Chapter 4 the u.s. federal reserve and the creation of money

The U.S. Federal Reserve and the

Creation of Money

Chapter 4

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall2

Central Banks and Their Purpose

Monetary authority

Reserve banks

Many countries have central banks

European Central Bank


Functions of Central Banks

Risk assessment

Risks reduction

Oversight of payment systems

Crisis management


The Federal Reserve System

Board of Governors

Federal Reserve Banks

Member Banks

Federal Open Market Committee


Instruments of Monetary Policy

Reserve Requirements

Open Market Operations

Open Market Repurchase

Agreements

Discount Rate


Reserve Requirements

Fractional Reserve Banking SystemRequired reserve ratio

Demand depositsTime deposits

Total reservesRequired reservesExcess reserves


Open Market OperationsFed purchases and sales of

government securitiesFed purchases

Increase excess reservesIncrease new loansIncrease money supply

Fed salesDecrease excess reservesDecrease loansDecrease money supply


Open Market Repurchase AgreementsRepurchase Agreement

Fed buys securities from a seller who agrees to repurchase them at a higher price

Reverse Repurchase AgreementFed sells securities and agrees to

repurchase them at a higher price


Discount RateRate charged on loans from the Fed’s

discount window.Administratively set by Board of

GovernorsAn increase in the discount rate

discourages banks from borrowing from the Fed

A decrease in the discount rate encourages banks to borrow from the Fed


Different Uses of MoneyUnit of Account

Numeraire

Medium of ExchangeCurrency and demand deposits

Store of ValueTime deposits


Monetary AggregatesMonetary Base: Currency in

circulationCurrency and coins plus total reserves

M1 Money SupplyCurrency plus demand deposits

M2 Money SupplyM1 plus short-term time deposits

M3 Money SupplyM2 plus long-term time deposits


Money MultiplierProcess by which changes in bank

reserves generate larger changes in the money supply.

Size of Multiplier Influenced by:Reserve requirement ratioPublic’s demand for cashBanks’ willingness to make loansLevel of interest Rates


Annual Rates of Growth of Monetary Aggregates


The Money Supply Process in an Open EconomyForeign Exchange Market

InterventionThe Fed’s purchase and sale of foreign currencies

Purchase of foreign currenciesIncreases monetary baseReduces value of the U.S. currency

Sale of foreign currenciesDecreases monetary baseIncreases value of the U.S. currency


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