Chapter 16 presentation.pptx

ECONOMICS Chapter 16 The Federal Reserve and Monetary Policy Section 1 The Federal Reserve System What is the Federal Reserve System? ■ The Federal Reserve System is the central bank of the United States, commonly called the Fed. ■ The Fed is an independent organization within the government, wh...

ECONOMICS Chapter 16 The Federal Reserve and Monetary Policy Section 1 The Federal Reserve System What is the Federal Reserve System? ■ The Federal Reserve System is the central bank of the United States, commonly called the Fed. ■ The Fed is an independent organization within the government, which has both public and private characteristics. ■ A central bank is a nation’s main monetary authority, which is able to conduct certain monetary practices. ■ Monetary is a term that means “relating to money.” Head of the Federal Reserve Jerome Powell Three Common Duties of Central Banks Holding Reserves ■ Central banks are sometimes called reserve banks. ■ The central bank holds these reserves to influence the amount of loanable funds banks have available. ■ This allows the central bank to control the money supply. Three Common Duties of Central Banks Assuring Stability ■ The central bank also acts to assure stability in the national banking and monetary systems. – Example: The central bank is one of the banking regulatory agencies that regulate and supervise banks to make sure that they act in ways that serve the interests of depositors and of the economy. Also, by controlling the way money is issued and circulated, the central bank attempts to avoid the confusion that might result when individual banks issue their own bank notes. Three Common Duties of Central Banks Lending Money ■ Its lending practices are unlike those of other banks, it does not seek to make a profit through lending, and it serves private banks and the government rather than individual customers and businesses. What are the duties of the Fed? ■ The Fed supervises banking in the United States by providing regulation and oversight to make sure that the banks follow sound practices in their operations. – The Fed also takes steps to ensure that banks do not defraud customers’ rights as they relate to borrowing. ■ The Fed provides banking services for both private banks and the national government. ■ It accepts and holds deposits in the form of cash reserves, transfers funds between banks or between banks and the government, and it makes loans to these institutions. – Because it performs such functions, the Fed is sometimes referred to as the bankers’ bank. ■ The Fed also distributes currency and regulates the supply of money. – The supply of money does not mean actual cash but all available sources of money. Specifically, the amount of money that banks have available to lend has important effects on the whole economy. Structure of the Fed Board of Governors ■ The Board of Governors is a board of seven appointed members who supervise the operations of the Fed and set policy. ■ The president appoints members for a single 14-year term, with the approval of the Senate. One board member’s term expires every two years, and the president may also appoint replacements to fill vacancies created by members who leave before the end of their terms. ■ The president chooses the chairman and vice-chairman, who serves four-year terms, from among the seven members. ■ The chairman is considered the most influential member and is the spokesperson for the board. Structure of the Fed District Banks ■ The Federal Reserve System is organized into 12 districts. ■ While the district banks are responsible for carrying out the national policy set forth by the Board of Governors, each one also serves the needs of its particular region. ■ South Carolina is in District 5, located in Richmond. Structure of the Fed Member Banks ■ All nationally chartered banks automatically are members of the Federal Reserve System. – State-chartered banks, if they wish, may apply to join the Fed. ■ Each member bank must purchase stock in the Federal Reserve district bank. ■ However, this stock ownership is not the same as ownership of a stock in a private corporation or a commercial bank; it may not be bought or sold on the open market. – Member banks earn a set dividend rate on the stock they hold. This helps to make up for the interest they do not earn on the reserves that the Fed requires them to hold. Structure of the Fed Federal Open Market Committee (FOMC) ■ The Federal Open Market Committee (FOMC) is a board of the Fed that supervises the sale and purchase of federal government securities. ■ The term open market refers to the way that government securities are bought and sold. ■ The FOMC consists of 12 voting members, including the Board of Governors, the president of the Federal Reserve Bank of New York, and four other Fed district bank presidents who take turns serving one-year terms. – All Fed bank presidents attend the meetings and provide input even when they have no vote. ■ The sale and purchase of federal government bonds on the open market are the principle tools used by the Fed to promote a stable, growing economy. ■ At the end of its meetings, the FOMC issues a public statement to explain the assessment of the economy and its latest actions. Structure of the Fed Advisory Councils ■ Three committees provide advice directly to the Board of Governors. – The 12 members of the Federal Advisory Council, one from each Fed district, represent the commercial banking industry. – The Consumer Advisory Council advises the board on matters concerning the Fed’s responsibilities in enforcing consumer production laws related to borrowing. Its 30 members, for the most part, are drawn from consumer groups and the financial services industry. – The Federal Reserve Board created the Thrift Institutions Advisory Council in 1980 to provide advice about the needs of this important segment of the financial services industry. ■ Thrift institutions are savings and loan institutions, savings banks, or other institutions that serves savers. Section 2 Functions of the Federal Reserve How the Fed Serves the Banking System Check Clearing ■ One of the services that the Fed offers to banks is check clearing, a service offered by the Fed to record receipts and expenditures of bank clients. ■ Each Fed district processes millions of checks every day, but most checks clear in two days or less. – Electronic-payment methods, such as credit and debit cards, have begun to replace checks. Further, more private companies are involved in the check-clearing process. As a result, check clearing has become a less important function of the Fed. How the Fed Serves the Banking System Lending Money ■ Banks often loan each other money on a short-term basis. Sometimes all of the banks in a region are faced with short-term cash flow issues, usually during natural disasters. At such times, the Fed will provide loans to banks and may charge reduce interest rates. – Banks must have sufficient assets and capital to qualify for Fed loans. In addition, smaller banks that have seasonal cash flow needs due to the nature of their local economy may borrow from the Fed. ■ The Fed also acts as the lender of last resort to prevent a banking crisis. How the Fed Serves the Banking System Regulating and Supervising Banks ■ Each Federal Reserve Bank supervises the practices of state- chartered member banks and bank holding companies in its district. – A bank holding company is a company that owns, or has a controlling interest in, more than one bank. ■ This supervision includes bank exams, an audit of the bank’s financial practices. – These exams make sure that banks are not engaged in risky or fraudulent practices, especially in lending. ■ The Fed monitors bank mergers to ensure that competition is maintained and enforces truth-in-lending laws to protect consumers in such areas as home mortgages, auto lines, and retail credit. Fed as the Federal Government’s Banker Paying Government Bills ■ When the IRS collects tax revenues, the funds are deposited with the Fed. ■ The Fed then issues checks to make electronic payments, via the U.S. Treasury, for such programs as Social Security, Medicare, and IRS tax refunds. – When these funds are deposited in the recipient’s bank account or the check is cashed, the Fed deducts that amount from the government’s account. ■ Direct government spending also comes from accounts at the Fed. – The Fed facilitates government payments in a way that is similar to the way it clears checks and processes electronic payments in the private sector. Fed as the Federal Government’s Banker Selling Government Securities ■ The Fed processes U.S. savings bonds and auctions other kinds of securities for the U.S. Treasury to provide funds for various government activities. ■ The Fed has many roles in this process. – It provides information about the securities to potential buyers, receives orders from customers, collects payments from buyers, credits the funds to the Treasury’s account, and delivers the bonds to their owners. – It also pays the interest on these bonds on a regular basis or at maturity. ■ In addition to selling government securities to raise money to fund government activities, the Federal Open Market Committee supervises the sales and purchases of government securities as a way to stabilize the economy. Fed as the Federal Government’s Banker Distributing Currency ■ The Department of the Treasury’s Bureau of Engraving and Printing prints Federal Reserve notes (the official paper currency), which are distributed by the Fed to its district banks. ■ The notes are then moved on to depository institutions and finally into the hands of individuals and businesses. ■ The Fed makes sure that bills are distributed to banks in the amounts that they need; when the bills get worn out, they are taken out of circulation, destroyed, and replaced with new ones. Fed as the Federal Government’s Banker Creating Money ■ Creating money does not mean printing paper currency and minting coins, it refers to the way money gets into circulation through deposits and loans at banks. ■ Because the United States has a fractional reserve banking system, banks are not allowed to loan out all the money they have in deposits. ■ The Fed establishes a required reserve ratio (RRR), which is the fraction of the bank’s deposits that must be kept in reserve by the bank, to control the amount a bank can loan. ■ Money on deposit in excess of the required reserve amount can be loaned out; the money in reserve may be stored as cash in the bank’s vault or deposited with the Fed. Section 3 Monetary Policy What is monetary policy? ■ Monetary policy includes the Fed’s actions that change the money supply in order to influence the economy. How does the Fed change the supply of money? Open Market Operations ■ Open market operations are the sales and purchase of federal government securities. – This is the monetary policy tool most used by the Fed to adjust the money supply. ■ When the Fed wants to expand the money supply, it buys government securities. The Fed pays for the bonds it buys from commercial banks or the public by writing checks on itself. When the sellers receive the funds from the Fed, they deposit them in banks; the banks can then lend their new excess reserves. ■ When the Fed wants to contract the money supply, it sells government bonds on the open market. The purchasers of the bonds transfer funds to the Fed to pay for the bonds. These bonds are taken out of circulation, and the reserves available for loans decrease. ■ The Fed communicates its intention to buy or sell bonds by announcing a target for the federal funds rate. ■ The federal funds rate is the interest rate the banks charge one another to borrow money. When the Fed lowers the target for the FFR, it buys bonds; when it raises the target the Fed does not set the rate directly but influences it through its actions How does the Fed change the supply of money? Adjusting the Reserve Requirements ■ The Fed set the required reserve ration (RRR) for all depository institutions; the RRR affects the money supply through the deposit multiplier formula. ■ Increasing the RRR can reduce the money supply; decreasing the RRR can expand the money supply. ■ Since the early 1990s, the RRR has been between 10 and 12 percent for transaction deposits and between 0 and 3 percent for time deposits. How does the Fed change the supply of money? Adjusting the Discount Rate ■ The discount rate is the interest rate that Fed charges when it lends money to other banks. ■ The discount rate affects the money supply because it sets the reserves that banks have available to lend. – When the Fed increases the discount rate, banks tend to borrow less money from the Fed, they must then use their existing funds to meet reserve requirements and have less excess reserves to lend. Therefore, the money supply decreases. – The opposite happens when the discount rate is lowered. Bans borrow more money from the Fed and increase their reserves. When this happens, they have more money to lend, and the money supply increases. ■ The prime rate is the interest rate that banks charge their best customers. Interest rates for other borrowers tend to be two or three percentage points above the prime. – To make a profit on the loans they make, banks need to charge higher rates than they pay to borrow. So when the discount rate increases, so does the prime rate, therefore, the cost of business and consumer credit. How does the Fed promote growth and stability in the American economy? Expansionary Policy ■ Expansionary monetary policy is a plan to increase the money supply. ■ This type of fiscal policy is used during a slowdown in economic activity. ■ It is sometimes called the easy-money policy, another name for expansionary monetary policy, because it puts more money into circulation by making it easier for borrowers to secure a loan. ■ During a recession, when unemployment is high, the Fed wants to have more money circulating in the economy to stimulate aggregate demand (the sum of all demand in the economy). – When it is easier to borrow money, consumers will take out more loans to buy homes, automobiles, and other goods and services. In response, businesses then produce more, which creates jobs and decreases unemployment. – An easy-money policy allows businesses to borrow funds to help them expand. When more loans are made, more money is created in the banking system. ■ The Fed enacts an easy-money policy by buying bonds on the open market, by decreasing reserve requirements, by decreasing the discount rate, or by some combination of these tools. – The Fed’s most common action in this situation is to buy bonds on the open market. ■ If the Fed expands the money supply too much, however, aggregate demand may increase to a level that causes inflation. How does the Fed promote growth and stability in the American economy? Contractionary Policy ■ Contractionary monetary policy is a plan to reduce the money supply. ■ It is sometimes called a tight-money policy, another name for contractionary monetary policy, because it is designed to reduce inflation by making it more difficult for businesses and individuals to get loans. ■ The Fed would want to have less money circulating because more money fuels demand and may lead to inflation in wages in prices. – In other words, the Fed would want to make it harder for businesses and individuals to borrow money. Therefore, it would decrease the money supply by decreasing reserves available for loans. ■ The Fed enacts a tight-money policy by selling bonds on the open market, increasing reserve requirements, or increasing the discount rate. – Selling bonds causes bond prices to fall and interest rates to increase. Higher interest rates discourage lending. Less lending decreases aggregate demand, which decreases growth in GDP, and lowers the general price level. – The Fed’s most common action in this situation is to sell bonds on the open market. ■ If the Fed contracts the money supply too much, however, aggregate demand may decrease to a level where unemployment increases.