Monetary Policy

The actions that the Federal Reserve System takes to influence the level of real GDP and the rate of inflation in the economy. Purpose

What is the Federal Reserve System? A privately owned system of 12 member banks that is publically controlled by the federal government. The federal government does not own any stock in the Fed, but it appoints its leaders and makes laws to regulate it. What is the Federal Reserve System?

7 Governors appointed by the President for 14 year terms under advice and consent from the Senate. Chairman of the Fed: President appoints one of the Governors to a renewable 4 year term Chairman of the Fed Structure of the Fed

Chicago Atlanta Cleveland Minneapolis Richmond San Francisco Dallas Kansas City Philadelphia St. Louis Boston New York City 12 District Banks Monitors and reports on economic conditions in their district. Oversees member banks.

All nationally chartered banks are required to join the Fed Approximately 2600 member banks today Member banks are the “stockholders” of the Fed Member Banks

Functions of the Fed Serve Government Maintain Treasury Department checking account Sell, transfer, and redeem government securities Issue currency Serve Banks Check clearing Lender of last resort Regulate Banks Approve charters and proposed mergers Enforce truth-in-lending laws Sets reserve requirements Conducts bank examinations Regulate Money Supply Monitors indicators of money supply Adjusts the money supply to stabilize the economy Functions of the Fed

Reserve Requirements – Banks are required to keep a certain percentage of their customers’ deposits. They loan out the rest. The Fed sets this percentage requirement. Example: You deposit $100 in your bank account. The current reserve requirement is 10%. Your bank is required to keep $10 of your deposit on hand, but can lend out $90 to other members of your bank in car loans, home loans, etc… Tools

Discount Rate / Federal Funds Rate – When banks need more money, they can borrow from each other at a certain interest rate (FFR), or in emergencies they can borrow from their district bank (DR). The Fed indirectly sets the FFR rate but directly sets the discount rate. Tools

Tools Open Market Operations – This is the Fed’s most important tool The buying and selling of government securities in order to change the money supply. The FOMC (Federal Open Market Committee) will order the Federal Reserve Bank of New York to either purchase or sell a certain quantity of government securities on the open market. This is the Fed’s most important tool Tools

Expansionary and Contactionary Policy Expansionary Policy (Easy Money ) Contractionary Policy (Tight Money) Reserve requirement Discount rate Open Market Operations BUY Reserve Requirement Discount Rate Open Market Operations SELL Expansionary and Contactionary Policy

Timing Bad Timing – If timing of a policy change is bad, it could actually make the situation worse Inside Lag – Takes time to recognize a problem…and then more time to enact the policy to fix it. Outside Lag – Takes time for the policy to become effective Predicting the Business Cycle – Monetary policymakers often don’t know how long a problem will last. So should they fix it (long term problem)....or let it fix itself (short term problem). Limitations