Chapter 16: The Federal Reserve
and Monetary Policy
Economics
How did the Panic of 1907 affect
U.S banking?
• The panic of 1907 had two causes. First, the nation’s
monetary system at the time had no mechanism for
expanding the amount of money in circulation. This meant
that business expansion was restricted because consumers
and businesses competed for a fixed supply of loanable
funds.
• Second, the system of pyramided reserve failed. In a
system of pyramided reserve, virtually all smaller, local
banks deposit some of their reserves at a larger city banks.
These larger city banks, in turn, deposit some of their own
cash reserves in the largest commercial banks in a nation’s
financial center suck as New York or Chicago in the
United states.
What are the purposes and characteristics
of the Federal Reserve system?
• The Federal Reserve system is a central banking system
for nations such as United Kingdom, Japan, Canada.
However the U.S Federal Reserve System has several
features that distinguish it:
• Lack of a single central bank
• Ownership and control by member banks
• Optional membership in the Fed of some banks
• The Federal Reserve relies on district banks to carry out
the banking policies developed at the national level. Stocks
are owned by the bank members, not the Government. In
most countries all banks are required to join the central
banks, however, in the U.S only nationally chartered banks
are required to join the Fed.
How is the Fed organized?
• The Federal Reserve System was designed to oversee
banking practices throughout the U.S caused many people
to be concerned that a single central bank would hold too
much power over the nations economy. To avoid this
problem the Fed is organized on two levels: National and
District
• The main decision on the national level are done by the
board of governors and Federal Open Market
Committee(FOMC) the president appoints each of the
board of governors. Each governor is appointed for 14year terms.There are 12 district levels each of these
districts serves as a designated geographic region of the
U.S.
What services does the Fed
provide to the banks?
• The Fed oversees the flow of money among
member banks and its district banks
– It does so mainly through check clearing and
by making loans to commercial banks
– Check clearing is the method the Fed uses to
keep track of the billions of monetary transfers
using a method of crediting and debiting banks’
reserve accounts—and, in turn, checking
accounts
How does the Fed serve the
federal government?
• The Fed manages the U.S. government’s
financial activities by serving as the
– Government’s bank
– Supervising member banks
– Regulating the money supply
How do economists measure the
U.S. money supply?
• Economists measure money supply in
many ways
– These measures are known as M1. M2, M3, and
L
– M1 includes the most limited amount of funds
– L includes the widest among
– Each fund is distinguished by how it identifies
“readily available” money
Why does the Fed rely on either an easymoney policy or a tight-money policy?
• Through it’s monetary policy, the Fed
attempts to promote economic growth and
stability as well as to avoid recessions
• To reach these goals, the Fed pursues either
an easy-money policy or a tight-money
policy
Why does the Fed rely on either an easymoney policy or a tight-money policy?
• Easy-money policy
– Low interest rates
– Used in times of recession to expand the money supply,
increase aggregate demand, create jobs and reduce
unemployment, and promote economic growth
• Tight-money policy
– Higher interest rates
– Contracting money supply
– Used during period of inflation to slow business
activity and stabilize prices
What are the three major tools the Fed’s
use to determine monetary policy?
• Open-market operations
• Discount rate
– The prime rate is the interest rate that commercial
banks charge on loans to their most reliable business
customers
– It is used to determine the bank’s general interest rate
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Reserve requirements
Margin requirements
Credit regulations
Moral suasion
What are challenges associated with
determining monetary policy?
• The Fed’s actions are limited by several factors,
including:
– Economic forecasts
– Time lags in developing and carrying out monetary
policy
– Priorities
– Trade-offs
– Lack of coordination among government agencies in
forming economic policies
– Conflicting opinions about monetary policy