Economics Unit 4 Lesson 6 The Federal Reserve

Economics Unit 4 Lesson 6 The Federal Reserve and Monetary Policy

Roles and responsibilities of the Federal Reserve System Ø The Federal Reserve Act of 1913 created the Federal Reserve System (the “FED”) to serve as the central bank of the United States. Ø Responsibilities of The FED: § Holds required reserves (“the bankers’ bank”) § Lends money to banks (“lender of last resort”) § Sets monetary policy § Regulates banking operations § Issue paper currency § Collect and clear checks

The Federal Reserve System Member Banks

The Federal Reserve District Banks ØIn which Federal Reserve district do you live? ØIn which city is your district’s Federal Reserve bank located?

Where did this bill originate?

Where did this bill originate?

The Bankers’ Bank - Reserves ØFED district banks monitor the required reserves of member banks ØMember banks must have a certain amount of reserves on hand at the end of each day (required reserves) ØMember banks can deposit excess reserves in the FED district banks

The Bankers’ Bank - Borrowing If a bank needs to borrow money it can borrow it from: § Another bank OR § The FED district bank (“lender of last resort”) The Discount Rate is the interest rate the FED charges for loans to its member banks.

Monetary Policy ØDefined: The actions that the Federal Reserve take to influence the money supply to achieve their stated macroeconomic goals of price stability and full employment. ØWays the FED Influences the Money Supply: ØIncrease / Decrease the Reserve Requirement ØIncrease / Decrease the Discount Rate ØBuy or Sell U. S. securities (Treasury notes, bills, bonds)

The Money Supply Ø Is a measure of the total amount of money in an economy Ø The FED influences the money supply to achieve macroeconomic goals of: § Price stability § Full employment § Economic growth

The Money Supply and Interest Rates The FED influences the amount of lending and borrowing by using its tools to influence the money supply By influencing the money supply, the FED indirectly influences the interest rate ◦ Think of the interest rate being equivalent of the price of a good or service. ◦ Low interest rates= more borrowing (like low price= more buying) ◦ High interest rates= less borrowing (like high price= less buying) Interest rates reflect the interaction of lenders (who supply the funds) and borrowers (who demand the funds)

Review: FED Sets Monetary Policy By: ØIncreasing/Decreasing the Reserve Requirement ØIncreasing/Decreasing the Discount Rate ØBuying/Selling U. S. securities (Treasury Notes, Bills, Bonds) through FOMC (Federal Open Market Committee)

“Easy Money” Monetary Policy ØUsed when the FED wants to stimulate growth due to a contracting economy ØEffects/Consequences § Increases the money supply, § Which leads to lower interest rates § Encouraging investment , spending, and employment

“Tight Money” Monetary Policy Used when the FED wants to slow growth due to a rapid expansion that may cause inflation Effects/Consequences § Decreases the money supply, § Which leads to higher interest rates § Discouraging investment and spending § Which can lead to lower employment