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Contents
CHAPTER FOCUS SECTION 1 Organization
and Functions of the Federal Reserve
System SECTION 2 Money Supply and
the Economy SECTION 3 Regulating the
Money Supply CHAPTER SUMMARY CHAPTER ASSESSMENT
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Chapter Focus 2
Chapter Overview
Chapter 15 describes or explains the organization
and functions of the Fed, how and why the supply
of money in the United States is regulated, and
the differences between tight money policies and
loose money policies.
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Section 1-3
Introduction

• Congress created the Federal Reserve System in
  1913 as the central banking organization in the
  United States. ?

• Its major purpose was to end the periodic
  financial panics (recessions) that had occurred
  during the 1800s and the early 1900s. ?
• Over the years, many other responsibilities have
  been added to the Federal Reserve System, or Fed.

Fed the Federal Reserve System created by
Congress in 1913
as the nations central banking organization
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Section 1-3
Introduction (cont.)

• In this section, youll learn how the Fed is
  organized to carry out its functions.

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Section 1-4
Organization of the Federal Reserve System

• The Fed is responsible for monetary policy. ?

• Monetary policy involves the changing rate of
  growth of the supply of money in circulation in
  order to affect the amount of credit, which
  affects business activity in the economy. ?

• The Board of Governors oversees 12 district
  Federal Reserve banks and regulates activity of
  member banks and all other depository
  institutions.

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Section 1-4
Organization of the Federal Reserve System
(cont.)

• The Federal Advisory Council reports to the board
  of governors on general business conditions in
  the country. ?

• The Federal Open Market Committee decides what
  the Fed should do to control money supply. ?

• Twelve Federal Reserve banks are set up as
  corporations owned by member banks.

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Section 1-4
Organization of the Federal Reserve System
(cont.)

• Member Banksall national banks, those chartered
  by the federal government, must join the Federal
  Reserve System state chartered banks may join if
  they choose. ?

• All institutions that accept deposits from
  customers must keep reserves in their district
  Federal Reserve bank.

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Figure 15.1
Organization of the Federal Reserve System
(cont.)
Figure 15.1 Organization of the Federal Reserve
System
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Figure 15.2
Organization of the Federal Reserve System
(cont.)
Figure 15.2 The Twelve Districts of the
Federal Reserve System
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Section 1-16
The Functions of the Federal Reserve System

• Has many functions, including check clearing,
  supervising member banks, holding reserves, and
  supplying paper currency. ?

• Its most important function is to regulate the
  money supply. ?

• The Fed sets standards for consumer protection,
  mainly truth-in-lending legislation.

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Figure 15.3
The Functions of the Federal Reserve System
(cont.)
Figure 15.3 How a Check Clears
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Section 2-1
Readers Guide
Section Overview
Section 2 explains the difference between loose
money policies and tight money policies, and how
fractional reserve banking is used to increase
the money supply. ?
Objectives

• What are the differences between loose money and
  tight money policies? ?

• What is the purpose of fractional reserve
  banking? ?
• How does the money supply expand?

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407 of your textbook.
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Section 2-3
Introduction

• The jobs of the Fed today range from processing
  checks to serving as the governments banker. ?

• In this section, youll learn that the Feds most
  important function, however, involves control
  over the rate of growth of the money supply.

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Section 2-3
Lecture Launcher

• In 1979 inflation had risen to almost 13. Under
  the leadership of Paul A. Volcker, the Fed
  implemented tight monetary policies. This led to
  the most severe recession the U.S. had
  experienced since the Great Depression, but
  Volcker had brought inflation under control. ?

• What are tight monetary policies and how do they
  work to control inflation? ?

• How does the Fed go about expanding the money
  supply?

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Section 2-4
Loose and Tight Money Policies

• Monetary policy involves changing the growth are
  of the money supply in order to change the cost
  and availability of credit. ?

• Loose money means credit is plentiful and
  inexpensive used to encourage economic growth. ?

• Tight money means credit is in short supply and
  expensive used to control inflation. ?

• The goal of monetary policy is to strike a
  balance between tight and loose money.

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Figure 15.5
Loose and Tight Money Policies (cont.)
Figure 15.5 Balancing Monetary Policy
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Section 2-7
Fractional Reserve Banking

• Many banks are required to keep a percentage of
  their total deposits in cash reserves in their
  vaults or with the Federal Reserve bank. ?

• This enable the bank to provide funds for
  customers who might suddenly want to withdraw
  large amounts of cash from their accounts. ?

• Currently most financial institutions are
  required to reserve 10 percent of their checkable
  deposits and none on their interest-paying
  deposits.

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Section 2-9
Money Expansion

• Banks can use non-reserved deposits to create new
  money. ?

• Money banks lend and receive is usually spent or
  deposited in another bank who can also use the
  deposits to create new money. ?

• This process is known as the multiple expansion
  of money.

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Figure 15.6
Money Expansion (cont.)
Figure 15.6 Expanding the Money Supply
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Section 3-1
Readers Guide
Section Overview
Section 3 discussed the methods the Fed uses to
regulate the money supplythe reserve
requirement, the discount rate, and open-market
operationsand explains the difficulties
associated with instituting monetary policy. ?
Objectives

• How can the Fed use reserve requirements to alter
  the money supply? ?

• How does the discount rate affect the money
  supply? ?
• How does the Fed use open-market operations? ?
• What are some of the difficulties of carrying out
  monetary policy?

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412 of your textbook.
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Section 3-3
Introduction

• The main goal of the Federal Reserve is to keep
  the money supply growing steadily and the economy
  running smoothly without inflation. ?

• In this section, youll learn the Fed uses
  several tools to achieve a smoothly running
  economy.

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Section 3-3
Lecture Launcher

• Controlling the money supply is a delicate
  process. For this reason the Fed rarely utilizes
  its most direct and powerful tool, a change in
  the reserve requirements. The last significant
  change to reserve requirements was in April of
  1992, when the rate on transaction accounts
  (checking) was reduced from 12 to 10. ?

• What is the primary goal of the Federal Reserve
  as it regulates the money supply.

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Section 3-3
Lecture Launcher (cont.)

• What three tools can the Fed use to adjust the
  money supply?

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Section 3-4
Changing Reserve Requirements

• The lower the percentage of deposits in reserve,
  the more money available to loan out. ?

• When the Fed raises its reserve requirements,
  banks can call in loans, sell off investments, or
  borrow from another bank (or the Federal
  Reserve). ?

• Raising the reserve decreases the amount of money
  in the economy and slows it down. ?

• Because of the extreme effect on money supply,
  the Fed has not been raising the reserve recently.

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Section 3-7
Changing the Discount Rate

• The discount rate is the interest rate the Fed
  charges its member banks when they borrow money
  to meet the reserve. ?

• The prime rate is the interest rate banks charge
  to their best customers. ?

• A higher discount rate means that members banks
  charge their customers higher interest, reducing
  the money supply. ?

• The federal funds rate is the interest rate
  charged by banks to each other for short-term
  loans.

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Section 3-13
Open-Market Operations

• The buying and selling of government securities
  is called open-market operations. ?

• When the Fed buys securities, it makes a deposit
  into the reserve account of the security dealers
  bank, giving that bank more money to lend out
  because its reserve account is higher than
  necessary.

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Section 3-13
Open-Market Operations

• When the Fed sells securities, the purchasing
  bank buys them with money from its reserves,
  leaving the purchasing bank with less reserve
  funds. ?

• This shows the multiple expansion of money
  working in reverse because more money is taken
  out of circulation than just the initial
  withdrawal.

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Section 3-17
Difficulties of Monetary Policy

• It is difficult to gather and evaluate
  information about the money supply. ?

• Some critics of the Fed want to stop the Fed from
  engaging in any monetary policy at all. ?

• Taxing and spending by the government affect the
  economy, and the Fed has to consider this also in
  the changes they can make.

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Chapter Summary 1
Section 1 Organization and Functions of the
Federal Reserve System

• Congress created the Federal Reserve System, or
  Fed, in 1913 as the central banking organization
  in the United States. ?

• The Fed is made up of a Board of Governors
  assisted by the Federal Advisory Council, the
  Federal Open Market Committee, 12 district banks,
  25 branch banks, and thousands of member banks.

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Chapter Summary 1
Section 1 Organization and Functions of the
Federal Reserve System (cont.)

• Among the Feds functions are check clearing,
  acting as the federal governments fiscal agent,
  supervising member state banks, holding reserves,
  supplying paper currency, and carrying out
  monetary policy.

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Chapter Summary 2
Section 2 Money Supply and the Economy

• The most important function of the Fed is
  monetary policy, or controlling the rate of
  growth of the money supply. ?

• With a loose money policy, credit is abundant and
  inexpensive to borrow. With a tight money policy,
  credit is in short supply and is expensive to
  borrow. ?
• The banking system is based on fractional reserve
  banking, in which banks hold a certain percentage
  of their total deposits either as cash in their
  vaults or in Fed banks.

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Chapter Summary 2
Section 2 Money Supply and the Economy (cont.)

• After banks meet the reserve requirement, they
  can loan out the rest to create what is, in
  effect, new money.

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Chapter Summary 4
Section 3 Regulating the Money Supply

• The Fed can control the money supply by changing
  the reserve requirements of financial
  institutions. Lowering the requirement allows
  banks to loan more, thus increasing the money
  supply. ?

• Other tools the Fed can use are changing the
  discount rate and federal funds rate, which also
  affect the prime rate. By making borrowing more
  expensive, banks and consumers are discouraged
  from spending, which halts the growth of the
  money supply.

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Chapter Summary 4
Section 3 Regulating the Money Supply (cont.)

• The main tool the Fed uses to control the money
  supply is open-market operationsbuying and
  selling government securities. By depositing
  money in the banking system (buying securities),
  the money supply grows. By withdrawing money from
  the banking system (selling securities), the
  money supply decreases.