Chapter 15: The Fed and Monetary Policy

1
Chapter 15 The Fed and Monetary Policy

• Chapter 15.1 The Federal Reserve System
• Chapter 15.2 Monetary Policy
• Chapter 15.3 Monetary Policy, Banking, and the
  Economy

2
Chapter 15.1 The Federal Reserve System

• The Fed provides financial services to the
  government, regulates financial institutions,
  maintains the payments system, enforces consumer
  protection laws, and conducts monetary policy.

3
Structure of the Fed

• The Fed is publicly owned by member banks
  commercial banks that hold stock in the Fed.
• Individual state banks have the choice to
  join. Nationally chartered banks have to join.
• The Fed is run by a seven-member board of
  governors these members are appointed by the
  President, approved by the Senate, and serve
  14-year terms.
• Their job is to supervise regulate the Fed.
• The Fed itself is made up of 12 district banks
  spread throughout the U.S.
• The Federal Open Market Committee makes the
  decisions about the size of the money supply and
  the level of interest rates. The FOMC is the
  Feds primary monetary policy-making body.

• Three Advisory Committees
• Federal Advisory Council - Advises the Govs on
  state of State of economy.
• Consumer Advisory Council oversees consumer
  credit laws.
• Thrift Institutions Advisory Council advises
  Govs on institutions that lend money (banks,
  savings loans, credit unions).

4
Regulatory Responsibilities of the Fed

• All depository institutions (commercial, savings,
  credit, etc.) must answer to the Fed.
• The Fed supervises/regulates foreign banks in the
  U.S. (250 branches/agencies) and U.S. banks in
  foreign countries.
• The Fed clears checks, enforces consumer
  legislation, maintains currency/coins, and
  provides financial services to the government.

5
Clearing checks

• 1. I write you a check and you deposit it in the
  bank.
• 2. The bank credits your account and send the
  check to the Fed.
• 3. The Fed sorts/processes your check, and sends
  the check and a true credit to your bank.
• 4. You bank puts real money into your account.
• 5. Your bank sends the check back to my bank and
  real money is taken out of my account.
• 6. Cleared checks are kept on file at my bank for
  future reference.

6
Chapter 15.2 Monetary Policy

• The Fed defines money in one of two ways
• M1 the transactional components of money
  (medium of exchange) currency, coins, checks,
  etc.
• M2 store of value components time
  deposits, saving deposits, money market funds,
  etc.

7
Monetary Policy

• One of the Feds biggest responsibilities is
  monetary policy the expansion or contraction
  of the money supply in order to influence the
  cost and availability of credit.

Vs.
8

• The U.S. has a fractional reserve system
  requires banks to keep a fraction of their
  deposits in the form of legal reserves
  (cash/coin).
• Under this system, banks have reserve
  requirements rule that a of each deposit must
  be set aside as legal reserves.
• Todays reserve requirement is 12.

9
Reserve Requirement Example

• 100 is deposited.
• 12 must be reserved/kept.
• 88 are considered excess reserves.
• Excess Reserves can be used to make loans to
  others.

10
Money Policy (2 Types)

• Easy Money Policies Fed increases money supply
  interest rates on loans fall economy
  increases.
• Tight Money Policies Fed decreases money
  supply interest rates on loans rise economy
  decreases.

11
Tools of Monetary Policy

•  The Fed can increase/decrease the monetary
  supply using any of 4 methods
• 1. Reserve Requirements
• 2. Open Market Operations
• 3. Discount Rates
• 4. Margin Requirements

12
1. Reserve Requirement

• Remember, the reserve requirement is the of
  each deposit that must be kept by a bank (cant
  be loaned out).
• A decrease in the reserve requirement increases
  the overall money supply (banks can lend more).
• An increase in the reserve requirement decreases
  the overall money supply (banks cant lend as
  much)

13
2. Open Market Operations

• The Fed can buy securities (stocks/ bonds) from
  the government.
• If the Fed buys securities, more money enters the
  economy and the overall money supply increases.
• If the Fed sells securities, money leaves the
  economy (it comes to the Fed) and the overall
  money supply decreases.

14
3. Discount Rate

• The Fed makes loans to common banks the
  discount rate is the amount of interest they
  charge.
• If the Fed decreases the discount rate (interest
  rates), more banks will take out loans and the
  overall money supply will increase.
• If the Fed increases the discount rate (interest
  rates), less banks will take out loans and the
  overall money supply will decrease.

15
4. Margin Requirements

• The Fed sets the margin requirement the amount
  of money that an investor must deposit to buy
  stock (today its 50).
• If margin requirement are decreased, more stock
  can be purchased, and the overall money supply
  increases.
• If the margin requirement is increased, less
  stock can be purchased, and the overall money
  supple decreases.

16
Chapter 15.3 Monetary Policy, Banking, and the
Economy

• Monetary policy has a huge effect on the economy
  it has long-run effects and short-run effects.

17
Short-Run Impact

• Monetary policy affects the interest rate (cost
  of credit).
• An increase in money supply causes interest rates
  to go down (cheaper to borrow money).
• A decrease in money supply causes interest rates
  to go up (more expensive to borrow money).

18
Long-Run Impact

• Monetary policy affects inflation.
• An increase in the money supply causes inflation
  (prices).
• A decrease in the money supply stabilizes
  inflation (prices).