Presentation on theme: "The Federal Reserve and Monetary Policy"— Presentation transcript:
1 The Federal Reserve and Monetary Policy Chapter 16
2 The Federal Reserve System Chapter 16, Section 1
3 Federal Reserve Act of 1913 Created the Federal Reserve (FED) System of federal banks12 districtsOverseen by the Board of Governors7 governors14 year terms appointed by the PresidentAppoints a chair confirmed by the SenateChairs serve a four year term that can be renewed
4 FED Districts 12 districts District bank reports on economic activity in the district to the central bankMember banks... All nationally chartered banks are required to join the Fed. Member banks contribute funds to join the system, and receive stock in and dividends from the system in return. This ownership of the system by banks, not government, gives the Fed a high degree of political independence.The FOMC (Federal Open Market Committee), which 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.
5 Structure of the Federal Reserve System 12 District Reserve BanksFederal Open Market Committee4,000 member banks and 25,000 other depository institutionsBoard of Governors
7 Functions of the FED Banking and fiscal services to the government Banking and fiscal services to member and nonmember banksRegulates the banking industryTracks and manages the money supply
8 Serving the Government Acts as the Government’s bankMaintains a checking account for the treasurySells securitiesIssues currencyCoins are created at the US MintCurrency is created by the Bureau of Engraving and PrintingThe FED issues the currency
9 Serving Banks Check clearing Loans to member banks Stock to member banksSupervise lending practicesLender of last resortBanks loan money to each other and charge interest known as the Federal Funds RateThe FED can lend funds to banks in times of need and charge interestThis is called the discount rate
10 Regulating the Banking System The FED requires banks to report on their reservesExamine banks to ensure they are following regulationsExaminers look at the banks Net Worth to determine if they are in troubleNet Worth represents total assets minus total liabilities
11 Regulating the Money Supply FED is best known for regulating the money supplyFactors that affect demand for moneyCash needed on handInterest ratesPrice levels in the economyGeneral level of incomeThe laws of supply and demand work the same with the money supply
13 Monetary PolicyMonetary policy refers to the action the FED takes to influence economic performanceThe FED can use monetary policy in a number of waysMoney creation...not making it but putting it into circulationChanging reserve requirementsChanging the discount (interest) ratesPurchasing bonds
14 Money Creation Banks keep a certain amount of funds on hand The required reserve ratio (RRR) is the amount that must be kept by banks...this is established by the FEDAfter the RRR is kept, banks can loan money. This process, along with gained interest creates money...or adds it to the money supplyThe money multiplier formula tells us how much money will be created through this processHowever, banks may keep excess reserves on handMore money than is required by the RRR
15 Reserve RequirementsThe FED can influence the economy by changing the RRRRaising the RRR will reduce the money in circulationLowering it will increase the money in circulationFED does not do this today as it can be very disruptive to the loan processLoans may have to be recalled
16 The Discount RateBanks borrow from the FED and the interest charged is known as the discount rate.In turn, these banks loan to customers (you and me) and the interest rate charged is known as the prime rate.By changing the discount rate, the prime rate changes and affects our spending behaviorsRaising the discount rate will slow borrowing, spending and the economyLowering the discount rate will increase borrowing, spending, and increase the economy2nd most used form of Monetary Policy
17 Open Market Operations The most used monetary tool is open market operationsThe FED can purchase bonds to put money into circulationThey sell government bonds to take money out of circulation
18 Review 1. The required reserve ratio is (a) the ratio of deposits to reserves required of banks by the Federal Reserve.(b) the ratio of accounts to customers required of banks by the Federal Reserve .(c) the ratio of reserves to deposits required of banks by the Federal Reserve.(d) the ratio of paper currency to coins required of banks by the Federal Reserve.2. All of the following will increase the money supply except(a) increasing the required reserve ratio.(b) bond purchases by the Fed.(c) reducing the required reserve ratio.(d) reducing the discount rate.
19 Monetary Policy and Macroeconomic Stabilization Chapter 16, Section 4
20 Using Monetary PolicyMonetarism...the belief that the money supply is the most important factor in macroeconomic performanceMoney supply and interest ratesIn basic terms, the interest rate is the cost of moneyWorks under the principles of supply and demandWhen money supply is high, interest rates are lowWhen money supply is low, interest rates are high
21 Easy Money vs. Tight Money Policy When money is in low supply, the FED may follow an easy money policy...or follow policy that will increase the money supplyWhen money is in high supply, the FED will try to lower the money supply or use tight money policy
22 Timing of Monetary Policy Policies of Monetary Policy need to be carefully enacted to have the desired effect...if they are not time accordingly, they may have a negative effect on the business cycleLike with Fiscal Policy, Monetary Policy takes time to put in place and take effect...lagsInside lag... Delay in implementing monetary policyThe government takes time to recognize the problem and create a solutionOutside lag...the time it takes for the policy to have an effectPredictions of the business cycle is key in this process
23 Fiscal and Monetary Policy Tools Fiscal policy toolsMonetary policy toolsOpen market operations: bond purchasesDecreasing the discount rateDecreasing reserve requirementsIncrease government spendingCutting taxesExpansionary ToolsOpen market sales: bond salesIncreasing the discount rateIncreasing reserve requirementsDecrease government spendingRaising taxesContractionary Tools
24 RememberFiscal Policy is how the government uses its taxing and spending to influence the economyMonetary Policy is how the FED uses its control of the money supply to influence the economy
25 Review 1. Monetarism is 2. Tight money policies aim to (a) the time it takes to enact monetary policy.(b) the belief that the money supply means little to macroeconomic performance.(c) the time it takes for monetary policy to take affect.(d) the belief that the money supply is the most important factor in macroeconomic performance.2. Tight money policies aim to(a) increase the money supply and expand the economy.(b) decrease the money supply and expand the economy.(c) decrease the money supply and slow the economy.(d) increase the money supply and slow the economy.