Federal Reserve System Macroeconomics Federal Reserve System (FRS or the FED) & Monetary Policy

Federal Reserve System (also known as FRS or the FED) & Monetary Policy Instructions: Watch the video on the FED & Monetary Policy by clicking here: Video on the Federal Reserve System Note: The video refers to the Chairman of the FED as Ben Bernanke, but a new Chairman has been named. Search www.google.com for name of current chairman of the Federal Reserve.

Federal Reserve System US Central banking system Established in 1913 Privately owned by member banks, but publically controlled

FRS Structure: Federal Board Of Governors: 7 Members, appointed by President to 14 year terms Led by a Chairman, appointed by President to 4 year term Current Chairman is: Janet Yellen

Federal Reserve System Regional FRS Banks are located in 12 big cities around US Each has a president

Federal Reserve System Regional FRS Banks: Responsible for monitoring banking & economic conditions in its area Southeastern regional bank located in Atlanta

Federal Open Market Committee (FOMC): Meets 8 times yearly Makes decisions about: interest rates money supply

What do District Banks do? Issue US currency Clears checks for all banks Regulates the banking system Lender of last resort for banks in trouble

FRS Functions or Most important function: Regulate the supply of money in the US! or

FRS Functions and MONETARY POLICY: Fed’s most important function Increase/decrease the nation’s money supply in order to meet the 3 main government economic goals of stable prices, full employment, and economic growth and

FRS Functions MONETARY POLICY: Easy Money = Increase in the nation’s money supply Tight Money = Decrease in the nation’s money supply

FRS Functions 3 Monetary Policy Tools: Open Market Operations Changes in Discount Rate Changes in the Reserve Requirement

Monetary Policy Tools 1. Open Market Operations: Occurs when the FED buys/sells US government securities (bonds) in the bond market in New York. Most frequently used of the 3 tools

Monetary Policy Tools Open Market Operations (Buying bonds): FED gives money to the sellers, putting more money into the economy, increasing the money supply (EASY MONEY)

The Business Cycle Alternating phases of growth (expansion) and decline (contraction) in the economy 4 phases of the business cycle: Peak Expansion (economic growth) Contraction (economic decline) Trough

Monetary Policy Tools Open Market Operations (Selling bonds): EASY MONEY used at this point in the business cycle (contraction), during periods of decline to stimulate the economy

Monetary Policy Tools Open Market Operations (Selling bonds): Fed takes money from the buyers, taking money from the economy, decreasing the money supply (TIGHT MONEY)

Monetary Policy Tools Open Market Operations (Selling bonds): TIGHT MONEY used at this point in the business cycle (expansion), during periods of growth to slow inflation

Monetary Policy Tools Inflation: increase in prices, occurs during periods of growth in the economy (expansion phase of the business cycle)

Monetary Policy Tools 2. Changes in the Discount Rate: Discount Rate is what the FED charges when it makes loans to other banks.

Monetary Policy Tools 2. Changes in the Discount Rate: Lower Rates Banks borrow more money from the FRS, making more money available to loan to their customers, increasing the money supply & economic growth (EASY MONEY).

Monetary Policy Tools 2. Changes in the Discount Rate: EASY MONEY used at this point in the business cycle (contraction), during periods of decline to stimulate the economy

Monetary Policy Tools 2. Changes in the Discount Rate: Higher Rates Banks borrow less money from the FRS, making less money available to loan to their customers, decreasing the money supply & economic growth (TIGHT MONEY).

Monetary Policy Tools

Monetary Policy Tools 2. Changes in the Discount Rate): TIGHT MONEY used at this point in the business cycle (expansion), during periods of growth to slow inflation

Monetary Policy Tools 3. Changes in the Reserve Requirement: RESERVE REQUIREMENT is the minimum amount of money that banks must keep in their reserve in order to back up checking & savings accounts (5-8% usually)

Monetary Policy Tools The Fed does not use this tool too much because it would be disruptive to normal banking routines.

Monetary Policy Tools 3. Changes in the Reserve Requirement (Decreasing the Reserve Requirement) Banks don’t have to keep as much money in reserve; therefore they have more money available to loan to their customers, increasing the money supply (EASY MONEY).

Monetary Policy Tools 3. Changes in the Reserve Requirement (Decreasing the Reserve Requirement): EASY MONEY used at this point in the business cycle (contraction), during periods of decline to stimulate the economy

Monetary Policy Tools 3. Changes in the Reserve Requirement (Increasing the Reserve Requirement) Banks have to keep more money in reserve; therefore they have less money available to loan to their customers, decreasing the money supply (TIGHT MONEY)

Monetary Policy Tools 3. Changes in the Reserve Requirement (Increasing the Reserve Requirement): TIGHT MONEY used at this point in the business cycle (expansion), during periods of growth to slow inflation

Policy Lags Delays in implementing the appropriate monetary policy INSIDE LAG: Delay in deciding what monetary policy to implement 2. OUTSIDE LAG: Delay in the time it takes for the policy to have its desired effect

DONE! 

Review Questions: 1.) What is the FED or FRS? 2.) What is the Federal Board of Governors? 3.) Who is the current chairman of the FED? 4.) What is the FRS structure?

Review Questions: 5.) What is the Federal Open Market Committee (FOMC)? 6.) How often does the FOMC meet? 7.) What are the FOMC’s responsibilities?

Review Questions: 8.) What are the district banks’ responsibilities? 9.) What is the FED’s most important function? 10.) What is Monetary Policy? 11.) What is Easy Money? 12.) What is Tight Money?

Review Questions: 13.) What are the 3 Monetary Policy Tools? 14.) What is Open Market Operations? 15.) What tool of Monetary Policy does the FRS use most often?

Review Questions: 16.) What is the Business Cycle? 17.) What are the phases of the Business Cycle? Describe each phase. 18.) What is inflation? 19.) What is the Discount Rate?

Review Questions: 20.) What is the Reserve Requirement? 21.) Why doesn’t the FED change the Reserve Requirement very often? 22.) What is an Inside Lag? 23.) What is an Outside Lag?