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The Federal Reserve and the Supply and Cost of Credit

Explore the role of the Federal Reserve in controlling the supply of money, achieving stable prices, full employment, and economic growth. Learn about the assets and liabilities of the Fed, the structure of the Federal Reserve system, expansion and contraction of money and credit, the tools of monetary policy, the impact of the Federal Reserve on interest rates, fiscal policy, inflation, deflation, and the impact on firms and foreign exchange.

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The Federal Reserve and the Supply and Cost of Credit

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  1. Chapter 3 The Federal Reserve and The Supply and Cost of Credit

  2. The Federal Reserve(the Fed) • The nation's central bank • Purpose: to control the supply of money in order to achieve • Stable prices • Full employment • Economic growth

  3. The Assets of the Fed • Gold certificates • Cash items in process • The float • U.S. government securities • Foreign currencies

  4. The Liabilities of the Fed • Federal Reserve Notes • Deposits by • Banks (reserves) • Federal government • Foreign depositor

  5. Structure of the Federal Reserve • Board of Governors • The twelve district banks • Federal Open Market Committee

  6. Structure of the Federal Reserve

  7. Expansion of Money and Credit • Fractional reserve banking • Expansion (and contraction) of the money supply • Importance of excess reserves

  8. Multiple Expansion • Reserves are either • Required or • Excess • The process of loan credition

  9. Multiple Epansion of the Supply of Money Initial Dep: $100 Reserve Req: 10%

  10. Multiple Expansion • Change in the money supply = change in excess reserves / reserve requirement

  11. Multiple Expansion • Reserve requirement = 10% • Reserves increase by $100 • Possible increase in the money supply: $100/0.1 = $1,000

  12. Impact of Cash Withdrawals • Multiple expansion in reverse • Money supply contracts

  13. Importance of the Federal Funds Market • Market for reserves • The lending of reserves between banks • The federal funds rate

  14. The Tools of Monetary Policy • The discount rate • Rate the Fed charges banks to borrow reserves

  15. The Discount Rate

  16. The Reserve Requirement • Percentage banks must hold against deposit liabilities • Changing commercial banks' reserves leads to: • Multiple expansion or • Multiple contraction

  17. The Tools of Monetary Policy • Open market operations • The buying and selling of Federal government securities • By far the most important tool of monetary policy

  18. Impact of The Federal Reserve • The Fed affects interest rates through its impact on the ability of the banking system to lend

  19. Monetary Expansion • To expand the money supply, the Fed buys government securities • Paying for the securities puts reserves into the banking system • The purchases reduce interest rates

  20. Monetary Contraction • To contract the money supply, the Fed sells government securities • Receiving payment for the securities removes reserves from the banking system • The sales increase interest rates

  21. Fiscal Policy • The federal government's • taxation • spending • debt management

  22. Deficit Spending • Government spending exceeds revenues • Sources of funds to finance the deficit • commercial banks • non-bank public • Federal Reserve

  23. Surplus • Government revenues exceed revenues • Question of how to use any surplus

  24. Fiscal Policy • The possible impact of deficit spending or a surplus on • the money supply • the reserves of the banking system • security prices

  25. Inflation • General increase in prices • CPI - measures the rate of inflation • Excessive expansion of money

  26. Changes in Inflation • Affect firms with natural resources • Oil • Precious metals (e.g., gold) • Some firms are better able to pass on price increases

  27. Fight Inflation by • Contracting the money supply • Raising interest rates • Raising taxes

  28. Deflation • A general decline in prices • Opposite impact of inflation • Unexpected deflation hurts debtors and helps creditors

  29. Impact of Monetary and Fiscal Policy on the Firm • Cost of funds • Demand for firm’s products and services • Ability to anticipate changes in economic policy

  30. Foreign Exchange • Foreign currencies • Exchange rate • Value of one currency in terms of another

  31. Foreign Exchange • Devaluation - depreciation of a currency • Revaluation - appreciation of a currency

  32. Fluctuations in the British Pound

  33. Balance of Payments • Current account • merchandise trade deficit or surplus • Capital account • Official reserve account - The IMF

  34. Balance of Trade

  35. International Monetary Fund (IMF) • Bretton Woods agreements • Loans to less-developed countries

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