Monetary Policy

2 Types of Monetary Policy: A. An “Easy-money”, or “Expansionary Monetary Policy” - Designed to... Expand the money supply (and access to credit), Thus lowering interest rates and... Increasing aggregate demand This creates jobs and reduces unemployment, Promoting economic growth

2 Types of Monetary Policy: B. A “Tight-money”, or “Contractionary Monetary Policy” – Designed to... Contract the money supply (and access to credit), Thus raising interest rates and... Reducing aggregate demand This slows business activity and raises unemployment, but... Stabilizes prices (limits inflation)

The Federal Reserve Bank System The U.S. has a Pyramid Reserves System in which smaller banks deposit some of their reserves into larger banks and the larger banks deposit some of their reserves into the largest banks and the Federal Reserve. The Federal Reserve Bank, or The FED, was created by The Federal Reserve Act of 1913  Not originally designed to control monetary policy  Fiscal policy (disciplined budgeting by government) doesn’t work now  (Who wants to raise taxes when you should? This is why Fed power has grown) **First Fed chairman to realize monetary policy could control economy died 18 months before Great Depression

Structure of the Fed:  The FED acts independently within the gov’t.  Can make the tough decisions politicians won’t with Fiscal Policy 1. The Board of Governors – at the top of the Fed System  7 members chosen by the President, approved by the Senate  Serve 14 yr. staggered terms – can serve longer if finishing someone else’s term  Rare to serve all 14 yrs. – $250,000/yr. – most would make millions elsewhere Chairman of Federal Reserve serves 4 year term within the 14 year term  Appointed by the President  Term is not coincident with Pres. Elections Janet Yellen 

Structure of the Fed: Federal Reserve Banks  12 Federal Reserve Banks to diffuse power and money throughout the country  Publicly owned  Voluntary membership  Each Bank elects 6 of their 9 board members – 3 appointed by Gov’t.  Board members do not have to be bankers  But usually bankers, business people, economists)  Often work their way up through bank system

Fed Reserve Banks

How the Fed differs from central banks in other countries: A. The Fed lacks a single, central bank B. Owned and controlled by its member banks instead of by the Gov’t. C. Only requires national banks, instead of all banks, to become members D. Members of the Board of Governors serve staggered 14 year terms The Federal Reserve System is organized on national and district levels  To distribute financial control among regions  To prevent single central bank or few financiers from holding too much power over the economy Setup frees Fed from political influence and enables it to act in best interests of economy

The role of the “Fed” (The Federal Reserve): 1. The Fed supervises member banks 2. Serves as the government’s bank 3. Lends Reserves to commercial banks and the gov’t 4. Regulates the Money Supply - moves money into or out of circulation 2 Goals:  Stable prices  Full employment. 1. Check Clearing a. Crediting and debiting banks’ reserve accounts – and, in turn, checking accounts b. Transferring money from one account to another (your bank account to the store’s bank account, for example)

Tools the Fed uses to enact monetary policy: A. Open-Market Operations - Buying and selling government securities  Most effective and common Fed tool  The tool that’s just right B. Raising or lowering the discount rate  - The interest rate Fed charges member banks for use of Fed reserves  - Not many banks do this, so this Fed tool has less of an effect  - The “feather” of Fed tools

C. Reserve requirement – The “Godzilla” of Fed tools  - The money that must be held by banks either in their own vaults or in their accounts at the district Federal Reserve Bank  - Small changes in the reserve requirement lead to huge changes in the money supply  - Reserve requirement ↑, $ supply ↓ -Reserve requirement ↓, $ supply ↑ D. Margin requirement - % of cash an investor must have to buy stocks, options, etc. E. Regulating credit F. “Moral suasion” – Persuasive statements by the Fed Unofficial pressures Fed policy makers exert on banking system to do what Fed wants.

Obstacles that can hinder the Fed’s monetary policy: A. Incorrect economic forecasts B. Time lags in enacting monetary policy C. Difficulties in establishing priorities and trade-offs D. Lack of coordination among government agencies E. Conflicting opinions about priorities