The Federal Reserve and Monetary Policy

Transcription

1 The Federal Reserve and Monetary Policy

2 Part I The Federal Reserve System

3 Banking History: A Central Bank? Debated since 1790 Following the Panic of 1907, Congress decided that a central bank was needed.

4 The Federal Reserve Act of 1913 The Federal Reserve System the Fed, is a group of 12 regional, independent banks. Initially did not work well because one regional bank would counteract another.

5 In 1935, Congress restructured the Federal Reserve so that regional banks can work together while still representing their own concerns.

6 Structure of the Federal Reserve The Board of Governors Seven-member board. Actions taken by the Federal Reserve are called monetary policy. Federal Reserve Districts The Federal Reserve Regional Banks monitor and report on economic activity in their districts.

7 Structure of the Federal Reserve Member Banks All nationally chartered banks are required to join the Fed. Member banks contribute funds to join the system This ownership of the system by banks, not government, gives the Fed a high degree of political independence.

8 The Federal Open Market Committee (FOMC) Consists of The Board of Governors and 5 of the 12 district bank presidents, makes key decisions about interest rates and the growth of the United States money supply.

9 4,000 member banks and 25,000 other depository institutions 12 District Reserve Banks Board of Governors Federal Open Market Committee The Pyramid Structure of the Federal Reserve Structure of the Federal Reserve System

10 5. What year did Congress restructure the Federal Reserve? Comprehension Check 1. How many Federal Reserve Districts are there? 2. How many members are on the Board of Governors? 3. What does FOMC stand for? 4. What year was the Federal Reserve created?

11 Part II Federal Reserve Functions

12 Serving Government 1. Federal Government s Banker maintains a checking account for the Treasury Department Processes payments: social security checks, IRS refunds.

13 2. Government Securities Auctions financial agent for the Treasury Department Sells, transfers, and redeems government securities. Handles funds raised from selling T- bills, T-notes, and Treasury bonds.

14 3. Issuing Currency Responsible for issuing paper currency (Department of the Treasury issues coins.)

15 Serving Banks Check Clearing 1. Process by which banks record whose account gives up money, and whose account receives money

16 The Journey of a Check - After you write a check, the recipient presents it at his or her bank. - The check is then sent to a Federal Reserve Bank. The Path of a Check Check writer Recipient - The reserve bank collects the necessary funds from your bank and transfers them to the recipient s bank. Your processed check used to be returned to you by your bank. Now due to digital age a record is kept only online. Check writer s bank Federal Reserve Bank

17 2. Supervising Lending Practices Ensures reserves are met Enforces truth-in-lending laws.

18 3. Lender of Last Resort In case of economic emergency, commercial banks can borrow funds from the Federal Reserve. The interest rate at which banks can borrow money is called the discount rate.

19 Regulating the Banking System Bank Examinations Ensures banks follow laws and regulations. Reserves Financial Institutions MUST repost its reserves and activities daily.

20 Regulating the Money Supply Best known for its role in regulating the money supply. monitors the levels of M1 and M2 and compares these measures of the money supply with the current demand for money.

21 Factors That Affect Demand for Money 1. Cash needed on hand (Cash makes transactions easier.) 2. Interest rates (Higher interest rates lead to a decrease in the demand for cash.) 3. Price levels in the economy (As prices rise, so does the demand for cash.) 4. General level of income (As income rises, so does the demand for cash.)

22 Stabilizing the Economy Monitors the supply of and the demand for money in an effort to keep inflation rates stable.

23 Part II Comprehension Check 1. What is M1? 2. What are Truth in Lending Laws? 3. Check clearing is done by what institution? 4. Who issues paper currency? 5. What MUST financial institutions do EVERY day?

24 Part III Monetary Policy Tools

25 The Money Creation Process Money Multiplier Formula. The money multiplier formula is calculated as 1/RRR. Money Creation You deposit $1,000 into your checking account. Your $1,000 deposit minus $100 in reserves is loaned to Elaine, who gives it to Joshua. Joshua s $900 deposit minus $90 in reserves is loaned to another customer. At this point, the money supply has increased by $2,710. $100 held in reserve $900 available for loans $90 held in reserve $810 available for loans

26 Federal Reserve Monetary Tools

27 1. Reserve Requirements Reducing Reserve Requirements Increasing Reserve Requirements

28 2. Discount Rate The discount rate is the interest rate that banks pay to borrow money from the Fed. Reducing the Discount Rate vs. Increasing the Discount Rate

29 3. Open Market Operations The most important monetary tool is open market operations. Open market operations are the buying and selling of government securities to alter the money supply.

30 Part IV Monetary Policy and Macroeconomic Stabilization

31 How Monetary Policy Works Monetarism is the belief that the money supply is the most important factor in macroeconomic performance. Interest Rates and Spending Easy money policy, it will increase the money supply. Tight money policy, it will decrease the money supply.

32 Real GDP Real GDP The Problem of Timing Good Timing Properly timed economic policy will minimize inflation at the peak of the business cycle and the effects of recessions in the troughs. Bad Timing If stabilization policy is not timed properly, it can actually make the business cycle worse. Business Cycles and Stabilization Policy Business cycle Business cycle with properly timed stabilization policy Business cycle with poorly timed stabilization policy Business cycle Time Time

33 Policy Lags Policy lags are problems experienced in the timing of macroeconomic policy. There are two types: Inside Lags An inside lag is a delay in implementing monetary policy. Inside lags are caused by the time it actually takes to identify a shift in the business cycle. Outside Lags Outside lags are the time it takes for monetary policy to take affect once enacted.

34 Anticipating the Business Cycle The Federal Reserve must anticipate changes in the economy. How Quickly Does the Economy Self-Correct? Estimates range from two to six years. Since the economy may take quite a long time to recover on its own, there is time for policymakers to guide the economy back to stable levels of output and prices.

35 Fiscal and Monetary Policy Tools The federal government and the Federal Reserve both have tools to influence the nation s economy. Fiscal and Monetary Policy Tools Expansionary tools Contractionary tools Fiscal policy tools 1. increasing government spending 2. cutting taxes 1. decreasing government spending 2. raising taxes Monetary policy tools 1. open market operations: bond purchases 2. decreasing the discount rate 3. decreasing reserve requirements 1. open market operations: bond sales 2. increasing the discount rate 3. increasing reserve requirements