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The Federal Reserve and Monetary Policy

Learn about the Federal Reserve's role in stabilizing the economy through monetary policy. Explore the tools and methods used, including open market operations and adjusting interest rates.

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The Federal Reserve and Monetary Policy

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  1. The Federal Reserve and Monetary Policy

  2. Two government methods to stabilize the economy… • Fiscal Policy: “The use of government spending and revenue (tax) collection measures to influence the economy.” • Think of our “Balancing the Budget” activity.

  3. Monetary Policy • “Actions by the Federal Reserve System to expand or contract the money policy in order to affect the cost and availability of credit.” • As you may recall from IOUSA this is the process of opening or closing the water spicket.

  4. What actually IS the Fed? • The Federal Reserve was established by Congress in 1913. It has been virtually unchanged since the 1930’s. • It is the central bank of the US, providing financial services to the government, regulating financial institutions, enforcing consumer protection laws, and conducting monetary policy. • It is privately owned by 12 district banks and about 3,000 member banks operating about 50,000 branches.

  5. The Board of Governors • 7 member board with each member serving 14 years in staggered terms • Members are picked by the president and approved by the Senate. • The Board establishes policies for all banks to follow. • You probably know…

  6. Tools of the Fed… • Use an EASY MONEY POLICY to allow the money supply to grow and interest rates to drop. • This tends to invigorate a lethargic economy. • Or pursue a…

  7. Tight Money Policy… • The Fed restricts the growth of the money supply which drives up interest rates. • When interest rates are high, consumers AND businesses borrow less and spend less, slowing economic growth.

  8. Question! • Why would the Fed EVER use a tight money policy if it slows economic growth? • To stop inflation

  9. 1st tool of monetary supply… • The Fed can raise or lower the “reserve requirement.” This is the percentage of every deposit that must be set aside as a legal reserve. Banks can use the rest of deposited funds for loans to businesses and consumers. • Higher reserve rates lead to higher interest rates and a lower money supply. Lower reserve rates lead to low interest rates and a larger money supply. • The Fed rarely uses this tool.

  10. The 2nd tool of the Fed… • The buying and selling of government securities is called “open market operations.” • By buying government securities in financial markets, the Fed can increase the money supply which lowers interest rates, stimulating the economy. • By selling government securities in the financial markets, the Fed can decrease the money supply which raises interest rates, slowing the economy.

  11. The 3rd tool of the Fed… • Raise or lower the “discount rate,” the interest the Fed charges on loans to other financial institutions • The lower the discount rate, the higher the money supply, sparking economic growth

  12. Lastly, the Fed may use… • “Moral suasion” – In essence using their ability to persuade through the use of announcements, press releases, etc. to affect desired changes • “Selective credit controls” pertain to loans for specific commodities such as homes or automobiles.

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