Chapter 15
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Over 30,000 different currency
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Anyone could create currency
Some currencies worth more than others
Some banks didn’t keep enough reserve to do
everyday banking of customers
Banks constantly going BANKRUPT
Congress creates The Federal Reserve Bank
(THE FED) in 1913
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Board of Governors
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Directs the operations
7 full time members
 Appointed by Pres – approved by Senate
 14 year term – new member every 2 years
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Federal Advisory Council
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12 members chosen by directors of each bank
Meets 4 times a year – reports directly to BoG
Federal Open Market Committee
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Decisions not approved by anyone
Meet 8 times a year
Controls Money Supply
Made up of 7 BoG, head of NY Fed Bank, 4 other bank heads rotate
12 District Banks
25 Branch Banks
Most other banks and lending institutions
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U.S. divided into 12 Federal Reserve Districts
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Each district has one Fed Reserve Bank
Set up as corporation with member banks as owners
25 Branch banks assist in carrying out duties
All national banks must join
State banks have choice
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Advantages:
 Stockholders of district bank
 Receive Dividends
 Vote for 6 of district banks 9 board members
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Check Clearing
Government’s Fiscal Agent
Supervising Banks
Holding Reserves and Setting Reserve
Requirement
Supplying Paper Currency
Regulating the Money Supply
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Main function
 Affects interest rates for borrowers
 Affects availability of credit
 Affects business activity
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Monetary Policy
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Cost of Credit – Interest paid
As cost goes up???
As cost goes down???
Loose Money Policy (AKA Expansionary)
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Changing the rate of growth of the money supply in order to affect the cost and
availability of credit
Lots of credit
Credit is cheap
Consumers buy more
Businesses expand
More employment
Tight Money Policy (AKA Contractionary)
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Difficult to get credit
Cost more to borrow
Businesses postpone expansion
Unemployment increases
Reduction in production
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Fed sets Reserve Requirement
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Amount of checkable deposits that must be in
“reserve” at all times
 Held in case customers want to withdraw funds
 Currently 10%
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Rest of money is used to create “New Money”
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Board of Governors can do 3 things to control
money supply
Changing Reserve Requirement
 Changing Discount Rate
 Open Market Operations
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Raising the Reserve???
 Less money (deposits) available to loan out
 Used to slow economy if too much spending
Lowering the Reserve???
 More money (deposits) available to loan out
 More loans means more in supply
 Consumers can spend more
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Banks may have to borrow from the Fed
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If goes below Reserve Requirement
 Customers borrowing
 Customers withdraw
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Fed charges Discount Rate (Interest) to banks
If Discount Rate High???
 Banks charge higher interest to customers
 Customers/Businesses likely won’t borrow
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Lowering the Discount Rate???
 Banks charge lower interest to customers
 Customers/Businesses will borrow at this times
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Can also alter the Federal Funds Rate
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Rate that banks charge when lending to each other
 When do banks borrow from each other???
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Buying/Selling Treasury Bonds, Notes, Bills
How does this alter Money Supply?
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Government buys securities
 Deposits money into dealer’s bank
 Bank then keeps RR and loans rest out
 Increases Money Supply
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Government sells securities
 Dealer’s banks must use deposits to purchase
 Banks have less money above reserve so less loans
 Decreases Money Supply
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No matter what tool used
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Takes about 12 months before fully felt
Criticisms of Fed Policies
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Have caused higher than necessary inflation because
improperly increasing money supply
Has made recessions worse by causing tight money
policy when economy already contracting
Some people call for The Fed to increase money
supply by same amount each year (steady inflation)
Tax policies of Federal Government can also affect
The Fed policy
 Sometimes work against each other