Federal Reserve System and Monetary Policy

1. Federal Reserve System and Monetary Policy

2. MONEY SPENDING • The amount of _______ in an economy is important because it affects the level of __________ in a country. • Too much spending can cause ________ while too little spending can cause ____________ and declining levels of _________. • In the United States, Congress has assigned the responsibility for controlling the money supply to the _______ ________ ________ INFLATION UNEMPLOYMENT PRODUCTION FEDERAL RESERVE SYSTEM

3. FED • The Federal Reserve System or “____” has functioned as the central bank of the United States since ____. • It consists of a ___-member Board of Governors in Washington, D.C., plus ___ regional banks throughout the country. Our Federal Reserve Bank is in Dallas. 1913 7 12 Ben Bernanke, Chairmen of the Federal Reserve Federal Reserve Bank of Dallas, Houston Branch

4. How do we print money?

5. NON-POLITICAL • The Federal Reserve System is designed to be as ____________ as possible. • We achieve this by… • The Governors serve staggered 14 year terms • The Fed does not rely on appropriations from congress (that is money to run it) • The governors’ terms end in January of even numbered years, so one president does not get to appoint many governors

6. A Central Bank • As a central bank, the Fed manages the ______ _______ by influencing the lending activity of commercial banks and other financial institutions. • But the major part of its direct influence comes about through its relationship and dealings with _________ ______, from which the effects spill over to the financial system as a ______. MONEY SUPPLY COMMERCIAL BANKS WHOLE

7. EXPAND CONTRACT MONETARY • The deliberate actions of the Federal Reserve System to ______ or _______ the money supply are called ________ ______. They purpose of monetary policy is to maintain the trend of _______ _______, __________ and _______ at desired levels. The Board of Governors and twelve heads of the regional banks regularly meet ___ times a year to decide on Federal Reserve monetary policy. POLICY ECONOMIC OUTPUT EMPLOYMENT PRICES 8

8. Expansionary or Contractionary • A policy of Fed designed to expand the growth of money and credit in the economy is known as an _____________ (or loose) monetary policy. • A policy to restrict the growth of money and credit in the economy is known as a _______________ (or _____) monetary policy. • The creation of too much ______ can cause _________, and the creation of too little money can cause a ___________. EXPANSIONARY CONTRACTIONARY TIGHT MONEY INFLATION RECESSION

9. What is Inflation or Deflation?

10. The Fed has three primary tools with which to carry out monetary policy. These are: • (1) _____ ________ __________, • (2) ________ ___________, • and (3) the _________ _____. OPEN MARKET OPERATIONS RESERVE REQUIRMENT DISCOUNT RATE

11. Open Market Operations SECURITIES • Open market operations refer to the Fed’s buying and selling of U.S. government __________ (like savings bonds) in order to ____ (+) or to ________ (-) from the reserves of the nation’s commercial banking system. • Government securities, such as U.S. Treasury _____, ______, and ______, are issued by the U.S. Treasury in return for money borrowed from individuals and businesses in order to finance government spending. ADD SUBTRACT BILLS NOTES BONDS

12. BUYS • If the Federal Reserve wants to put money into the economy, it _____ some of these government securities by writing a check to itself. If for instance, the Fed buys _______ worth of government with such a check, it creates the _______ used to pay them. • The sellers are not $10,000 richer, since they no longer own the securities, but the money supply grows because there is $10,000 of ____ ______ in the economy. $10,000 $10,000 NEW MONEY

13. CONTRACTIONARY SELLS • If the Fed wants to purse a ____________ monetary policy, it ______ some of the government securities it owns. • The money that is paid to the Federal Reserve for these securities is ________ from the economy, so the money supply _______. • Open Market Operations are the most frequent used _____ of the monetary policy REMOVED SHRINKS TOOL

14. Reserve Requirement RESERVE • A second important tool of monetary policy consists of ________ ____________ for bank deposits. The Federal Reserve requires that banks keep as reserves a certain ________ of the deposits they hold. These reserves must be kept as balances at Federal Reserve banks or as ______ the banks have on hand (i.e., ______ ______). Banks that fail to meet their reserves are subject to monetary penalties. These reserves cannot be _______ to borrowers. REQUIREMENTS FRACTION CASH VAULT CASH LENT

15. Reserve Requirements • If the Fed wants to pursue a _____________ monetary policy, it can ______ reserve requirements, thereby restricting the amount of funds bank can lend. • If the Fed wants to pursue an ______________ monetary policy, it can ________ reserve requirements. CONTRACTIONARY RAISE EXPANSIONARY LOWER

16. $10,000 15 • Let’s say you deposit ______ at your local bank and the reserve requirement on deposits is ____ percent. This means that your bank would have to keep ______ on reserve at the Fed (.15 x $10,000 = _______). It could lend the other _____ to borrowers. If the Fed were to ______ the reserve requirement to ___ percent, then the bank could lend ____ more of your $10,000 deposit or a total of ______. Such an expansion of lending causes the money supply in the economy to _________. $1,500 $1,500 $8,500 LOWER 10 $500 $9,000 INCREASE

17. RAISE 20 $8000 • However, if the Fed were to _______ its reserve requirements to ___ percent, the bank could lend only _____ of your $10,000 deposit, thus curbing the possible increase in the money supply. Changes in reserve requirements can be a very powerful _____ of monetary policy but this tool is used infrequently precisely because it is so powerful. Most often, the Fed desires to make ________ or minor changes in policy, aims for which changes in reserve requirement are ____ suitable. TOOL GRADUAL NOT

18. Discount Rate • The __________ _____ , the third tool of monetary policy, is the interest rate the Federal Reserve charges ______ that borrow money. • If a bank borrows from the Federal Reserve, the reserves lent to the bank are _________ by the Fed. • This process _________ the amount of money and credit in the economy. DISCOUNT RATE BANKS CREATED INCREASES

19. The Federal Reserve does not automatically allow a bank to borrow from it whenever the bank wants to. The Fed can _______ such a loan. • IF the discount rate is _____ and the Fed does not discourage banks form borrowing form it, the Federal Reserve will foster an ______________ monetary policy. REFUSE LOW EXPANSIONARY

20. HIGH • IF the discount rate is _____ and the Fed discourages banks from borrowing from it, the Federal Reserve will foster a ________ monetary policy. • This discount rate is probably the least strong of the ___ principles of monetary policy, but the Federal Reserve does use a change in it to indicate an overall ____________ or _____________ of monetary policy TIGHT 3 TIGHTENING LOOSENING