The Federal Reserve

1. The Federal Reserve Vincent Reitano October 25th 2010

2. Outline & Methodology Introduction to Federal Reserve Real World Impact of Fed • General definitions: Central Bank & MP • History and organization of Fed • Federal Funds Rate • Policy Implementation • New policies (QE, TALF) • Modeling the US economy through indicators and economic identities • Quantitative view of GDP • AD/AS Model, graphs • Impact of Fed, Fiscal Policy • Financial Markets

3. Definition & Role of Fed • The US Federal Reserve • “The Federal Reserve System is the central bank of the United States. It was founded by Congress in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system. Over the years, its role in banking and the economy has expanded.” • Key Concepts: Central Bank & Monetary System • Domestic, international

4. Central Banks & Monetary Policy

5. U.S. Economic History 19th-20th Century: Economic issues 1907 Panic Creation of Federal Reserve

6. 19th-20th Century Bank Panics Variables -Instability in financial markets -Lack of bank reserves -Speculation -Lack of Regulation

7. National Monetary Commission • Panic of 1907 • Variables, Influences • JP Morgan • Congress, Nelson Aldrich

8. The Federal Reserve Act of 1913 • Signed by President Wilson December 23, 1913 with changes/amendments • Finally fulfilled Alexander Hamilton’s dream • Created Central Bank & Regional Banks • Specific language used in act: • Provided for the establishment of Federal Reserve Banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.

9. Modern Fed Policy: Controversy “Fed Speak” • Paul Volcker: 1979-1987; 2008-Current • Stagflation • Associated Federal Funds Rate increases • Alan Greenspan: 1987-2006 • Lost PhD paper on housing bubbles • Reactions to historical events

10. Organization of the Fed • Board of Governors • 7 Members, Chairman and Vice-chairman • Recent Chairmen…. • Federal Open Market Committee (FOMC) • Board of Governors + 5/12 Regional Fed Presidents • Regional Banks

11. Role of the Fed 1. Banking system regulation • Fractional-Reserve Banking • Reserve Ratio, Money creation, Multiplier Example • “Lender of last resort” 2. Money Supply • M1, M2, M3, MZM • Liquidity of money and other assets • Fisher Effect: Nominal  Real • (1+r)*(1+h)=(1+R)

12. Classical Money Supply Graph

13. Federal Funds Rate Interbank loan rate Basis Points Greenspan Predictions!

14. Policy Tools • Open Market Operations • Sale of bonds: taking money out of the economy • Purchase of bonds: put money into the economy • Logically, this implies…. • Discount Rate • Inverse relationship between rate and lending • Reserve Requirements • Cash or Fed Reserves

15. Modern Policy Tools • What the textbooks will not tell you… • 1. Quantitative Easing (QE) • 2. Term Asset Backed Securities Loan Facilities • Effectiveness of these policies

16. Building a Model • GDP=Y=C+I+G+NX • Income Expenditure Identity (a) • What does each variable represent? • Total Production=Total Income=Total Expenditure • Fundamental Identity of National Income Accounting (b) • Y=Y=Y?

17. Almost there… • Spvt+Sgovt=Y+NFP-C-G • Derived from substitution of both formulas; • Input Identity (a) • Economic fact that NX+NFP=CA

18. Finally finished… Spvt=I+(-Sgovt)+CA

19. AD/AS Model Y=AF(K,N); derivative of AD=MPK; shifts

20. What about Fiscal Policy…? • Expansion vs. Contraction • Taxes and spending/stimulus • Business Cycles • How Monetary Policy & Fiscal Policy interact

21. Side Note: Econ, Politics & Media Classical vs. Keynesian economics Economic Theory/Conjecture vs. Fact Democrat vs. Republican Media: The sky is falling everyday

22. The Fed is awesome! Where do I look for current information? • FRB Website • FRB email updates • St. Louis Bank FRED • Beige Book • BLS, BEA • Great external sites: Seeking Alpha, blogs of economists • Connecting math and economics

23. Works Cited Abel, Andrew B., Ben Bernanke, and Dean Darrell Croushore. Macroeconomics. Boston: Addison-Wesley, 2011. Print. "Banking Panics in the US: 1873-1933 | Economic History Services." EH.Net | Economic History Services. Economic History Association. Web. 22 Oct. 2010. <http://eh.net/encyclopedia/article/wicker.banking.panics.us>. "The Federal Reserve System: Purposes & Functions." Board of Governors of the Federal Reserve System. Web. 15 Oct. 2010. "Federal Reserve System." Wikipedia, the Free Encyclopedia. Web. 15 Oct. 2010. <http://en.wikipedia.org/wiki/Federal_Reserve#Tools>. "The Founding of the Fed." Federal Reserve Bank of New York. Web. 20 Oct. 2010. <http://www.ny.frb.org/aboutthefed/history_article.html>. "FRB: Term Asset-Backed Securities Loan Facility." Board of Governors of the Federal Reserve System. Web. 20 Oct. 2010. <http://www.federalreserve.gov/monetarypolicy/talf.htm>. "FRB: Term Deposit Facility." Board of Governors of the Federal Reserve System. Web. 20 Oct. 2010. <http://www.federalreserve.gov/monetarypolicy/tdf.htm>. Greenspan, Alan. "The Delphic Future." The Age of Turbulence: Adventures in a New World. New ed. New York: Penguin, 2007. Print. Mankiw, N. Gregory. Principles of Macroeconomics. 4th ed. Mason, OH: Thomson South-Western, 2007. Print. "Panic of 1907." Wikipedia, the Free Encyclopedia. Web. 15 Oct. 2010. <http://en.wikipedia.org/wiki/1907_Panic>. Statute, By. "FRB: Reserve Requirements." Board of Governors of the Federal Reserve System. Web. 15 Oct. 2010. <http://www.federalreserve.gov/monetarypolicy/reservereq.htm>. Thomas, Mark. "Central Bank Independence and Inflation." Economist's View. 20 Nov. 2005. Web. 21 Oct. 2010. <http://economistsview.typepad.com/economistsview/2005/11/central_bank_in.html>.

24. Questions