Chapter 16 Section 2

1. Chapter 16 Section 2 Functions of the Federal Reserve

2. Functions of the Federal Reserve • Lending Money • Banks often lend to each other on short-term basis • In natural disaster, all banks in region lack cash flow • Fed lends to banks with enough assets and capital to qualify • Small banks with seasonal cash flow needs may borrow from Fed • Fed serves as lender of last resort to prevent banking crisis

3. Functions of the Federal Reserve • Regulating and Supervising Banks • Fed banks supervise state-chartered members, bank holding companies • bank holding company owns, has controlling interest in several banks • Fed banks enforce truth-in-lending laws • Conduct bank exams—audit financial practices of banks in district • Monitor bank mergers to ensure competition

4. Serving the Federal Government • KEY CONCEPTS • Fed serves as federal government’s banker • helps carry out taxation and spending activities

5. Serving the Federal Government • Service 1: Paying Government Bills • Tax revenues are deposited with the Fed • Fed issues checks, makes electronic payments via U.S. Treasury • for transfer payments, employee wages, direct spending, tax refunds • deducts amounts from government’s account • Processes postal money orders, food stamps

6. Serving the Federal Government • Service 2: Selling Government Securities • Fed processes U.S. savings bonds, auctions other securities • provides information, collects payment, credits funds, delivers bonds • Pays interest on bonds • Federal Open Market Committee (FOMC) supervises sales of securities • purpose is to stabilize the economy

7. Serving the Federal Government • Service 3: Distributing Currency • Federal Reserve notes are official paper currency of U.S.: fiat money • Treasury Department prints notes that go to Fed district banks • Fed banks distribute notes to depository institutions in amounts needed • currency then goes to people and businesses • Fed also distributes coins produced by U.S. Mint

8. Creating Money • Creating money—how money enters circulation through deposits, loans • Fed establishes required reserve ratio (RRR) for banks • fraction of bank’s deposits that it must keep in reserve • Reserve may be stored as cash in bank’s vault or deposited with Fed

10. Creating Money • Example: Money Creation • Banking system creates money whenever banks get deposit and make loan • Level of the RRR determines how much money may be loaned • Money supply increases by total loans made after initial cash deposit • deposit multiplier formula tells how much money supply will increase

12. Questions • Why might the Fed help a small bank in an agricultural region stabilize its cash flow? • How are the banking services the fed provides to the government similar to the services it provides to banks? • If the Fed raised the RRR from 10% to 12%, how would it affect the money supply? • You have been planning your college finances and you know that you’ll have to take a bank loan to cover tuition costs. You read that the Fed intends to raise the RRR rate from 10% to 20%. How will this change affect the money supply and your ability to borrow money for college tuition?