Money and Banking

What is the Fed? Central bank of the United States Established in 1913 Purpose is to ensure a stable economy for the nation What is the Fed? The Federal Reserve is the central bank of the United States and its purpose is to help ensure a stable economy for the nation. Established as a result of the Federal Reserve Act, signed in 1913. Receives no congressionally appropriated funds. Its operations are financed primarily from the interest earned on the U.S. government securities it acquires in the course of its monetary policy actions. Another major source of income is derived from the fees received for certain services provided to depository institutions. After payment of certain expenses, all the net earnings of the Federal Reserve Banks are transferred to the U.S. Treasury. In 2004, for example, the Fed paid approximately $18.1 billion to the U.S. Treasury.

Structure of the Fed Board of Governors – 7 members appointed by the President; Serve 14 year terms District Banks – 12 banks each responsible for a district – Memphis/ Millington is in district 8 located in St. Louis Bank for Banks

Where is my Fed? Reserve Banks are the decentralized components that carry out the Fed’s policies and activities at the regional level. Each bank is identified with a corresponding letter and number to identify Districts. There are several Divisions within the Fed that carry out its mandated responsibilities: Supervision & Regulation, Financial Services and Research.

Structure of the Fed FOMC – 12 members (7 Board of Governors, New York district bank president, and 4 rotating district bank presidents) They meet 8 times a year and make decisions about the growth of the money supply and the level of interest rates

Fed Functions Providing Financial Services Bank for banks and bank for federal government Check Clearing Issuing Currency - Fed issues and the Bureau of Engraving and Printing actually prints

Fed Functions Supervising and Regulating Banks Regulation is the rules that define what is acceptable behavior and bank supervision is enforcement of these rules

Fed Functions Conducting Monetary Policy – actions taken by the Fed to ensure that the economy is working at its best, not having inflation or a recession (controlling the money supply)

Monetary Policy 1. Reserve Requirement 2. Discount Rate Tools: 1. Reserve Requirement 2. Discount Rate 3. Open market operations

Reserve Requirement Required amount of money that the bank has to leave on hand at the bank and cannot lend out. Current RR is 10%

How do banks create money? Deposit 10% Reserve Requirement Loans Made $1,000 $100 $900

How do banks create money? Deposit 10% Reserve Requirement Loans Made $1,000 $100 $900 $90 $810 The recipient of the $900 loan spends it, and the recipient deposits his money in a bank. This bank only holds 10% of the money, $90, and the bank proceeds to loan out the rest of the money, $810. This continues through the rest of the loans and deposits into banks.

How do banks create money? Deposit 10% Reserve Requirement Loans Made $1,000 $100 $900 $90 $810 $81 $729 729 $72.90 $656.10 $65.61 $590.49 $59.05 $531.44 $53.14 $478.30 When all the money has been deposited, loaned out, re-deposited, re-loaned out, etc. until there is no more money to loan out, you will arrive at these totals $10,000 $1000 $9,000

Conducting Monetary Policy Reserve Requirement Reserve Requirement – Up Money Supply – Down (contractionary/tight monetary policy) Reserve Requirement – Down Money Supply – Up (expansionary/loose monetary policy)

Conducting Monetary Policy Interest Rate is the price you pay to borrow or the price you charge for a loan Discount Rate Discount Rate – Up Money Supply – Down (contractionary/tight monetary policy) GDP? Unemployment? Discount Rate – Down Money Supply – Up (expansionary/loose monetary policy) GDP? Unemployment?

Conducting Monetary Policy Open Market Operations (Most Common Tool Used) – Buying and selling of bonds Sell Bonds Money Supply – Down (contractionary/tight monetary policy) Buy Bonds Money Supply – Up (expansionary/loose monetary policy)

What are three actions the Fed could take to increase the money supply What are three actions the Fed could take to increase the money supply? When would they want to do this? What are three actions the Fed could take to decrease the money supply? When would they want to do this?

Monetary Policy The Federal Reserve System has three main policy tools at its disposal. It uses these tools to affect the money supply and interest rates.