1. The Federal Reserve

2. Origins of the Fed Two central banks were terminated in 1811 and 1836
Fears of a centralized power and of interests based on money
After 1836, the U.S. had no “lender of last resort”
An institution that will extend credit when no one else will (helps banks that are about to collapse)
The Federal Reserve Act of 1913 created a decentralized system that was more politically acceptable

3. Federal Reserve Banks
Four groups are empowered within the Federal Reserve system
12 Federal Reserve Banks
Private commercial member banks
The Board of Governors
The Federal Open Market Committee
16% of state chartered banks and 1/3 of all private banks are part of the Federal Reserve System, but all banks are subject to Federal Reserve requirements and regulatory policy

4. Functions of the 12 Regional Federal Reserve Banks
Manage check clearing
Manage currency in circulation by withdrawing old notes and issue new ones as banks withdraw cash from excess reserves
Make discount loans to banks in their districts

5. Supervise and regulate banks in their districts by examining member banks and evaluating proposed mergers
Act as a liaisons between the business community and the Fed system
Examine bank holding companies and state-chartered member banks
Collect data on local business conditions
Staff professional economists to research topics related to the conduct of monetary policy

6. Federal Reserve Independence
The Fed operates largely independent of pressure from Congress, the President, and business groups
The President does appoint directors, and the Senate confirms them, however Congress can change laws governing the Fed (not part of the Constitution)
Although the Fed is independent, it collaborates closely with the U.S. Treasury in times of crisis (think 2008 financial crisis)

7. Fed Independence Advantages
Free from political pressure to create more money (this would inevitably lead to inflation)
Monetary policy is too important to leave to politicians
Disadvantages
Fed structure is not democratic
Fed is not accountable to any agency
Often difficult to coordinate fiscal and monetary policy
Fed does not always make successful monetary policy (1970s Great Inflation)

8. Increasing or decreasing the money supply
Monetary Policy
Increasing or decreasing the money supply

9. Goals of Monetary Policy
Price Stability
The Fed should insure that the overall level of prices moves in a stable and predictable fashion (2-3% inflation per year)
High employment
The fed would like to maintain the unemployment at its natural rate (5-8%)
Economic growth
The Fed’s ultimate goal is maximum sustainable economic output in the long-run. This can be done by creating policies to foster growth in the short-run

10. Keep financial markets stable
If the financial market is unstable, the Fed will be unable to achieve other goals
Keep the interest rate stable
Rapid fluctuations of interest rates can destroy the financial system

11. Tools of the Fed for Monetary Policy
Open Market Operations
The Fed can buy U.S. treasuries from commercial banks, which will increase the money supply (or sell and decrease)
Discount Rate
Changes in the discount rate affect how much commercial banks can borrow from the Fed (borrow more = more money in the money supply
Change the Reserve Requirement
The Fed can change the percentage of how much money banks must have on hand
Lower reserve  money supply rises
Higher reserve  money supply falls

12. Consequences!
Whenever the Fed increases the money supply, inflation will eventually happen