Transcript No Slide Title

Principles of Economics
2nd edition
by Fred M Gottheil
PowerPoint Slides prepared by Ken Long
Chapter 27, The Federal Reserve
System and Monetary Policy
©1999 South-Western College Publishing
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What is the Federal
Reserve System?
The central bank and
monetary authority of
the United States;
known as “the Fed”
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When was our National
Bank formed?
After two unsuccessful starts
in 1811 and 1816, our
present central bank was
established in 1864 and took
its present form with the
Federal Reserve Act 1913
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Federal Reserve System
Board of Governors
Alan Greenspan,
Chair,
Federal Reserve Board
How long do most Board
Members serve?
14 years, after which they
cannot be redesignated
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How long does the
Chairman of the
Board serve?
The Chairman serves 4 years,
but can be redesignated up
to a total of 14 years
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The Federal Reserve System
President appoints
Senate confirms
Open Market Committee
Advisory Committee
Board of Governors
12 Federal Reserve Banks
National Banking System
Commercial banks, Savings & Loans, Mutual savings banks, Credit Unions
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Who makes the decisions
for the Federal Reserve?
The Board of Governors
and the Open Market
Committee
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Who owns the Fed?
Each of the 12 district
Federal Reserve banks is
owned by its member banks
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The 12 Federal Reserve
Banks
What are the two
types of banks?
There are about 5,000
Nationally Chartered
banks and about
6,000 State banks
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What is a Nationally
Chartered Bank?
A commercial bank that
receives its charter from
the comptroller of the
currency and is subject to
federal law as well as the
laws of its state
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What is a
State Chartered Bank?
A commercial bank that
receives its charter to
function from a state
government and is
subject to state laws
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Are all banks members
of the Federal Reserve?
All nationally chartered
banks and about 15% of
state chartered banks are
members of the Fed
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What percent of deposits
reside in member banks?
More than 50% of
all deposits reside
in member banks
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Why are some banks
not members of the
Federal Reserve?
• High minimum capital
requirements
• Restrictions & regulations
• Can use Fed’s major
facilities anyway
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What is the major
function of the Fed?
To control the growth of the money
supply, in an effort to ensure the
availability of enough money and
credit in the banking system to
support a growing and noninflationary economy
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What are the goals of
the Federal Reserve?
• high level of employment
• economic growth
• price stability
• stability in markets
©1999 South-Western College Publishing
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What are the
responsibilities of the Fed?
•
•
•
•
•
•
•
Influence our money supply
Issue and maintain our currency
Act as a national clearing house for checks
Serve as a bank for the federal government
Serve as a “bankers bank”
Replace old currency
Act as a “lender of last resort”
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How does the Fed influence
the money supply?
• Open market operations
• Discount rate
• Reserve requirements
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Which monetary tool is
most often used?
Open-market operations
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What are
Open Market Operations?
Purchases and sales of
government securities
by the Federal Reserve
in an effort to influence
the money supply
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What are
Government Securities?
Bonds sold by the federal
government
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What happens when the
Fed purchases
government securities?
• The money supply
expands
• Don’t forget the
multiplier effect also!
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What happens when the
Fed sells government
securities?
• The money supply
contracts
• Don’t forget the
multiplier effect also!
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What is the
Discount Rate?
The interest rate that
banks are charged
when they borrow
money from the Fed
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What happens when the
Fed lowers the discount
rate?
• Banks tend to borrow
more from the Fed,
expanding the money
supply
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What happens when the
Fed raises the discount
rate?
• Banks tend to borrow
less from the Fed,
slowing the growth of
the money supply
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Does the Fed loan money
to private companies?
No, they only do business
with financial institutions
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3rd tool of the Fed,
changes in reserve
requirements
Lower reserve ratio raises
the money multiplier,
thus expanding the
money supply
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What happens if the Fed
raises reserve
requirements?
Higher reserve ratio
lowers the money
multiplier, thus
contracting the money
supply
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What is the role of the
Federal Open Market
Committee?
The FOMC makes decisions
as to the buying and selling
of government securities
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Who makes up the Federal
Open Market Committee?
The FOMC is made up
of the 7 board members
and 5 presidents of
Federal Reserve Banks
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What is the Federal
Advisory Council?
Committee of 12 members,
one from each Federal
Reserve district who
advise but do not vote
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Why would the Fed want to
decrease the money supply?
To lower inflation or if they are
worried the economy is growing
too fast
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Why would the Fed
want to increase the
money supply?
To stimulate employment during
recessions or sluggish economic
times
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To fight inflation, what are
possible policies of the Fed?
• Sell bonds on the open market
• Raise the discount rate
• Raise reserve requirements
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To fight unemployment, what are
possible policies of the Fed?
• Buy bonds on the open market
• Lower the discount rate
• Lower reserve requirements
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Are these Fed policies
really symmetrical?
Probably not, perhaps
easier to slow the
economy rather than
stimulate it
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Why???
• The Fed can drain
reserves so that banks
cannot loan, but they
cannot force people to
borrow
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What are two ancillary
tools of the Fed?
• Controlling stock market
margin requirements
• Moral Suasion
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Note that Fed policies
can affect interest rates,
such as the Federal
Funds Rate
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What is the
Federal Funds Rate?
The interest rate that one
bank will charge another
bank to borrow money
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What will happen to the
federal funds rate if the
Fed buys more bonds?
Banks have more
reserves and the
Federal Funds rate
falls
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What will happen to the
federal funds rate if the
Fed sells bonds?
Banks have less
reserves and the
Federal Funds rate
rises
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What is the Prime
Interest Rate?
The interest rate that
big banks charge their
best and most credit
worthy customers
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www.bankrate.com/goocal/
news/fed/20021106a.asp
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http://www.law.cornell.edu/uscode
/12/38.shtml
http://www.bog.frb.fed.us
http://www.bep.treas.gov
http://www.ny.frb.org/pihome/edu
cator/fomcsim.html
http://www.frbsf.org/system/fedsys
tem/monpol/tofc.html
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• What is a State Chartered
Bank?
• What is a Nationally Chartered
Bank?
• What is the Federal Reserve
System?
• What are the responsibilities of
the Fed?
• Who makes the decisions for
the Federal Reserve?
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• What is the role of the Federal
Open Market Committee?
• Why would the Fed want to
decrease the money supply?
• Why would the Fed want to
increase the money supply?
• How does the Fed influence the
money supply?
• Which monetary tool is most
often used?
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END
©1999 South-Western College Publishing
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