The Federal Reserve System and the Monetary Policy

The Federal Reserve System and the Monetary Policy Chapter 16

The FRS History 1790: Bank of the USA 1811 charter ends 1816: restore Second Bank of USA 1836 charter ended 1907: Bank Panic - Congress acts 1913: Federal Reserve Act

Federal Reserve Act 1913 The Fed recommended by National Monetary Commission 1908 1930 - 33: tight money policy --exactly wrong, except NY region 12 regional banks acted independently 1935 reforms for FRS; more centralized

Structure of the FED Board of Governors Sets monetary policy Headquarters in Washington DC 7 member board serve 14 years Appointed by President, approved by Senate President appoints chairmen - serves 4 years Alan Greenspan: 1987 - 2006 Ben Bernake: 2006

12 Districts One FR Bank in each district Monitors reports on economic and banking conditions Member banks in district elect 3 bankers and 3 leaders in industry, commerce, or other businesses to district boards

Member Banks All nationally chartered banks State chartered banks join voluntarily Approximately 4, 000 Fed member banks Federal Advisory Council collects information about each district and reports to each FRS

Federal Open Market Committee FOMC Makes key decisions about interest rates and Ms Meets 8 times a year Committee members Board All governors 12 of governors District banks 5 of 12 district bank presidents

Functions of the FRS Serving Government Serving Banks Regulating Money Supply Ms

FRS: Serves Government Federal Governments Bank Checking accounts for Treasury Dept. Government Sells, transfers, redeems government bonds, bills, notes Issuing securities auction currency Federal reserve notes

FRS: Serving Banks Clears checks Supervising lending practices Bank mergers (bank holding company) Lender of last resort Federal fund rate: interest banks pay when banks loan money to banks Discount rate: interest rate when banks borrow from the FRS

FRS: Regulating Banking System Reserve requirement Bank examination Net worth

FRS: Regulating Ms Factors that affect demand for money Cash needed on hand Interest rates Price levels in the economy General level of economy Stabilizing the economy Recession Inflation

Ms, ir and I Ms ir ir Md I Q Q

Dept. of Treasury & Money Dept. of Treasury manufactures money prints Coins 2013 $1. 2 Trillion Money gets into the economy Money creation: process by which money enters the economy Fractional banking Required reserve ratio (RRR) Money multiplier = 1/rrr Excess reserves Reserve shortage

Federal Reserve Tools Reserve Rate (reserve ratio) Discount Rate Open Market Operation Quantitative Easing (2008)

Policy Options requirement =Ms Reserve requirement =Ms Discount Rate =Ms Buy Bonds = Ms Federal Fund Rate Sell bonds = Ms Reserve Federal Fund Rate

Using Monetary Policy Omo are the most used of FRS monetary policy tools Today do not change RRR Omo or discount rate do not disrupt financial institutions Federal fund rates Greenspan used

Monetary Policy and Macroeconomic Stabilization Recessionary gap Ms needs to increase Easy monetary policy gap Ms needs to decrease Tight money policy Buy bonds Inflationary Fed fund rate down Discount rate down Reserve requirement down Sell Bonds Fed fund rate up Discount rate up Reserve requirement up

Problem of Timing Good timing: smooths fluctuations Bad timing: makes economy worse Policy lags Inside lags: delay in implementing policy Outside lags: time it takes for monetary policy to have an effect

Predict Business Cycle Inflation Recession

Fiscal & Monetary Policy Tools: Congruent Expansionary Tools Fiscal policy G increases T decreases Contractionary Tools Monetary policy Omo purchase bonds decrease fed fund rate Decrease reserve requirements Decrease discount rate Fiscal Policy G decreases T increase Monetary Policy Omo sale of bonds Increase Fed fund rate Increase reserve requirement Increase discount rate

Fiscal and Monetary Policy: Not Congruent LBJ Presidency Spending Vietnam Great Society Fiscal Increase spending Decrease taxes Monetary Tight monetary policy Sell bonds in omo Increase reserve ratio Increase discount rate Obama Presidency/Republica n Congress Cut deficit / cut debt Decrease spending Increse taxes Loose monetary policy Fiscal Monetary Buy bonds Decrease reserve ratio Decrease discount rate Quantitative Easing (QE)