THE FEDERAL RESERVE AND MONETARY POLICY https://www.youtube.com/watch?v=1dq7mMort9o

I. THE FEDERAL RESERVE SYSTEM A. Overview 1. US lacked a national bank in early 1900s 2. runs on the banks were common 3. Govt. passed Federal Reserve Act of 1913

B. Roles of the Fed 1. Conduct the nation’s monetary policy Dual mandate-price stability and maximum employment 2. Supervise and regulate banks Banks are rated on CAMELS Capital Asset quality Management Earnings Liquidity Sensitivity 3. Maintain stability of the financial system 4. provide financial services to banks, US government, and foreign institutions

C. Organization of the Fed 1. Board of Governors (Federal Reserve Board) a. President appoints 7 members, Sen. confirms b. 14 year terms c. Chairman and vice chairman serve 4 year terms d. Issues policies to regulate money supply e. Chair testifies before Congress f. Oversee Reserve Banks, approve appointments of their presidents and 3 of their board of directors g. Participate on the FOMC

2. Federal Open Market Committee (FOMC) a. chief body for monetary policy b. Made up of 12 members: 7 board of governors, pres. of New York’s bank; 4 others are district bank presidents on 1 year rotating terms c. Discuss economic outlook and forecasts, developments in financial markets d. Vote on monetary policy

3. Federal Reserve Banks (12) across country a. serve as banker’s bank distributing currency, making loans, processing electronic transactions b. Help govt by holding accounts for Treasury dept, process govt checks, conduct bond sales c. Conduct research on economy d. Are set up like private corporations; member banks have stock in them and earn dividends and get to appoint 6 out of 9 of the board of directors e. supervise banks in their district and help Fed carry out objectives in that area

https://www.youtube.com/watch?v=RaeIBeJT5hY II. MONETARY POLICY STRATEGIES A. Affect on Aggregate Demand 1. Monetary policy-expanding or contracting the money supply to influence the cost and availability of credit 2. Easy/Expansionary Money-designed to increase money supply, increase demand, create jobs 3. Tight/Contractionary Money-designed to contract the money supply, decrease demand, halt inflation

B. Components of Monetary Policy 1. Open-Market Operations a. buying and selling of govt. securities by the Fed b. most used monetary policy tool c. federal funds rate-interest rate at which banks borrow from each other: Fed Reserve sets a target for this and uses OMO to reach it i. Lowering it makes borrowing easier and increases the money supply ii. Raising it makes borrowing more difficult to borrow and decreases the money supply d. Fed buys securities to expand (ease) the money supply; sells govt. securities to contract (tighten) the money supply

EXPANSIONARY (easy money) POLICY Fed buys govt bonds depositing money in the banks Bank reserves for lending increase Banks decrease interest rates to attract borrowers

CONTRACTIONARY (tight money) POLICY Interest rates go up because there is less money to lend Fed sells govt bonds taking money from the banks Bank reserves for lending decrease

2. Discount Rate a. the interest rate the Fed charges member banks b. Fed acts as lender of last resort c. lowering makes it easier for banks to borrow and increases the money supply; raising it contracts the money supply

3. Reserve Requirement a. money that must be held by banks either in their own vaults or in their accounts at the district Fed bank b. if it’s low, banks can loan more money out and expand the money supply; it it’s high, banks have to hold more so the money supply contracts c. rarely changed Reserve Requirements Liability Type Requirement % of liabilities Effective date Net transaction accounts 1      $0 to $11.5 million2 12-29-11      More than $11.5 million to $71.0 million3 3      More than $71.0 million 10

D. how banks create money 1. money multiplier = 1/reserve requirement If the reserve requirement is 10% (.1) divide 1/.1=10 A $1 deposit in the bank can create $10 of new lending Example $100 deposited, $10 set aside, $90 loaned out $90 deposited, $9 set aside, $81 loaned out $81 deposited, $8.10 set aside, $72.90 loaned out $72.90 deposited, $7.29 set aside, $65.61 loaned out

E. Limitations of Monetary Policy 1. Economic forecasts a. don’t know if they’ll be accurate or not 2. Time Lags a. takes a long time to study data b. takes a long time to make decisions on what to do c. takes time for policies to cause desired effect 3. Priorities/Trade-Offs a. must balance inflation and unemployment 4. Lack of Coordination a. with fiscal policy 5. Conflicting Opinions a. people disagree on how money supply should be regulated

Federal Reserve/Monetary Policy Review Mark E for easy money and T for tight money strategy by the Federal Reserve 1. The Fed raises the federal funds rate. 2. The Fed lowers the reserve requirement. 3. The Fed conducts an open-market operation by purchasing govt. securities from banks. 4. The Fed lowers the discount rate. 5. The Fed conducts an open-market operation by selling govt. securities to banks. 6. The Fed raises the discount rate.

7. If the economy is experiencing inflation, should the Fed use an easy money or tight money policy? 8. If the economy is experiencing high levels of unemployment and recession, should the Fed use an easy money or tight money policy?