Transcript The Federal Reserve System

The Federal Reserve System
“the Fed”
12 Federal Reserve Districts
Commercial banks’ banker
Board of Governors
Board of Governors
• 7 members
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–
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appointed by president
approved by Senate
14 yr. term
Chair : Janet Yellen
• formerly
– Ben Bernanke
– Alan Greenspan
6 Major Jobs of the Fed
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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.
• 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
The Money Creation Process
These tools are used to implement
MONETARY
POLICY
Monetary policy has two basic goals:
to promote "maximum" sustainable output and employment
to promote "stable" prices
Why would the Fed want to
change the money supply?
• Slow INFLATION
• (too much money chasing too few goods)
• Lower UNEMPLOYMENT
• (too many people out of work)
• Promote Growth in the Economy
• Slow down an “over-heated” economy
– Adjusting for the normal business cycle
Typical Business Cycle
Long Term Growth
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
• To prevent “bubbles”
3 Important Tools
1. Changing the Reserve Requirement
2. Changing the Discount Rate
3. Conducting “Open Market Operations”
The three tools are interactive
1. 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)
2. Changing the discount rate
• discount rate = interest rate on fed to bank
loans (set by Fed)
• federal funds rate = interest rate on bank to
bank loans (set by fed funds market)
Raising the interest rate influences how much banks will
decide to borrow from the fed (who will lend them money
“out of thin air”, increasing money supply)
Keeping the discount rate low encourages borrowing
federal funds rate=interest rate on bank to bank loans
discount rate=interest rate on fed to bankAnother
loans
bank
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 encourage borrowing by
keeping rates low
currently:
discount rate - .75%
federal funds rate - 0-.25%
2006 discount rate - 6.25%
federal funds rate - 5.25%
What is the Fed trying to do?
Federal Open Market Committee
(FOMC)
1
• 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.