Transcript Document

Ch. 13: The Federal Reserve
System
Del Mar College
John Daly
©2003 South-Western Publishing, A Division of Thomson Learning
The Federal Reserve System
• There are 12 Federal Reserve Districts; each
District has a Federal Reserve Bank with its
own president.
The Fed’s Structure
• There is a seven-member board of governors that
coordinates and controls the activities of the
Federal Reserve System.
• Each governor serves a fourteen year term.
• A governor is appointed every other year, so no
one president can “stack” the Fed.
• The major policy making group within the Fed is
the Federal Open Market Committee.
• Open Market Operations is the buying and selling
of government securities by the Fed.
Functions of the Federal Reserve
System
• Control the Money
Supply.
• Supply the economy
with paper money.
• Provide checkclearing services.
• Hold depository
institutions’ reserves.
Functions of The Federal Reserve
System
• Supervise Member
Banks
• Serve as the
government’s banker
• Serve as the lender of
last resort
• Serve as a fiscal agent
for the Treasury.
The Check-Clearing Process
Q&A
• The president of which Federal Reserve
District Bank holds a permanent seat on the
Federal Open Market Committee (FOMC)?
• What is the most important responsibility of
the Fed?
• What does it mean to say the Fed acts as
“lender of last resort”?
Fed Tools For Controlling the
Money Supply: Open Market
Operations
• The main “thing” the Fed
buys and sells is U.S.
government securities, which
are bonds the government
originally sold to investors
when it needed to borrow
funds.
• The Fed buys and sells such
securities in the financial
market, it is said to be
engaged in open market
operations.
Open Market Purchases
• Consider an open market purchase of government
securities by the Fed.
• The Fed receives the securities from a bank, and
the bank’s reserves increase by the amount the
purchase (remember Reserves = Bank deposits at
the Fed + Vault Cash).
• When the banks have a reserve increase and no
other bank has a similar decline, the money supply
expands through a process of increased loans and
checkable deposits.
Open Market Sales
• Open market sales refer to Fed sales of
government securities to banks and others.
• In one of these sales, a bank buys securities from
the Fed and the money is taken from the reserves
of the bank.
• This decreases the money supply by having the
bank reduce total loans outstanding, which
reduces the total volume of checkable deposits and
money in the economy.
Open Market Operations
The Required-Reserve Ratio
• The Fed can also influence the money
supply by changing the required-reserve
ratio.
• An increase in the required-reserve ratio
leads to a decrease in the money supply, and
a decrease in the required-reserve ratio
leads to an increase in the money supply.
The Discount Rate
• There are two major places a bank can go to
acquire a loan: the federal funds market or the
Fed.
• The bank will pay an interest rate for this loan,
and the rate it pays for the loan in the federal
funds market is the federal funds rate.
• The rate it pays for the loan from the Fed is called
the discount rate.
• When a bank borrows money from the Fed’s
discount window, its reserves increase while the
reserves of no other bank decrease; meaning, the
money supply increases.
The Spread Between the
Discount Rate and the Federal
Funds Rate
The bank may borrow from the higher Federal Funds
Rate. Here are some reasons why:
1. The bank may know that the Fed is hesitant to extend
loans to banks that want to take advantage of profitmaking opportunities.
2. The bank doesn’t want to deal with the Fed bureaucracy
that regulates it, particularly if Fed officials interpret a
request for a loan as mismanagement.
3. The bank realizes that acquiring a loan from the Fed is a
privilege and not a right, and doesn’t want to abuse the
privilege.
Discount Rate Vs. Federal Funds
Rate
• If the discount rate is
significantly lower than
the federal funds rate,
most banks will borrow
from the Fed.
• An increase in the
discount rate relative to
the federal funds rate
reduces bank borrowings
from the Fed.
Which Tool Does the Fed Prefer
to Use?
• The Fed can use open market operations, the
required-reserve ratio, or the discount rate to
influence the money supply.
• The Fed prefers to us Open Market Operations.
• Open market operations are flexible
• Open market operations can be reversed
• Open market operations can be implemented
quickly
Fed Monetary Tools & their
Effects on the Money Supply
Q&A
• What is the difference between the federal
funds rate and the discount rate?
• If bank A borrows $10 million from bank B,
what happens to the reserves in bank A? In
the banking system?
• If bank A borrows $10 million from the Fed,
what happens to the reserves in bank A? In
the banking system?