The Federal Reserve System and Monetary Policy Chapter 15 The Federal Reserve System and Monetary Policy

Organization and Functions of the Federal Reserve System Chapter 15 Section 1 Organization and Functions of the Federal Reserve System

Learning Target Students will identify how the Federal reserve System is organized and it's role in determining the nation's monetary policy Main Idea: The Federal Open Market Committee of the Federal Reserve is responsible for implementing monetary policy

What is the Federal Reserve? The Federal Reserve System, often referred to as the Federal Reserve or simply "the Fed," is the central bank of the United States. It was created by the Congress to provide the nation with a safer, more flexible, and more stable monetary and financial system.

Organization of the Federal Reserve The Fed is responsible for monetary policy. Monetary policy: involves the changing rate of growth of the supply of money in circulation in order to affect the amount of credit, which affects business activity in the economy. The Board of Governors oversees 12 district Federal Reserve banks and regulates activity of member banks and all other depository institutions.

Organization of the Federal Reserve Board of Governors 7 individuals appointed by the U.S. president and confirmed by the Senate U.S. president appoints one of the 7 chair whose 4-year term is renewable Offices in Washington, D.C. Serve nonrenewable 14-year terms Independence of Federal Reserve Staggered terms of Governors Budget separate from Congress

Organization of the Federal Reserve: Board of Governors Board of Governors has two main functions: 1. Regulate commercial banks Supervise and regulate member banks and bank holding companies Oversight of 12 Fed district banks Establish consumer finance regulations after Congressional legislation

Organization of the Federal Reserve 2. Establish and effect monetary policy Direct control over two tools of monetary policy Set reserve requirements Approve discount rate set by district banks Indirect control in a third area Governors are members of the Federal Open Market Committee

Board of Governors

Board of Governors chairman JANET YELLEN= 1st Fed Chairwoman Formerly Ben Bernanke Alan Greenspan

Organization Continued The Federal Advisory Council reports to the board of governors on general business conditions in the country. The Federal Open Market Committee decides what the Fed should do to control money supply. Twelve Federal Reserve banks are set up as corporations owned by member banks.

Organization of the Federal Reserve Federal Open Market Committee (FOMC) meets every 6 weeks 12 members 7 from the Board of Governors President of the New York Fed 4 other district bank presidents appointed on a rotating basis Other presidents participate but do not vote on monetary policy matters

Organization of the Federal Reserve Federal Open Market Committee (FOMC) Monetary policy goals of: high employment price stability economic growth Make monetary policy decisions to achieve goals Forward decisions to N.Y. Fed open market desk Advisory committees from private sector also are a part of overall structure of the Fed

Organization Member Banks—all national banks, those chartered by the federal government, must join the Federal Reserve System. State chartered banks may join if they choose. All institutions that accept deposits from customers must keep reserves in their district Federal Reserve bank.

Checks and Balances at the Fed

The Federal Reserve System

Functions The fed has many functions, including check clearing, supervising member banks, holding reserves, and supplying paper currency. Clearing checks is the method by which money is deposited from one bank to another. Supervising member banks means the Fed must regulate federally chartered commercial banks. The Fed maintains the nation’s paper money.

Functions Its most important function is to regulate the money supply. The Fed determines the amount of money in circulation. More money in circulation means lenders are more likely to offer money for loans. The Fed sets standards for consumer protection, mainly truth-in-lending legislation.

6 Major Jobs of the Fed Supply the economy with paper money and coins. Hold bank reserves. Provide check-clearing services Supervise member banks Serve as lender of last resort. Control the money supply

1.Supply the economy with paper money and coins. “U.S. Mint” Bureau of Engraving and Printing

2. Hold bank reserves reserves at the Fed + vault cash =total reserves

3.Provide check-clearing services Facilitates check-cashing between commercial banks. for example, Wells-Fargo and Bank of America

Between banks, cities EXAMPLE: Pete pays Sue for a used car. He gives her a check for $2,000. Sue deposits the check in her bank and is credited with $2,000 in her account. Sue’s bank sends the check to FRB who increases the bank’s reserve account by $2,000. FRB decreases Pete’s bank’s reserve by $2,000 FRB notifies Pete’s bank to reduce Pete’s account by $2,000.

4. Supervise member banks 5. Serve as lender of last resort Fed may “audit” a bank check that the loans it made are good be sure it has followed banking rules verify the accuracy of its accounting. Fed can lend funds to struggling banks. Glass-Steagall Act (1933) establishes FDIC Fed of Minneapolis flies to the rescue. page 291 in text

6. Control the money supply. I kept the most important for last! Tools for changing the money supply Reserve Requirement Discount Rate Open Market Operations Why is changing the money supply important? TO CONTROL INFLATION and/or UNEMPLOYMENT Monetary Policy Stop here and do money supply kinetic

Decisions to raise or lower interest rates are made by the ______. A) Board of Governors B) Federal Advisory Council C) Federal Open Market Committee D) President

Decisions to raise or lower interest rates are made by the ______. A) Board of Governors B) Federal Advisory Council C) Federal Open Market Committee D) President

Where are the headquarters of the Federal Reserve located? A) San Francisco. B) Washington, D.C. C) Richmond. D) Boston.

Where are the headquarters of the Federal Reserve located? A) San Francisco. B) Washington, D.C. C) Richmond. D) Boston.

Money Supply and the Economy Chapter 15 Section 2 Money Supply and the Economy

Learning Target

ACDC MOVIES https://youtu.be/RaeIBeJT5hY https://youtu.be/tOXpijd6t6k

Loose and Tight Money Policies Monetary policy involves changing the growth rate of the money supply in order to change the cost and availability of credit. Loose money means credit is plentiful and inexpensive. Used to encourage economic growth.

Loose and Tight Money Policies Tight money means credit is in short supply and expensive. Used to control inflation. The goal of monetary policy is to strike a balance between tight and loose money.

The Two Faces of Monetary Policy Copyright © 2005 Pearson Addison-Wesley. All rights reserved.

Banks are not required to keep 100% reserves to back their deposits fractional reserve banking System in which only a fraction of the deposits in a bank is kept on hand, or in reserve reserve requirements Regulations set by the Fed requiring banks to keep a certain percentage of their checkable deposits as cash in their own vaults or as deposits in their Federal Reserve district bank

The U.S. has a “fractional reserve system”: requires banks to keep a fraction of their deposits in the form of legal reserves (cash/coin). Under this system, banks have “reserve requirements”: rule that a % of each deposit must be set aside as legal reserves. Today’s reserve requirement is 10%. https://www.federalreserve.gov/mon etarypolicy/reservereq.htm

Fractional Reserve Banking Many banks are required to keep a percentage of their total deposits in cash reserves in their vaults or with the Federal Reserve bank. This enables the bank to provide funds for customers who might suddenly want to withdraw large amounts of cash from their accounts.

Money Expansion Banks can use non-reserved deposits to create new money. Money banks lend and receive is usually spent or deposited in another bank who can also use the deposits to create new money. This process is known as the multiple expansion of money.

Regulating the Money Supply Chapter 15 Section 3 Regulating the Money Supply

Changing Reserve Requirements Main Idea: The Fed can change the growth rate of the money supply by changing reserve requirements on bank deposits. The lower the percentage of deposits in reserve, the more money available to loan out. When the Fed raises its reserve requirements, banks can call in loans, sell off investments, or borrow from another bank (or the Federal Reserve).

Changing Reserve Requirements Raising the reserve decreases the amount of money in the economy and slows it down. Because of the extreme effect on money supply, the Fed has not been raising the reserve recently.

Changing the Discount Rate Main Idea: the Fed can change the growth rate of the money supply by changing short term interest rates. Sometime banks get into a situation in which they do not have enough reserves to make the reserve requirement. This could occur if customers (depositors) unexpectedly withdraw large amounts or customers begin to borrow a great deal. The bank must then borrow funds to meet the requirement, they can ask the Federal Reserve district bank for a loan (they charge interest) =discount rate Discount Rate: interest rate that the Fed charges on loans to member banks If the bank does borrow from the Fed and discount rates are high, they will pass on that cost to its customers in the form of higher interest rates on loans. Prime Rate: rate of interest that banks charge on loans to their best business customers A higher discount rate means that member banks charge their customers higher interest, reducing the money supply.

Changing the Discount Rate Federal Funds Rate: interest rate that banks charge each other on loans (usually overnight) Used to help a bank to increase its reserves by borrowing from another bank. If the Fed decreases the federal fund rate, banks will borrow more and, thus, lend more. This increases business activity.

Open-Market Operations Main Idea: The Fed controls the money supply primarily through the purchase and sale of government securities. The buying and selling of government securities is called open- market operations. Major tool the Fed uses to control money supply When the Fed buys securities, it makes a deposit into the reserve account of the security dealer’s bank, giving that bank more money to lend out because its reserve account is higher than necessary.

Open-Market Operations When the Fed sells securities, the purchasing bank buys them with money from its reserves, leaving the purchasing bank with less reserve funds. This shows the multiple expansion of money working in reverse because more money is taken out of circulation than just the initial withdrawal.

https://youtu.be/zEP2vkK-LIk

Difficulties of Monetary Policy It is difficult to gather and evaluate information about the money supply. Some critics of the Fed want to stop the Fed from engaging in any monetary policy at all. Taxing and spending by the government affect the economy, and the Fed has to consider this also in the changes they can make.

https://youtu.be/Oz5hNemSdWc