Ch. 24
Section 2
The Federal Reserve
System
Structure and Organization
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The Federal Reserve System (FED) is the central
bank of the U.S.
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It is the bank for banks; when banks need money,
they borrow from the FED
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Established in 1913, the government did not have
the money to set up the central bank, larger banks
had to help by buying stock into it.
Structure and Organization (cont.)
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The U.S. is divided into 12
Federal Reserve Districts
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Each has one main Federal
Reserve Bank and most
have branch banks
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Boston
Philadelphia
NY
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
K.C.
Dallas
San Francisco
Structure and Organization (cont.)
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Federally chartered commercial banks must be
members of the FED; state chartered banks may join
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Member banks buy stock in the FED and earn
dividends from it.
Structure and Organization (cont.)
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A Board of Governors (7) is appointed by the
President and he selects one to chair the board for a
4 year term.
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The Board of Governors is supposed to be
independent of the President and Congress
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Without political pressure, economic decisions can
be made freely in the countries best interest.
Structure and Organization (cont.)
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Officials of the district banks serve on the FEDs
advisory councils which keep the FED informed of:
- economic conditions within each district
- financial institutions
- issues related to consumer loans
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Federal Open Market Committee (FOMC) is the
FEDs major policy making group.
FOMC
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Federal Open Market Committee (FOMC) makes
decisions that affect the economy as a whole by
manipulating/controlling the money supply
Functions of the FED
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The FED oversees most large commercial banks. It
can block a merger between banks if the merger
would lessen competition.
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Oversees the international business of American
banks and foreign banks that operate in this country.
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Enforces laws that deal with consumer borrowing;
creates laws that require lenders to spell out the
details of a loan before a consumer borrows
Functions of the FED (cont.)
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Acts as the government’s bank. Government
deposits revenues in the FED and withdraws it to
buy goods.
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Sells U.S. government bonds and Treasury bills,
which the government uses to borrow money.
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Issues the nation’s currency. Government agencies
produce the money, but the FED controls its
circulation.
Conducting Monetary Policy
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Monetary Policy – controlling the supply of money
and the cost of borrowing money (interest rates)
according to the needs of the economy.
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The FED can change interest rates by changing the
money supply
Conducting Monetary Policy (cont.)
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If the FED wants a lower interest rate, it expands the money
supply, which moves the supply curve to the right.
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If the FED wants a higher interest rate, it contracts the money
supply, which moves the supply curve to the left.
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The FED manipulates the money supply by 3 means:
- discount rate
- reserve requirement
- open market operations
Discount Rate
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Discount Rate – the rate the FED charges member banks for
loans.
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If the FED wants to stimulate the economy, it lowers the
discount rate.
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Lower rates encourage banks to borrow from the FED and that
means more loans to their customers (lower interest rates)
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If the FED wants to slow down the economy, discount rates are
raised to discourage borrowing. This contracts the money
supply and raises interest rates
Reserve Requirement
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Member banks must keep a certain % of their money
in the Federal Reserve Banks as a reserve.
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The FED can raise the reserve requirement to
reduce the money banks have available to lend.
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It can lower the reserve requirement to increase the
money banks have to lend.
Open Market Operations
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Open Market Operations – the purchase or sale of U.S.
government bonds and Treasury bills.
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Buying bonds from investors puts more cash into investors
hands thus increasing the money supply; this shifts the supply
curve of money to the right lowering interest rates
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Selling bonds to investors takes cash out of investors hands
thus decreasing the money supply; this shifts the supply curve
of money to the left raising interest rates
Implementation of Monetary Policy
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Can be done more quickly this way than by allowing
politicians to argue their views on Capitol Hill.
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FED can always adjust its actions when needed
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Manipulation of interest rates is key when trying to
influence business investments and consumer
spending
Loose Money Policy
Loose Money Policy:
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Can lead to inflation.
1.
Easy to borrow
2. Consumers buy more
3.
Business expansion
4.
Employment increases
5. Spending increases
Tight Money Policy
Tight Money Policy:
–
Can lead to recession
1.
Difficult to borrow
2.
Consumers buy less
3.
No business expansion
4.
Unemployment increases
5. Production decreases