The FedThe Fed

Chapter 16Chapter 16

A Stronger FedA Stronger Fed

In 1935, Congress adjusted the In 1935, Congress adjusted the Federal Reserve structure so that Federal Reserve structure so that the system could respond more the system could respond more effectively to crises. effectively to crises.

Today’s Fed has more centralized Today’s Fed has more centralized powers so that regional banks can powers so that regional banks can work together while still work together while still representing their own concerns.representing their own concerns.

Structure of the Federal Reserve System

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The Federal Open Market The Federal Open Market Committee (FOMC)Committee (FOMC)

• The The FOMC, FOMC, which consists of The Board which consists of The Board of Governors and 5 of the 12 district of Governors and 5 of the 12 district bank presidents,bank presidents, makes key decisions makes key decisions about interest rates and the growth of about interest rates and the growth of the United States money supply.the United States money supply.

The Fed. ServicesThe Fed. Services

Serves Serves GovernmentGovernment

Federal Government’s Federal Government’s BankerBanker

Government Government Securities AuctionsSecurities Auctions

Issuing CurrencyIssuing Currency

Serves BanksServes Banks

Check ClearingCheck Clearing

Supervising Lending Supervising Lending PracticesPractices

Lender of Last ResortLender of Last Resort

Regulating Banking SystemRegulating Banking System

Bank Bank ExaminationsExaminations

ReservesReserves

Regulating Money SupplyRegulating Money Supply

The Federal Reserve is best known for its role in regulating the money supply.

Stabilizing the EconomyStabilizing the Economy The Fed monitors the supply of and the demand The Fed monitors the supply of and the demand

for money in an effort to keep inflation rates for money in an effort to keep inflation rates stable.stable.

Money creation is the process by which money enters into circulation.

Money Creation

You deposit $1,000 into your checking account.

Your $1,000 deposit minus $100 in reserves is loaned to Elaine, who gives it to Joshua.

$100 held in reserve $900 available for loans

Joshua’s $900 deposit minus $90 in reserves is loaned to another customer.

At this point, the money supply has increased by $2,710.

$90 held in reserve $810 available for loans

The Fed has three tools available to adjust the money supply of the nation. The first

tool is adjusting the required reserve ratio.

Reducing Reducing Reserve Reserve

RequirementsRequirements (increase money supply)(increase money supply)

Increasing Increasing Reserve Reserve

RequirementsRequirements(Reduce money supply)(Reduce money supply)

The discount rate is the interest rate that banks pay to borrow money from the Fed.

Reducing the Reducing the Discount Discount

RateRate(encourages more loans)(encourages more loans)

Increasing Increasing the Discount the Discount

RateRate (discourages loans)(discourages loans)

The most important monetary tool is open market operations. Open market operations are the

buying and selling of government securities to alter the money supply.

Bond Bond PurchasesPurchases

(increase money supply)(increase money supply)

Bond SalesBond Sales(decrease money supply)(decrease money supply)

Interest Rates and SpendingInterest Rates and Spending

If the Fed adopts an If the Fed adopts an easy money policy,easy money policy, it will increase the it will increase the money supply. This money supply. This will lower interest will lower interest rates and increase rates and increase spending. This causes spending. This causes the economy to the economy to expand. expand.

If the Fed adopts a If the Fed adopts a tight money policy,tight money policy, it will decrease the it will decrease the money supply. This money supply. This will push interest rates will push interest rates up and will decrease up and will decrease spending.spending.