The Federal Reserve and Monetary Policy

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					 The Federal
Reserve and
The Federal Reserve &
Monetary Policy

    Monetary policy includes all the Federal
     Reserve actions that change the money
     supply in order to influence the economy.
     Its purpose is to curb inflation or to reduce
     economic stagnation or recession.
Creating the Fed
      govt struggled to stabilize economy until
       Federal Reserve Act

      Central bank—a nation’s monetary authority
          monetary means “relating to money”

      Federal Reserve System—central bank of the
       U.S., called the Fed
          independent organization within govt;
           established 1913
The Structure of the Fed
  Elements      of the Fed
     Board of Governors—sets policy; supervises
      operations of the Fed
         chairman is most influential member and

     12 district banks carry out policy; serve as central
      bank for regions

     Member banks: all nationally-chartered banks;
      state banks may apply
         must buy district bank stock; cannot sell in open
Serving the Banking System

    1: Check Clearing
    2: Lending Money
    3: Regulating & Supervising Banks
Serving the Federal govt
 1: Paying govt Bills
 2: Selling govt Securities
 3: Distributing Currency
Creating Money
    Creating money—how money enters
     circulation through deposits, loans

    Fed establishes required reserve ratio (RRR)
     for banks
      fraction   of bank’s deposits that it must keep in
The Fed’s Monetary Tools

    Monetary policy—actions the Fed takes
    to change money supply
       purpose   is to influence the economy
The Fed’s Monetary Tools
 Open       Market Operations
    Open market operations—sales and purchase of
     govt securities
        Fed buys securities to expand money supply; sells to
         contract supply

    Federal funds rate (FFR)—interest rate banks
     charge one another

    Fed signals intent to buy or sell by announcing a
     target for the FFR
        if lowers target, Fed buys bonds; if raises target, it sells
The Fed’s Monetary Tools
 Adjusting       the Reserve Requirement
    Fed changes required reserve ratio to
     change the money supply

              in RRR reduces money supply;
      increase
      decrease expands it

      RRRaverages 10–12% for transaction deposits,
      0–3% for time deposits
The Fed’s Monetary Tools
   Adjusting     the Discount Rate
       Discount rate—interest rate Fed charges on loans
       to other banks
          affects money supply because it determines reserves
           banks have to lend

      Prime rate—interest rate banks charge their best
          other borrowers pay 2-3 percentage points above

      If discount rate rises, so do prime, business &
       consumer rates
          Approaches to
          Monetary Policy

    Expansionary monetary policy—plan to
    increase the money supply

    Contractionary monetary policy—plan to
    reduce the money supply
Approaches to Monetary
 Expansionary     Policy
    In recession, Fed increases money supply to
     increase aggregate demand
    Fed can buy bonds on open market,
     decrease RRR or discount rate
      mostcommon practice is to buy bonds to
       make interest rates fall
Approaches to Monetary
 Contractionary      Policy
    Fed decreases money supply to check
     aggregate demand, inflation
    Fed can sell bonds on open market,
     increase RRR or discount rate
      most common action is to sell bonds to raise
      interest rates
Impacts and Limitation of
Monetary Policy
 Short-Term     Effects
    The short-term effect is a change in the
     price of credit

    Open market operations influence FFR fairly
      change   loanable reserves banks have

    Easy-money policy lowers interest rates;
     tight-money raises them
Impacts and Limitation of
Monetary Policy
 Other    Issues
    Monetary policy more effective if
     coordinated with fiscal policy

    Goals of Fed may clash with those of
     Congress or President
      governors  serve 14 years; have less political
       pressure than politicians

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