The Federal Reserve System and the Monetary Policy Chapter 16

The FRS  History  1790: Bank of the USA  1811 charter ends  1816: restore Second Bank of USA  1836 charter ended  1907: Bank Panic - Congress acts  1913: Federal Reserve Act

Federal Reserve Act 1913  The Fed recommended by National Monetary Commission 1908  : tight money policy --exactly wrong, except NY region  12 regional banks acted independently  1935 reforms for FRS; more centralized

Structure of the FED  Board of Governors  Sets monetary policy  Headquarters in Washington DC  7 member board serve 14 years  Appointed by President, approved by Senate  President appoints chairmen - serves 4 years  Alan Greenspan:  Ben Bernake: 2006

12 Districts  One FR Bank in each district  Monitors reports on economic and banking conditions  Member banks in district elect 3 bankers and 3 leaders in industry, commerce, or other businesses to district boards

Member Banks  All nationally chartered banks  State chartered banks join voluntarily  Approximately 4,000 Fed member banks  Federal Advisory Council collects information about each district and reports to each FRS

Federal Open Market Committee  FOMC  Makes key decisions about interest rates and Ms  Meets 8 times a year  Committee members  Board of governors  All governors  12 District banks  5 of 12 district bank presidents

Functions of the FRS  Serving Government  Serving Banks  Regulating Banks  Regulating Money Supply Ms

FRS: Serves Government  Federal Governments Bank  Checking accounts for Treasury Dept.  Government securities auction  Sells, transfers, redeems government bonds, bills, notes  Issuing currency  Federal reserve notes

FRS: Serving Banks  Clears checks  Supervising lending practices  Bank mergers (bank holding company)  Lender of last resort  Federal fund rate: interest banks pay when banks loan money to banks  Discount rate: interest rate when banks borrow from the FRS

FRS: Regulating Banking System  Reserve requirement  Bank examination  Net worth

FRS: Regulating Ms  Factors that affect demand for money  Cash needed on hand  Interest rates  Price levels in the economy  General level of economy  Stabilizing the economy  Recession  Inflation

Ms, ir and I ir Ms Md ir I Q Q

Dept. of Treasury & Money  Dept. of Treasury manufactures money  prints  Coins  2013 $1.2 Trillion  Money gets into the economy  Money creation: process by which money enters the economy  Fractional banking  Required reserve ratio (RRR)  Money multiplier = 1/rrr  Excess reserves  Reserve shortage

Federal Reserve Tools  Reserve Rate (reserve ratio)  Discount Rate  Open Market Operation  Quantitative Easing (2008)

Policy Options  Reserve requirement  =Ms   Reserve requirement  =Ms   Discount Rate  =Ms   Discount Rate  =Ms   Buy Bonds = Ms   Federal Fund Rate   Sell bonds = Ms   Federal Fund Rate 

Using Monetary Policy  Omo are the most used of FRS monetary policy tools  Today do not change RRR  Omo or discount rate do not disrupt financial institutions  Federal fund rates Greenspan used

Monetary Policy and Macroeconomic Stabilization  Recessionary gap  Ms needs to increase  Easy monetary policy  Buy bonds  Fed fund rate down  Discount rate down  Reserve requirement down  Inflationary gap  Ms needs to decrease  Tight money policy  Sell Bonds  Fed fund rate up  Discount rate up  Reserve requirement up

Problem of Timing  Good timing: smooths fluctuations  Bad timing: makes economy worse  Policy lags  Inside lags: delay in implementing policy  Outside lags: time it takes for monetary policy to have an effect

Predict Business Cycle  Inflation  Recession

Fiscal & Monetary Policy Tools: Congruent  Expansionary Tools  Fiscal policy  G increases  T decreases  Monetary policy  Omo purchase bonds  decrease fed fund rate  Decrease reserve requirements  Decrease discount rate  Contractionary Tools  Fiscal Policy  G decreases  T increase  Monetary Policy  Omo sale of bonds  Increase Fed fund rate  Increase reserve requirement  Increase discount rate

Fiscal and Monetary Policy: Not Congruent  LBJ Presidency  Spending Vietnam  Great Society  Fiscal  Increase spending  Decrease taxes  Monetary  Tight monetary policy  Sell bonds in omo  Increase reserve ratio  Increase discount rate  Obama Presidency/Republica n Congress  Cut deficit / cut debt  Fiscal  Decrease spending  Increse taxes  Monetary  Loose monetary policy  Buy bonds  Decrease reserve ratio  Decrease discount rate  Quantitative Easing (QE)