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Chapter Introduction

Section 1: Organization and Functions of the Fed

Section 2: Money Supply and the Economy

Section 3: Regulating the Money Supply

Visual Summary

Chapter Intro 1

Governments strive for a balance between the costs and benefits of their economic policies to promote economic stability and growth.

Chapter Intro 2

In this chapter, read to learn about who is in charge of the U.S. money supply and how they decide how much currency to put into circulation.

Chapter Preview-End

Section 1-Main Idea

Section Preview

In this section, you will learn about how the Federal Reserve System, or Fed, is organized, and its role in determining the nation’s monetary policy.

Section 1

Organization of the Federal Reserve System

The Federal Open Market Committee of the Federal Reserve is responsible for implementing monetary policy.

Section 1

• The Federal Reserve System, or Fed, is a system, or network, of banks that share power.

• The Fed is responsible for monetary policy in the United States.

Organization of the Federal Reserve System (cont.)

View: Organization of the Fed

Section 1

• The Board of Governors, consisting of 7 full-time members appointed by the president, directs the operation of the Fed.

• They are assisted by the Federal Advisory Council (FAC)—12 members elected by the directors of each Federal Reserve district bank.

Organization of the Federal Reserve System (cont.)

Section 1

• The Federal Open Market Committee (FOMC) has 12-voting members that meet 8 times a year to decide the course of action that the Fed should take to control the money supply.

Organization of the Federal Reserve System (cont.)

• The nation is divided into 12 Federal Reserve districts, with each district having a Fed district bank.

View: The Federal Reserve System

Section 1

• Each district bank is set up as a corporation owned by its member banks.

Organization of the Federal Reserve System (cont.)

• The system also includes 25 Federal Reserve branch banks.

• All national banks are required to become members of the Federal Reserve System.

Section 1

Functions of the Fed

The primary function of the Federal Reserve is to control the money supply.

Section 1

Functions of the Fed (cont.)

• Functions of the Federal Reserve:

– Check clearing

– Acting as the federal government’s fiscal agent

– Supervising banks

– Holding reserves and setting reserve requirements

View: How a Check Clears

Section 1

Functions of the Fed (cont.)

– Supplying paper currency

– Regulating the money supply

– Sets standards for certain types of consumer legislation

View: Functions of the Fed

Section 1-End

Section 2-Main Idea

Section Preview

In this section, you will learn how the Fed controls the money supply and interest rates.

Section 2-Key Terms

• loose money policy

• tight money policy

• fractional reserve banking

• reserve requirements

Content Vocabulary

Section 2-Objectives

• function

• portion

Academic Vocabulary

Section 2

Loose and Tight Money Policies

The goal of monetary policy is to promote economic growth and employment without causing inflation.

Section 2

Loose and Tight Money Policies (cont.)

• Credit, like any good or service, has a cost—the interest that is paid to obtain it.

• If the Fed implements a loose money policy (often called expansionary) credit is abundant and inexpensive to obtain, possibly leading to inflation.

View: Balancing Monetary Policy

Section 2

Loose and Tight Money Policies (cont.)

• If the Fed implements a tight money policy (also called “contractionary”), credit is in short supply and is expensive to obtain, which slows the economy.

A. A

B. B

Section 2

If more people are employed, borrowing is easy, and people spend more, which type of policy is in effect?

A. Loose

B. Tight

A B

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Section 2

Fractional Reserve Banking

Banks are not required to keep 100 percent reserves to back their deposits.

Section 2

Fractional Reserve Banking (cont.)

• The banking system is based on fractional reserve banking.

• Many banks have reserve requirements.

• A larger portion of the money supply consists of funds that the Feds and customers deposit in banks.

• Banks may only keep 10% of the deposits in reserve, so they use the remaining 90% in reserves to create new money.

Section 2

Fractional Reserve Banking (cont.)

• When each bank uses the non-required reserve portion of money deposits to make loans to businesses and individuals, the process is known as the multiple expansion of the money supply.

View: Expanding the Money Supply

Section 2-End

Section 3-Main Idea

Section Preview

In this section, you will learn about several tools that the Fed uses to control the size of the U.S. money supply

A. A

B. B

C. C

Section 3-Polling Question

Do you feel that the actions of the Fed impact your daily life?

A. Yes

B. Somewhat

C. Not at all

A B C

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Section 3

Changing Reserve Requirements

The Fed can change the growth rate of the money supply by changing reserve requirements on bank deposits.

Section 3

Changing Reserve Requirements (cont.)

• The Federal Reserve can choose to control the money supply by changing the reserve requirements of financial institutions.

– If the Fed raises the reserve requirements, it would decrease the amount of money in the economy.

– If the Fed lowers the reserve requirements, it would increase the amount of money in the economy.

View: Raising and Lowering Reserve Requirements

Section 3

Changing the Discount Rate

The Fed can change the growth rate of the money supply by changing short-term interest rates.

Section 3

Changing the Discount Rate (cont.)

• If a bank does not have enough reserves to meet its reserve requirement, it can ask the Federal Reserve district bank for a loan.

• If the discount rate is high, the bank passes its increased costs on to customers in the form of higher interest rates on loans.

Section 3

Changing the Discount Rate (cont.)

• Banks might raise their prime rate.

– High interest rates discourage borrowers and may keep down the growth of the money supply.

– Low interest rates encourage borrowers and may lead to growth of the money supply.

Section 3

Changing the Discount Rate (cont.)

• Changing the reserve requirement or the discount rate is now rarely used by the Fed.

• Rather, the Fed states periodically that it is going to change the federal funds rate.

• If the Fed causes the federal funds rate to drop, banks will borrow more and, thus, lend more—and vice versa.

View: Federal Funds Rate

Section 3

Open-Market Operations

The Fed controls the money supply primarily through the purchase and sale of government securities.

Section 3

Open-Market Operations (cont.)

• The major tool the Fed uses to control the money supply is a practice known as open-market operations.

• When the Fed buys securities—such as Treasury bills, notes, and bonds—it pays for them by making a deposit in the dealer’s bank.

• This increases the bank’s reserves, thus increasing the money supply.

Section 3

Open-Market Operations (cont.)

• When the Fed sells Treasury bills to a dealer, the dealer’s bank must use its deposits to purchase securities.

• This decreases the bank’s reserves, thus decreasing the money supply.

• Some people feel that the Fed should not engage in monetary policy due to misjudgments in the past.

Section 3

Open-Market Operations (cont.)

• The spending and taxing policies of the federal government also affect the economy.

Section 3-End

VS 1

The primary function of the Federal Reserve System is to control the money supply, but it has other responsibilities as well.

VS 2

The Fed can implement either a loose or tight money policy to try to promote economic growth and employment.

VS 3

The Fed has several tools at its disposal to use to regulate the money supply.

VS-End

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Transparency 18 Monetary Policy

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Vocab1

Fed: the Federal Reserve System created by Congress in 1913 as the nation’s central banking organization

Vocab2

monetary policy: policy that involves changing the rate of growth of the supply of money in circulation in order to affect the cost and availability of credit

Vocab3

Federal Open Market Committee (FOMC): 12-member committee in the Federal Reserve System that meets 8 times a year to decide the course of action that the Fed should take to control the money supply

Vocab4

check clearing: method by which a check that has been deposited in one institution is transferred to the issuer’s depository institution

Vocab5

loose money policy: monetary policy that makes credit inexpensive and abundant, possibly leading to inflation

Vocab6

tight money policy: monetary policy that makes credit expensive and in short supply in an effort to slow the economy

Vocab7

fractional reserve banking: system in which only a fraction of the deposits in a bank is kept on hand, or in reserve; the remainder is available to lend

Vocab8

reserve requirements: regulations set by the Fed requiring banks to keep a certain percentage of their checkable deposits as cash in their own vaults or as deposits in their Federal Reserve district bank

Vocab9

discount rate: interest rate that the Fed charges on loans to commercial banks and other depository institutions

Vocab10

prime rate: rate of interest that banks charge on loans to their best business customers

Vocab11

federal funds rate: interest rate that banks charge each other on loans (usually overnight)

Vocab12

open-market operations: buying and selling of United States securities by the Fed to affect the money supply

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