Da Fed!
The Fed works to strengthen & stabilize the nation’s monetary system*
Functions of the Fed
Provides financial services to the government
Regulates financial institutions
Maintains the payments system
Enforces consumer protection laws
Conducts monetary policy.*
Quick Reminders
Created in 1913.
Owned by Member Banks.
Board of Governors appointed by the POTUS.
12 Federal Districts with 25 branch banks.*
Regulatory Responsibilities
The PRIMARY function of the Fed is to control the money supply.
The primary instrument the Fed uses to affect the money supply is the FOMC.
(Federal Open Market Committee)*
FOMC
Makes decisions about:
Growth of Money Supply
Level of Interest Rates*
Regulatory Responsibilities (cont)
1) Supervise member Banks
Monitor bank reserves
2 Major purposes:
Reserves are used to clear checks
Reserves control the size of the money supply.*
Regulatory Responsibilities (cont)
2) The Fed oversees bank holding companies. (Suntrust, CitiGroup, etc)
3) The Fed oversees foreign banks operating in the United States as well as the
international operations of U.S. member banks and holding companies operating abroad.
4) The Fed approves bank mergers.*
Fed Reserve Services
Clearing Checks
The Fed is the bank that banks use.*
Fed Reserve Services
Regulation Z = Truth in Lending Laws.
Protect consumers who purchase using credit.
Also prints money & mints coins.*
Monetary Policy
The expansion or contraction of the money supply in order to influence the cost and
availability of credit.
The most important purpose of the Fed.
•The Fed does not hesitate to change interest rates whenever the economy’s health is
threatened.*
Fractional Reserve System
The Fed requires that member banks keep a certain percentage of their deposits in the
form of legal reserves.
Fractional Reserve System (cont)
•Every time a bank customer makes a deposit, the bank must set aside a portion of the
deposit as reserves.
Banks earn money by lending out that portion of their deposits that need not be held as
reserves.
•To earn its profits, a bank usually needs to charge 2-3 percent more for its loans than the
rate of interest it pays for its saving accounts and time deposits, interest bearing deposits
that cannot be withdrawn by check.*
Simplified
Commercial banks charge interest on their loans and use the income to pay expenses,
keeping the remainder as profit.*
Bank terms
Current Reserve Requirement is 12%
Deposit $100
$12 MUST be kept in reserve (Legal Reserve)
$88 May be loaned out for bank profit. (Excess Reserve)*
How Banks Operate (cont)
Liabilities = debts and obligations owed to others.
Assets = Properties, Possessions, Claims on others.
Both shown on balance sheet.
Net Worth = Excess amount of Assets over Liabilities. (The value of the
business/bank)*
Bonds & Securities
Used by banks to make profit on excess reserves.
They are nice because they earn interest and they have liquidity.
Liquidity is the ability to be quickly turned into cash.*
Additional Funds
CD’s (Certificates of Deposit) and Savings accounts are also useful to increase
reserves.*
Tools of Monetary Policy
Tool #1 Reserve Requirement
The Fed can affect the money supply by changing the reserve requirement.
The reserve requirement determines the amount of legal reserves a bank has to keep,
which then determines how much money a bank can lend and the size of the money
supply.*
Tool #1 Reserve Requirement (cont)
The
size of the money supply is determined by the reserve requirement and the
reserves in the system. An increase in the reserve requirement will shrink the money
supply. A decrease in the requirement will expand the money supply.*
Tool #2 Open market Operations
The Fed can affect the money supply by buying and selling government securities (open
market operations).*
Tool #3 Discount Rate
The Fed can affect the money supply by changing the discount rate, the interest rate the
Fed charges on loans to financial institutions.
Increase means banks will be less likely to lend money.
Decrease means banks are more likely to lend money.*
Sneaky Tools
Moral Suasion = FED Chief makes comments that cause banks to react without actually
doing anything.
Selective Credit Controls – Used in WWII – don’t worry about it.*
Impact of Monetary Policy Summary
Reserve requirement–by requiring banks to hold more in reserve, the Fed can restrict
money supply; by requiring less, it can increase money supply.
Open market operations–by buying or selling government securities, the Fed can restrict
or increase money supply.
Discount rate–by raising or reducing interest rate it charges on loans to financial
institutions, the Fed affects cost of borrowing, thus restricting or increasing money
supply.*
Impact of Monetary Policy
Monetary policy affects interest rates in the short run and inflation in the long run,
forcing the Fed into a trade-off between lower interest rates today and more inflation later
on.*
Impact (cont)
The impact of monetary policy varies, sometimes affecting the economy sooner, and
sometimes later. Monetary policy also affects some sectors of the economy differently
than others.*
Impact (cont)
•The interest rate is one of the most visible and politically sensitive prices in the
economy. For political reasons, the Fed is often pressured to keep interest rates low, even
at the expense of future inflation.*
Short-run Impact
Short-run impact affects interest rates and the availability of credit.*
Long-run Impact
Long-run impact affects inflation rather than interest rates.*
Prime Rate
The prime rate is a loan rate charged by banks to their best or “prime” customers.
The rate is determined by general trends in interest rates. As rates decline, the prime rate
will also move lower.
This usually happens when the Federal Reserve makes major changes in monetary
policy.*