The Federal Reserve The Federal Reserve SystemSystem
Chapter 14Chapter 14
ObjectivesObjectives
How did the Panic of 1907 affect U.S. How did the Panic of 1907 affect U.S. banking?banking?
What is the purpose of the Federal What is the purpose of the Federal Reserve System?Reserve System?
How is the Fed organized?How is the Fed organized? What services does the Fed provide to What services does the Fed provide to
banks?banks? How do economist measure the money How do economist measure the money
supply?supply? Easy-money policy v. tight-money policyEasy-money policy v. tight-money policy How is monetary policy made?How is monetary policy made?
Central BankCentral Bank
Many of the founders were Many of the founders were distrustful of a central bankdistrustful of a central bank
The Second Bank of the United The Second Bank of the United States had its charter expire States had its charter expire under Andrew Jackson.under Andrew Jackson.
No central bank was proposed No central bank was proposed again until the Panic of 1907again until the Panic of 1907
Panic of 1907Panic of 1907
CausesCauses No ability to expand the nation’s No ability to expand the nation’s
money supplymoney supply The system of pyramided reserves The system of pyramided reserves
failedfailed
Money SupplyMoney Supply
Businesses and individuals Businesses and individuals competed for a fixed supply of competed for a fixed supply of funds available as loansfunds available as loans
When these were not available, When these were not available, withdrawals were made from withdrawals were made from savings accountssavings accounts
““Runs” on banks would occur.Runs” on banks would occur.
Pyramided ReservesPyramided Reserves
Smaller banks deposit with Smaller banks deposit with larger banks who deposit with larger banks who deposit with large commercial banks in New large commercial banks in New York, Chicago or San FranciscoYork, Chicago or San Francisco
Even small financial panics Even small financial panics could cause serious “runs” on could cause serious “runs” on even the commercial banking even the commercial banking houses.houses.
Federal ReserveFederal Reserve
1908 – establishment of the 1908 – establishment of the National Monetary CommissionNational Monetary Commission Federal Proposed the Federal Proposed the
establishment of a new central establishment of a new central bankbank
Reserve Act passed in 1913Reserve Act passed in 1913
Role of the Federal ReserveRole of the Federal Reserve
Fed supervises member banksFed supervises member banks Holds cash reservesHolds cash reserves Moves money in and out of Moves money in and out of
circulationcirculation
Characteristics of the FedCharacteristics of the Fed
There is no central bank. There is no central bank. District banks carry on the District banks carry on the policiespolicies
The government owns no The government owns no shares in the Fed—Congress shares in the Fed—Congress does have oversightdoes have oversight
Only nationally chartered banks Only nationally chartered banks are required to join the Federal are required to join the Federal Reserve System.Reserve System.
OrganizationOrganization
National LevelNational Level Decisions made by the Board of Decisions made by the Board of
Governors and Federal Open Governors and Federal Open Market CommitteeMarket Committee
District LevelDistrict Level 12 separate federal reserve banks12 separate federal reserve banks
National LevelNational Level
The Board of Governors supervises policy The Board of Governors supervises policy and controls the supply of moneyand controls the supply of money
There are 7 members on the board. They There are 7 members on the board. They are nominated by the president and are nominated by the president and confirmed by the senate and serve a term confirmed by the senate and serve a term of 14 years.of 14 years.
The 7 members of the board and the The 7 members of the board and the president of the Federal Reserve Bank of president of the Federal Reserve Bank of New York are permanent members of the New York are permanent members of the FOMC.FOMC.
The remaining 4 members are district The remaining 4 members are district federal reserve bank presidents who serve federal reserve bank presidents who serve one rotating termsone rotating terms
District LevelDistrict Level
12 District Federal Reserve Banks each 12 District Federal Reserve Banks each serving a particular geographic region.serving a particular geographic region.
There are 25 branch offices located There are 25 branch offices located throughout the countrythroughout the country
All commercial banks are nationally All commercial banks are nationally chartered and belong to the Fedschartered and belong to the Feds
Each district has a board of 9.Each district has a board of 9. The federal reserve district elect 6 The federal reserve district elect 6
members (3 may be bankers). The Board members (3 may be bankers). The Board of Governors appoint the remaining 3 of Governors appoint the remaining 3 members.members.
Federal Reserve Services to Federal Reserve Services to BanksBanks
Services offered by Fed Reserve Banks making your banking Services offered by Fed Reserve Banks making your banking easiereasier
The Fed clears checksThe Fed clears checks 1. Mrs. Pacheco writes a check to Macy’s1. Mrs. Pacheco writes a check to Macy’s 2. Macy’s deposits the check in their account with Bank of 2. Macy’s deposits the check in their account with Bank of
New YorkNew York 3. Bank of New York credits Macy’s account for the amount 3. Bank of New York credits Macy’s account for the amount
of the check and sends the check to the District Fed of the check and sends the check to the District Fed Reserve Bank of New YorkReserve Bank of New York
4. The Fed Reserve Bank of New York credits the Bank of 4. The Fed Reserve Bank of New York credits the Bank of New York and sends the check to Federal Reserve Bank in New York and sends the check to Federal Reserve Bank in San FranciscoSan Francisco
5. The Federal Reserve Bank in San Francisco credits the 5. The Federal Reserve Bank in San Francisco credits the Federal Reserve Bank of New York for the value of the Federal Reserve Bank of New York for the value of the check and sends the check on to Mrs. Pacheco’s bankcheck and sends the check on to Mrs. Pacheco’s bank
6. Mrs. Pacheco’s bank credit the Federal Reserve Bank in 6. Mrs. Pacheco’s bank credit the Federal Reserve Bank in San Francisco and debits the amount of the check from her San Francisco and debits the amount of the check from her accountaccount
Loans to BanksLoans to Banks Federal Reserve Banks make Federal Reserve Banks make
loans to state or regional banks loans to state or regional banks for the short termfor the short term
Often small banks need loans to Often small banks need loans to cover short term increases in cover short term increases in withdrawalswithdrawals
Sometimes the Fed make loans Sometimes the Fed make loans to help in times of national to help in times of national emergenciesemergencies
Services to GovernmentServices to Government
Serves as the Government’s Serves as the Government’s BankBank Depository of RevenuesDepository of Revenues Provide a government checking Provide a government checking
accountaccount Keeps records of deposits and Keeps records of deposits and
withdrawals and conducts withdrawals and conducts purchase and sales of T-Billspurchase and sales of T-Bills
Acts as advisor to the executive Acts as advisor to the executive and legislative branchesand legislative branches
The Federal Reserve acts as a The Federal Reserve acts as a “watchdog” over the 12 District “watchdog” over the 12 District Federal Reserve BanksFederal Reserve Banks
The District Banks have bank The District Banks have bank examiners who audit member examiners who audit member banks to ensure proper banks to ensure proper procedures and an adequate procedures and an adequate amount of cash is available to amount of cash is available to depositorsdepositors
Regulate bank mergers and Regulate bank mergers and charters of bank holding charters of bank holding companies companies
The Fed’s regulate the nation’s The Fed’s regulate the nation’s money supplymoney supply Paper money is printed by the Treasury Paper money is printed by the Treasury
Department’s Bureau of Engraving and Department’s Bureau of Engraving and PrintingPrinting
Coins are minted at the U.S. mintsCoins are minted at the U.S. mints New Currency is placed in circulation New Currency is placed in circulation
to:to: Replace worn out notesReplace worn out notes Increase the amount of money in Increase the amount of money in
circulationcirculation The Fed’s increase or decrease the The Fed’s increase or decrease the
money supply by trading in U.S. money supply by trading in U.S. SecuritiesSecurities
Money SupplyMoney Supply
Economist determine how much Economist determine how much money is in circulation by money is in circulation by several means:several means:
M1M1 M2M2 M3 and LM3 and L
M1M1
The simplest of the measuresThe simplest of the measures Considered in the measure areConsidered in the measure are All of the currency in circulationAll of the currency in circulation All deposits in checking All deposits in checking
accountsaccounts All Traveler’s checksAll Traveler’s checks
M2M2
Is a broader and more Is a broader and more encompassing measure of moneyencompassing measure of money
It includes everything in M1 andIt includes everything in M1 and Money market accountsMoney market accounts Money market mutual fund sharesMoney market mutual fund shares Savings accountsSavings accounts Certificates of Deposit that are less Certificates of Deposit that are less
than $100,000.than $100,000.
M3 and LM3 and L
These are the most inclusive of These are the most inclusive of the measuresthe measures
M3 include all aspects of M1 M3 include all aspects of M1 and M2 and and M2 and CDs over $100,00CDs over $100,00
L include M1, M2 and M3 and L include M1, M2 and M3 and Savings bondsSavings bonds Short-term treasury securitiesShort-term treasury securities
Monetary Policy and Monetary Policy and Aggregate DemandAggregate Demand
Fed regulates the amount of Fed regulates the amount of money and credit available.money and credit available.
Monetary policy effects the cost Monetary policy effects the cost of credit via money supplyof credit via money supply
Aggregate demand is the Aggregate demand is the demand for all goods and demand for all goods and servicesservices
Easy Money PolicyEasy Money Policy
Designed to expand the money Designed to expand the money supply. This willsupply. This will
Increase jobs, aggregate Increase jobs, aggregate demand demand
This policy is used to aid the This policy is used to aid the economy during a recessioneconomy during a recession
Tight Money PolicyTight Money Policy
Slows business growth and Slows business growth and stabilizes the economystabilizes the economy
Inflation may develop if there is Inflation may develop if there is too much money in circulationtoo much money in circulation
Higher interest rates, reduced Higher interest rates, reduced aggregate demand, decreased aggregate demand, decreased money supplymoney supply
Components of Monetary PolicyComponents of Monetary Policy
Open Market OperationsOpen Market Operations The buying and selling of The buying and selling of
government securitiesgovernment securities FOMC makes the decision to buy FOMC makes the decision to buy
or sell securitiesor sell securities The Federal Reserve Bank of New The Federal Reserve Bank of New
York handles the transactionsYork handles the transactions Selling – contracts money supplySelling – contracts money supply Buying – expands money supplyBuying – expands money supply
Discount Rate is the interest Discount Rate is the interest rate that the Fed charges rate that the Fed charges member banksmember banks
Adjustments are done to Adjustments are done to encourage or discourage encourage or discourage borrowingborrowing
The prime rate is the interest The prime rate is the interest rate that commercial banks rate that commercial banks charge their best customerscharge their best customers
Reserve Requirement is the Reserve Requirement is the money that must be held by money that must be held by banks banks
It is a percentage of a bank’s It is a percentage of a bank’s total net transaction accountstotal net transaction accounts
This percentage is on fluid This percentage is on fluid accountsaccounts
The Fed can increase or The Fed can increase or decrease the money supply by decrease the money supply by adjusting the reserve adjusting the reserve requirementrequirement
The SEC can adjust the margin The SEC can adjust the margin requirement to increase or requirement to increase or decrease the money supply and decrease the money supply and investmentinvestment
As the margin increases, As the margin increases, investment decreasesinvestment decreases
Credit Regulation is the power Credit Regulation is the power to regulate consumer credit to regulate consumer credit during times of nation during times of nation emergencyemergency
This power was revoked in This power was revoked in 1952.1952.
Moral SuasionMoral Suasion The indirect method of the Fed The indirect method of the Fed
exerting pressure on the economyexerting pressure on the economy Done through direct appeal to Done through direct appeal to
banking, congress and the publicbanking, congress and the public The Fed can change the lending The Fed can change the lending
policies of banks.policies of banks.
Policy LimitationsPolicy Limitations
Economic forecastingEconomic forecasting Used to develop monetary policy based on Used to develop monetary policy based on
educated guesseseducated guesses Time LagsTime Lags Period of time between forecast and implementation Period of time between forecast and implementation
of policyof policy Priorities and Trade OffsPriorities and Trade Offs Monetary policy can fight inflation or recessionMonetary policy can fight inflation or recession Lack of CoordinationLack of Coordination Government agencies sometimes have agendas Government agencies sometimes have agendas
that differ from those of the Fedthat differ from those of the Fed Conflicting OpinionConflicting Opinion Economists and government agencies often have Economists and government agencies often have
different ideas about what will positively effect the different ideas about what will positively effect the economyeconomy