The Fed The Federal Reserve System consists of 12 Federal Reserve Banks, one in each of the Federal Reserve Districts into which the United States is divided

Federal Reserve System The Federal Reserve System is owned by its member banks, although publicly controlled by the federal government. All nationally chartered banks must join the Federal Reserve System; membership for all other banks is voluntary.

The Federal Reserve Act, established the Federal Reserve System in 1913, was an attempt to solve problems in the banking system by providing more access to money for consumers and businesses, and providing banks with emergency cash to prevent bank runs.

Why the Federal Reserve? The Federal Reserve Act of 1913, which established the Federal Reserve System, was an attempt to solve the problems in the banking system that had caused the Panic of 1907.

Reform of the Fed In 1935, Congress reformed the Federal Reserve System in response to lessons learned during the Great Depression. These reforms changed the structure of the Fed to allow the twelve district banks to work more closely together and not cancel out one another’s actions.

The Fed The Fed offers loans to any bank that needs short-term cash, even if that bank is not a member of the Federal Reserve System.

Function of the Fed 1. Clear Checks 2. Process Checks for the Federal Gov’t 3. Regulate the money supply

District Federal Banks The district Federal Reserve Banks issue paper currency. Bank examiners, employed by the Federal Reserve and other regulatory agencies, make periodic visits to banks to make sure they are following sound lending practices.

The Federal Government The federal government is the Federal Reserve’s biggest customer. It handles the Treasury Department’s deposits and payments. It also issues the nation’s currency.

Commercial Banks One reason commercial banks sometimes borrow from the Fed is so they can maintain their reserve requirements.

Money Supply One reason the Fed regulates the money supply is to make sure there is not too much money in the economy. Too much money leads to higher prices, or inflation. The monetary policy tool the Fed uses the most to change the money supply is the buying and selling of government securities, known as open market operations.

Reserve Requriments Although an effective way to change the money supply, changing reserve requirements would be disruptive to the banking system: for example, a small increase in the required reserve ratio would require banks to call in a large number of loans.

Reserve requirements The Fed might decide to lower reserve requirements if it thinks the economy is slowing down. However, the Fed does not use this monetary policy very often.

Open Marker Operations Open market operations are the monetary policy tool the Fed uses the most to change the money supply. Open market operations are the buying and selling of government securities By purchasing government securities, the Fed adds money to the money supply.

Federal Open Market Committee The Federal Open Market Committee meets at least eight times per year to discuss monetary policy. Once it has decided that changes are called for, it can enact policy almost immediately through open market operations or changes to the discount rate. The Federal Open Market Committee (FOMC) makes decisions about interest rates and the growth of the money supply.

The Fed While banks borrow from the Fed, as well as other banks, on a routine basis, the Fed can be counted on to lend money to a bank in a financial emergency, such as the need to maintain required reserves.

Just sit there Rather than possibly overcorrect the economy by enacting an easy money policy, it may be wiser to leave the economy alone when a recession is expected to be short-lived. Laissez-faire economists believe the economy will self- adjust quickly and that new monetary policies will make the business cycle get worse.

Interest rates Low interest rates make it cheaper to borrow money, so businesses have more incentive to borrow.

Fiscal Policy If the economy were clearly facing a long recession, the Fed would be most likely to introduce an easy money policy. Tax rebates (are a fiscal policy that Congress might introduce in the same situation. However, rebates are not a monetary policy.

Bank of the Federal Gov’t As part of its role as banker for the federal government, the Federal Reserve sells government bonds, notes, and bills, and makes interest payments on them.

Rapid Expansion A tight money policy reduces the money supply, resulting in an increase in interest rates, leading to a decline in investment spending and the level of real GDP.

Excess Reserves The Federal Reserve requires banks to keep a certain amount of money on hand for customer needs, but sometimes banks will hold excess reserves just to make certain they can meet reserve requirement and customer demands.

Money Multiplier The formula for calculating the money multiplier is 1 divided by the required reserve ratio (RRR). If the RRR is 25 percent, then the money multiplier is 1/0.25 = 100/25 = 4.

Inside Lag An inside lag in monetary policy is the amount of time it takes the Fed to identify a problem in the economy and implement monetary policy.

Outside lag Monetary policy may not have its full effect for several years because it can take months or years for businesses to change their investment plans in reaction to changes in interest rates. At the same time, it is difficult to predict how long a recession will last.

The Fed While banks borrow from the Fed, as well as other banks, on a routine basis, the Fed can be counted on to lend money to a bank in a financial emergency, such as the need to maintain required reserves.