Transcript The Federal Reserve System

The Federal Reserve System
“the Fed”
Reference Chapter 11
12 Federal Reserve Districts
Commercial banks’ banker
Board of Governors
Board of Governors
• 7 members
–
–
–
–
appointed by president
approved by Senate
14 yr. term
chairman
• Ben Bernanke
• formerly
– Alan Greenspan
6 Major Jobs of the Fed
•
•
•
•
•
•
Supply the economy with paper money
and coins.
Hold bank reserves.
Provide check-clearing services
Supervise member banks
Serve as lender of last resort.
Control the money supply
1.Supply the economy with paper money and coins.
“U.S. Mint”
Bureau of Engraving and Printing
2. Hold bank reserves
reserves at the Fed + vault cash =total reserves
3.Provide check-clearing services
• Facilitates check-cashing between
commercial banks.
– for example, Wells-Fargo and Bank of America
Between banks, cities
• EXAMPLE:
• Pete pays Sue for a used car. He gives her a
check for $2,000.
• Sue deposits the check in her bank and is
credited with $2,000 in her account.
• Sue’s bank sends the check to FRB who
increases the bank’s reserve account by $2,000.
• FRB decreases Pete’s bank’s reserve by
$2,000
• FRB notifies Pete’s bank to reduce Pete’s
account by $2,000.
4. Supervise member banks
5. Serve as lender of last resort
• Fed may “audit” a bank
– check that the loans it made are good
– be sure it has followed banking rules
– verify the accuracy of its accounting.
• Fed can lend funds to struggling banks.
– Glass-Steagall Act (1933) establishes FDIC
6. Control the money supply.
I kept the most important for last!
• Tools for changing the money supply
– Reserve Requirement
– Discount Rate
– Open Market Operations
Why is changing the money supply important?
TO CONTROL INFLATION and/or UNEMPLOYMENT
Monetary Policy
Reserve Requirement
currently: 3-10%
• Raise the reserve requirement = Less
money in circulation
– slows the economy
• eventually brings price stability (lowers inflation)
• Lower the reserve requirement = More
money in circulation
– More money to buy goods and services
• requiring more jobs to produce them
(lowers unemployment)
Discount Rate
• federal funds rate=interest rate on bank to bank loans
• discount rate=interest rate on fed to bank loans
When the federal funds rate is lower than the discount rate,
who would you borrow from?
When the discount rate is lower than the federal funds rate,
who would you borrow from?
• The Fed can change the discount rate to change the
money supply
– DR less than FFR: More money in circulation
• lower unemployment
– DR more than FFR: Less money in circulation
• lower inflation
• The Fed can encourage borrowing by keeping rates low
discount rate currently: .75%
federal funds rate currently: 0-.25%
• What is the Fed trying to do?
Federal Open Market Committee
(FOMC)
• controls Open Market Operations
– Open Market Purchases buys government
securities = increases money supply
– Open Market Sales sells government
securities = reduces the money supply
Important Background Information
• U.S. Department of the Treasury
– the agency of government responsible for
paying for government and its actions
• collects taxes
• borrows money if needed
– It borrows from the public by offering securities
» securities: promises to repay with interest at some
future time
Open Market Purchases
• Fed offers to buy your government
security.
– “Thin air” money is given to you.
– Money supply increases
Open Market Sales
• Fed offers to sell government securities it
holds.
– You pay for it.
– Your money “disappears” into the Fed
– Decreases the money supply.
Monetary Policy
• Fed is responsible for maintaining price stability
and employment
• “Expansionary Monetary Policy”
– goal is to increase money supply
• to reduce unemployment
• to avoid deflation
• “Contractionary Monetary Policy”
– goal is to decrease the money supply
• to reduce inflation
Review
1. Describe the structure of the Federal Reserve
System.
7 member Board of Governors
appointed by president, ratified by Senate
14 year term, chairman
12 districts
Review
1. 6 major jobs?
• Supply the economy with paper money
and coins.
• Hold bank reserves.
• Provide check-clearing services
• Supervise member banks
• Serve as lender of last resort.
• Control the money supply
Review
• Describe the check-clearing process.
• Pete pays Sue for a used car. He gives her a check for
$2,000.
• Sue deposits the check in her bank and is credited with
$2,000 in her account.
• Sue’s bank sends the check to FRB who increases the
bank’s reserve account by $2,000.
• FRB decreases Pete’s bank’s reserve by $2,000
• FRB notifies Pete’s bank to reduce Pete’s account by
$2,000.
Review
• Why would a bank choose to join the
Federal Reserve System?
• FRB helps maintain bank stability
• Consumers want their accounts to be
covered by FDIC
Review
• What are three ways the Fed can control
the money supply?
Reserve Requirement
Discount Rate
Open Market Operations
Review
• Why does the Fed want to control the
money supply?
• Monetary Policy:
maintain employment
control inflation
Review
• What is the “reserve requirement”?
– If the Fed wants to reduce the money supply,
what does it do to the reserve requirement?
• What is the discount rate?
– What is the federal funds rate?
– If the Fed wants to increase the money
supply, what does it do to the discount rate?
Review
• What is the difference between an Open Market
Sale and an Open Market Purchase?
• action?
• goal?
Homework
• Read 12.1,
MEASURING ECONOMIC
PERFORMANCE: “National Income Accounting”
pages 310-316
– Take notes using Red and Blue subheadings
– Highlight key terms
– Write answers for Section Review Qs #2-6
discount rate currently: .75%
federal funds rate currently: 0-.25%
• The Fed can change the discount rate to
change the money supply
– DR less than FFR: More money in circulation
• lower unemployment
– DR more than FFR: Less money in circulation
• lower inflation
• What is the Fed trying to do?
Stagflation
What’s up with that?
• stagnant (persistently high) unemployment
and
• inflation
1970’s US and other industrialized nations experienced stagflation
• erratic monetary policy: stop-and-go, on-and-off
• supply shocks (OPEC)