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KRUGMAN’S Economics for AP® S E C O N D E D I T I O N

Section 5 Module 27

What You Will Learn in this Module Describe the functions of the Federal Reserve System Explain the primary tools the Federal Reserve uses to influence the economy What You Will Learn in this Module Section 5 | Module 27

The Functions of the Federal Reserve System Provide financial services Supervise and regulate banking institutions Maintain the stability of the financial system Conduct monetary policy Section 5 | Module 27

What the Fed Does Sets reserve requirements - rules set by the Federal Reserve that determine the minimum reserve ratio for a bank. For example, in the United States, the minimum reserve ratio for checkable bank deposits is 10%. The federal funds market allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves. The federal funds rate is the interest rate determined in the federal funds market. Section 5 | Module 27

Reserve Requirements and the Discount Rate Operates the discount window – an arrangement in which the Federal Reserve stands ready to lend money to banks in trouble. The discount rate is the rate of interest the Fed charges on loans to banks. Section 5 | Module 27

Open-Market Operations Conducts open-market operations – the principal tool of monetary policy. The Fed can increase or reduce the monetary base by buying government debt (U.S. Treasury Bills) from banks or selling government debt to banks. The Federal Reserve’s Assets and Liabilities: Section 5 | Module 27

Open-Market Operations by the Federal Reserve Section 5 | Module 27

Open-Market Operations by the Federal Reserve Section 5 | Module 27

F Y I Who gets the profits? U.S. taxpayers do. Who Gets the Interest on the Fed’s Assets? Who gets the profits? U.S. taxpayers do. The Fed keeps some of the interest it receives to finance its operations, but turns most of it over to the U.S. Treasury. For example, in 2013 the Federal Reserve system received $79.5 billion in interest on its holdings of Treasury bills, of which $77.7 billion was returned to the Treasury. The Fed decides on the size of the monetary base based on economic considerations—in particular, the Fed doesn’t let the monetary base get too large, because that can cause inflation. Section 5 | Module 27

Summary The Federal Reserve System provides financial services, supervises and regulates banking institutions, maintains the stability of the financial system, conducts monetary policy. The monetary base is controlled by the Federal Reserve, the central bank of the United States. The Fed regulates banks and sets reserve requirements. To meet those requirements, banks borrow and lend reserves in the federal funds market at the federal funds rate. Through the discount window facility, banks can borrow from the Fed at the discount rate. Section 5 | Module 27

Summary Open-market operations by the Fed are the principal tool of monetary policy: the Fed can increase or reduce the monetary base by buying U.S. Treasury bills from banks or selling U.S. Treasury bills to banks. Section 5 | Module 27