Member Banks
in countries with a central bank gov’t owns all shares of stock, allowing tight control
member banks own stock in Fed; resulting in political independence
Optional membership in the Fed for some banks
nationally chartered banks must be members; state chartered banks are optional
less than 40% of banks nationally are Fed members; 5800 Member Banks

4. Organization of the Fed
Board of Governors (another mechanism for independence)
highest policy making body in Fed regulating money supply
7 member board appointed by President; serve 14 years; new appointment every 2 years; each serves 4 year terms
7 members and Chairman (Ben Bernanke) are permanent members of the Federal Open Market Commission
Federal Open Market Commission—12 member committee; decides whether to buy or sell gov’t securities
Board of Governors plus 4 district bank presidents that rotate
Federal Reserve Banks—1913,
12 F.R. district banks that deal only with government and financial institutions that serve a designated geographic region
25 branch offices
Member Banks
2750 national member banks
1000 state member banks

5. Organization of the Federal Reserve

6. Federal Reserve District Banks

8. Services to Banks: 12 district banks don’t have checking, savings accounts; they service member banks
Clearing Checks
Americans write 40 billions checks a year
Fed tracks this by crediting and debiting reserve accounts
Loans to Banks
we get loans from banks; banks get loans from Fed
banks need loans to cover increased withdrawals or loans
most are short-term to cover immediate problem
farm loans, natural disasters, financial emergencies
participating banks face strict monitoring and scrutiny

9. Services to Government
Dept. of Treasury is Gov’t banker; collect taxes through IRS and Customs; produces money with U.S. Mint; Fed is gov’t bank
Serving as the Government’s Bank
serves as depository for federal revenues; deposited by Treasurer
holds a Treasury checking account
records the deposits and withdrawals of federal funds
advises Congress and President on economic policy
Supervising member banks “banking systems watchdog”
monitors loans and investments and reviews bank records of reserves
regulates bank mergers
Regulating the Money Supply—amount of money circulating in the economy
Dollars—printed by Bureau of Engraving and Printing
Coins—printed by U.S. Mint
Fed distributes currency
Currency is put into distribution for 2 reasons:
replace old and worn out notes
increase amount of money in circulation by buying or selling government securities (T-bills and bonds)

10. Money Supply: Economists way to measure the nation’s money supply
M1—easiest way to measure only easily accessible
counts all currency in circulation + travelers checks + checking account deposits
checking accounts are 63% of M1
M2—a broader measure used by those who feel M1 doesn’t measure all accessible money
Counts M1 + mutual funds + savings deposits + time deposits < $100, 000
M3 and L—both are broader measures than M2
M3 counts M2 + large time deposits
L counts M3 + savings bonds + short term T-Bills + any other Near money

11. Questions Who is the current Chairman of the Federal Reserve?
What are the three roles of the Federal Reserve?
The Federal Reserve is broken into 4 levels of organization. What are the four levels, and what is the role of each?
What services does the Fed offer to member banks?
What services does the Fed provide the federal government?
What events led to the creation of the Federal Reserve System?
How is the Federal Reserve System designed to be largely independent of the federal government? Why would this separation from elected representatives be desirable?
How would Fed policy change if Mr. Bernanke were an elected official instead of appointed?
What services does the Fed provide to banks?
How does the Fed serve the government?
What are the four different measurements of the U.S. money supply? Which funds are included in each measurement?

12. Monetary Policy
Monetary Policy—plan to expand or contract the money supply in order to influence the cost and availability of credit
done by regulating money supply and interest rates;
Policy is based on the Federal Reserve measures of the money supply and Aggregate Demand
Policy is enacted by the Federal Reserve

13. Monetary Policy: Strategies
Easy-Money Policy—designed to expand money supply, increase aggregate demand, reduce unemployment, and promote economic growth during recessions
Charges banks lower interest rates, encourages borrowing (spending)
Fed can expand money supply by buying securities
Tight-Money Policy—Slows business activity and helps stabilize prices to reduce aggregate demand
Results from inflation when too much money is circulating and credit is too easily accessible
Fed can raise interest rates to make credit less accessible
Fed can decrease the money supply by selling securities

14. Monetary Policy: Tools—ways to affect aggregate demand
Open-Market Operations—buying and selling of securities
To contract money supply Fed sells government securities. Cash paid for securities is withdrawn from bank reserves, shrinking money supply and decreasing aggregate demand
To expand money supply Fed buys government securities. Money makes it way into individual and business accounts increasing cash reserves and loan pools. This increases aggregate demand which leads to an increase in production
Discount Rate—interest rate that the Fed charges member banks for the use of its reserves.
a lower interest rate encourages banks to borrow more for their reserves. They then loan this to businesses and consumers to spend, increasing aggregate demand
increasing interest rates discourages banks from borrowing. Banks will pass this increased interest onto businesses and consumers by raising the prime rate, ultimately decreasing the amount of loans that are made, decreasing aggregate demand.
prime rate—interest rates banks charge on loans to their most reliable business customers
law of demand—as price to borrow money increases (prime rate) demand decreases; as price decreases demand increases

15. Monetary Policy: Tools—ways to affect aggregate demand
Reserve requirements—changes affect lending capacity of banks
increase reserve requirement—less money available for loans
decrease reserve requirement—more money available for loans
“Moral Suasion”—attempts by the Federal Reserve to put pressure on the member banks either to increase or decrease all or certain kinds of loans. Takes form of news releases, letters of appeal, Congressional testimony and conferences.

16. Summary of Monetary Policy Tools
Formal Tool
Fed Action
Effects on Economy
Money Supply
Open Market Securities
Buys gov’t securities
Bank reserves increase; aggregate demand & production increases
Expands
Sells gov’t securities
Bank reserves shrink; aggregate demand decreases
Contracts
Discount Rate
Lowers discount rate
Encourages banks to borrow from the Fed; bank reserves increase
Raises discount rate
Discourages banks to borrow from Fed; bank reserves decrease
Reserve Requirement
Lowers the reserve requirement %
Banks hold fewer reserves & extend more loans; interest rates fall; Aggregate demand increases
Raises the reserve requirement %
Banks hold more reserves & extend fewer loans; interest rates rise; Aggregate demand decreases
contracts

17. Challenges to Monetary Policy
Economic Forecasting
U.S. economy has millions of economic actors buying, selling, producing
Forecast can be difficult, and if incorrect could harm economy
Time Lags
collection and analysis of economic data
discussion and debate to reach consensus on data
consumers/ producers need time to adjust their economic activity
Priorities and Trade-offs
easy-money policy fights recession, but increases inflation
tight-money policy fights inflation, but contributes to recession
Lack of Coordination
sometimes Monetary Policy will conflict with Fiscal Policy
Conflicting Opinions
economics is not an exact science and can be influenced by personal economic philosophies of conservative v. liberal

18. Questions!
How does Monetary Policy affect investment spending in factories and equipment? The housing market? Consumer spending?
Who enacts Monetary Policy? Why is Monetary Policy easier to enact than Fiscal Policy during periods of inflation?
What are the tools of Monetary Policy?
What Monetary Policy should be enacted during a recession? Inflation?
What are some challenges to enacting Monetary Policy?
Considering our current economic situation, would you expect the Fed to enact easy money or tight money policies?