The Federal Reserve What is the Fed? How does the Fed help shape the economic conditions in the US? How does the Fed implement monetary policy?

What is the Federal Reserve? Created by the U.S. Congress in 1913 U.S. lacked a way to study and implement monetary policy, actions the Fed uses to influence the amount of money and credit in the U.S. economy –markets often unstable, little faith in banking system Fed is a politically independent entity, subject to oversight (periodical reviews) from Congress Headed by a government agency called the Board of Governors of the Federal Reserve

12 Federal Reserve Banks in major cities are supervised by the BOG –act as operating arm of the central bank and do most of the work of the Fed –create income from four main sources: Services provided to banks Interest earned on government securities--debt obligation (local or national) backed by the credit and taxing power of a country with very little risk of default (bonds, bills…) Income from foreign currency held Interest on loans to depository institutions (banks) –Income from these used to finance daily operations like info. gathering/research. Any excess income is funneled back into the U.S. Treasury The system also includes the Federal Open Market Committee (FOMC), the policy-making branch of the Federal Reserve. –makes important decisions on interest rates and other monetary policies

What does it do? Mandate is "to promote sustainable growth, high levels of employment, stability of prices to help preserve the purchasing power of the dollar and moderate long-term interest rates.” –sound banking system, healthy economy –serves as the banker's bank, the government's bank, the regulator of financial institutions and nation's money manager Issues all coin and paper currency –U.S. Treasury actually produces the cash, Fed Banks distributes it to financial institutions. –Check bills for wear, take damaged currency out of circulation Federal Reserve Board (FRB) has regulatory and supervisory responsibilities over banks –monitoring banks in the system, international banking in the U.S., foreign activities of member banks and the U.S. activities of foreign- owned banks –helps develop federal laws governing consumer credit –the policeman for banking activities within the U.S. and abroad

How does it implement monetary policy? Primary responsibility of the Fed is devising and implementing monetary policy Changes to amount of money and credit affect interest rates—the cost of credit—and economic performance –if the cost of credit is reduced, more people and firms will borrow money and the economy will grow The Toolbox—main tools the Fed uses to influence monetary policy: –Buying/selling federal gov’t securities (open-market operations) influences the level of reserves in the banking system affect the volume and the price of credit open market is where securities dealers compete; most frequently employed tool –Regulating amount of money a member bank must have in reserves setting reserve requirements - funds banks are required to hold in reserve against deposits; determines how much money banks can create through loans and investments (10%) –Changing interest charged to banks (borrowed from Fed) setting the discount rate -the interest rate banks pay on short-term loans from a Federal Reserve Bank; raise/lowering affects money banks lend