1. Chapter 16 Section 2
Functions of the Federal Reserve

2. Functions of the Federal Reserve
Lending Money
Banks often lend to each other on short-term basis
In natural disaster, all banks in region lack cash flow
Fed lends to banks with enough assets and capital to qualify
Small banks with seasonal cash flow needs may borrow from Fed
Fed serves as lender of last resort to prevent banking crisis

3. Functions of the Federal Reserve
Regulating and Supervising Banks
Fed banks supervise state-chartered members, bank holding companies
bank holding company owns, has controlling interest in several banks
Fed banks enforce truth-in-lending laws
Conduct bank exams—audit financial practices of banks in district
Monitor bank mergers to ensure competition

4. Serving the Federal Government
KEY CONCEPTS
Fed serves as federal government’s banker
helps carry out taxation and spending activities

5. Serving the Federal Government
Service 1: Paying Government Bills
Tax revenues are deposited with the Fed
Fed issues checks, makes electronic payments via U.S. Treasury
for transfer payments, employee wages, direct spending, tax refunds
deducts amounts from government’s account
Processes postal money orders, food stamps

6. Serving the Federal Government
Service 2: Selling Government Securities
Fed processes U.S. savings bonds, auctions other securities
provides information, collects payment, credits funds, delivers bonds
Pays interest on bonds
Federal Open Market Committee (FOMC) supervises sales of securities
purpose is to stabilize the economy

7. Serving the Federal Government
Service 3: Distributing Currency
Federal Reserve notes are official paper currency of U.S.: fiat money
Treasury Department prints notes that go to Fed district banks
Fed banks distribute notes to depository institutions in amounts needed
currency then goes to people and businesses
Fed also distributes coins produced by U.S. Mint

8. Creating Money
Creating money—how money enters circulation through deposits, loans
Fed establishes required reserve ratio (RRR) for banks
fraction of bank’s deposits that it must keep in reserve
Reserve may be stored as cash in bank’s vault or deposited with Fed

10. Creating Money Example: Money Creation
Banking system creates money whenever banks get deposit and make loan
Level of the RRR determines how much money may be loaned
Money supply increases by total loans made after initial cash deposit
deposit multiplier formula tells how much money supply will increase

12. Questions
Why might the Fed help a small bank in an agricultural region stabilize its cash flow?
How are the banking services the fed provides to the government similar to the services it provides to banks?
If the Fed raised the RRR from 10% to 12%, how would it affect the money supply?
You have been planning your college finances and you know that you’ll have to take a bank loan to cover tuition costs. You read that the Fed intends to raise the RRR rate from 10% to 20%. How will this change affect the money supply and your ability to borrow money for college tuition?