The Federal Reserve System

1. The Federal Reserve System • 1913 signed into law • W. Wilson • Goal: more responsive money supply

2. The Fed 4 Main Parts • Board of Governors • Federal Open Market Committee • 12 Federal Reserve banks • Member banks MONETARY POLICY

4. Board of Governors • Makes policy for nations banking system • Consists of 7 members appt’d by President and confirmed by Senate • 14 year terms (1 is up every 2yrs) • Chairman & Vice named by Pres. • Decisions not subject to approval by govt to keep politics out

5. Federal Open Market Committee • 7 members from Board of Governors +5 presidents of Fed Reserve Banks • Sets policy on purchase of securities which is part of Monetary Policy* * discussed later

6. Federal Reserve Banks • 12 banks each a separate district in US • Each is a corporation • Stocks only sold to member banks in district not public • 9 member Board of Directors– bankers, industry members

8. Member Banks • All national banks are members of Federal Reserve and chartered by nat’l govt • State banks can decide to join or not • Must comply with federal laws and permit supervision • 1980 deregulation law– makes little difference= all must follow Fed’s reserve requirements

9. 6 Major Functions of Fed • Holding required reserves • Regulating supply of money • Clearing checks • Supplying economy with paper currency • Acting as fiscal agent for govt • Supervising member banks

10. Reserve Requirements • A tool to regulate money supply • Amt of money banks must hold and not loan out • Raising Reserve Requirement: --reduces the size of loans banks can make which reduces the money supply and can help stop inflation • Lowering Reserve Requirement --increases the size of loans banks can make which adds to the money supply and can combat recession

11. $$$$$ $$$

12. Regulating the supply of money • To combat the ups and downs of the business cycle • Can adjust the amount of money in the economy (see previous slide) MONETARY POLICY

13. Clearing Checks The Fed deducts appropriate amount from buyers bank and deposits it in sellers bank -no real money changes hands—entries in bank records are made

14. Paper Currency • Federal Reserve notes are our paper bills • Issued by the 12 Fed Banks • Bank is indicated on seal on left side of front of bill • Created by US Treasury’s Bureau of Engraving and Printing in WA, DC but put in circulation by one of 12

16. Fiscal Agent of govt • Works with US Treasury • Holds checking acct for govt • Ex– pensions, vets benefits, govt purchases

17. Supervising Member Banks • Ensures members comply with laws • Ensures members use sound banking practices • Ensures adequate capital, oversees mergers, and est. of branches, sets loan/investment limits • Shares this resp. with govt agency

19. *Back to Open Market Operations (Monetary Policy) Another way the Fed can add or subtract money in the economy • The Fed itself can either buy or sell government bonds (securities) • Ex. #1—the Fed BUYS a bond from ‘you’—you deposit the money=more $ in economy • EX. #2—the Fed SELLS a bond to ‘you’—you withdraw $ from bank=less $ in economy

20. bond $ FED Bank $$ $$$ $$ FED Bank bond

21. Manipulating Interest Rates(Monetary Policy, too) • Banks sometimes need more cash than they have in reserve thus they can borrow $ just like ‘you’ • The Fed loans $ to banks • Banks must pay an interest rate on the borrowed money (just like ‘you’) • Called the Discount Rate • By raising or lowering the % the Fed can influence the amt $ in economy

22. Discount Rate • Raising the rate signals ‘tight money’—attempt to reduce amt of money in economy • Lowering the rate signals ‘easy-money’—attempt to add amt of money to economy 3% 5% 6% 7% 8% 9% 10%

23. FED 3% $ Bank 5% Too expensive FED 5% Bank 7%

24. Summary Adding Money in the economy fights recession Subtracting money from economy fights inflation Purpose: to prevent business cycle from being too ‘bumpy’ (boat on waves analogy)

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