The Federal Reserve And Monetary Policy The Federal

The Federal Reserve And Monetary Policy

The Federal Reserve Act of 1913 The Federal Reserve System, often referred to as “the Fed, ” is a group of 12 regional, independent banks.

Ben Bernanke 2006 -?

The Pyramid Structure of the Federal Reserve Federal Open Market Committee 12 District Reserve Banks 4, 000 member banks and 25, 000 other depository institutions 40 percent of all US banks belong These members hold about 75 percent of all bank deposit. Board of Governors Structure of the Federal Reserve System

Structure of the Fed

Serving Government • Federal Government’s Banker – Maintains a checking account for the Treasury Department and processes payments such as social security checks and IRS refunds. • Government Securities Auctions – The Fed sells, transfers, and redeems government securities. T-bills, T-notes, and Treasury bonds. • Issuing Currency – The district Federal Reserve Banks are responsible for issuing paper currency, while the Department of the Treasury issues coins.

Serving Banks • Check Clearing – Check clearing is the process by which banks record whose account gives up money, and whose accounts receives money when a customer writes a check. • Supervising Lending Practices – Act as a supervisor for banks who lend $ to their customers. • Lender of Last Resort – In case of economic emergency, commercial banks can borrow funds from the Federal Reserve.

The Journey of a Check • After you write a check, the recipient presents it at his or her bank. The Path of a Check writer Recipient • The check is then sent to a Federal Reserve Bank. • The reserve bank collects the necessary funds from your bank and transfers them to the recipient’s bank. • Your processed check is returned to you by your bank. Check writer’s bank Federal Reserve Bank

The Money Creation Process To determine how much money is actually created by a deposit, we use the 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. $100 held in reserve $900 available for loans Joshua’s $900 deposit minus $90 in reserves is loaned to another customer. At this point, the money supply has increased by $2, 710. $90 held in reserve $810 available for loans

Reserve Requirements The Fed has three tools available to adjust the money supply of the nation. The first tool is adjusting the required reserve ratio. Reducing Reserve Requirements • A reduction of the RRR would allow banks to make more loans. • This would lead to a substantial increase in the money supply. Increasing Reserve Requirements • Hold more money in reserve, • shrinking the money supply.

Discount Rate The discount rate is the interest rate that banks pay to borrow money from the Fed. Reducing the Discount Rate Increasing the Discount Rate This causes banks to lend out • This causes banks to lend more money, which leads to out less money, which leads an increase in the money to a decrease in the money supply.

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. Bond Purchases • In order to increase money in circulation, the Fed buys bonds and securities from citizens to put $ in their pockets. Bond Sales • When the Fed sells bonds, it takes $ out of the citizen’s pocket and replaces it with a piece of paper.

How Monetary Policy Works Monetarism is the belief that the money supply is the most important factor in macroeconomic performance. The Money Supply and Interest Rates • The market for money is like any other, and therefore the price for money — the interest rate – is high when the money supply is low and is low when the money supply is large. Interest Rates and Spending • If the Fed adopts an easy money policy, it will increase the money supply. This will lower interest rates and increase spending. This causes the economy to expand. • If the Fed adopts a tight money policy, it will decrease the money supply. This will push interest rates up and will decrease spending.

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 cycle with properly timed stabilization policy Real GDP Business Cycles and Stabilization Policy Business cycle with poorly timed stabilization policy Business cycle Time

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 Monetary policy tools 1. increasing government spending 2. cutting taxes 1. open market operations: bond purchases 2. decreasing the discount rate 3. decreasing reserve requirements 1. decreasing government spending 2. raising taxes 1. open market operations: bond sales 2. increasing the discount rate 3. increasing reserve requirements