History of the Federal Reserve
In 1913, the Federal Reserve System was established
The fed has a monopoly of money supply in the United States
The Fed is a private institution with a public component
The Board of Governors oversees the system
7 members who are appointed 14 year terms by the president and approved by the Senate
Chairs are appointed to renewable 4-year terms
The Federal Reserve Structure
12 Federal Reserve Banks each in charge of their district
Audit books of private-sector banks to ensure banks are financially sound
New York Fed plays the special role of carrying out open-market operations
Federal Open Market Committee (FOMC) makes decisions about monetary policy
- Board of Governors plus the New York Fed Presidents and 4 rotating Bank Presidents of the other 11 Districts
Function of the Federal Reserve
Provide Financial Services
Serve as the "banker's bank" as well as the bank for the United States
The government has a checking account with the Fed through the U.S. Treasury
Supervise and Regulate Banking Institutions
Charged with ensuring the soundness of the nation's banking and financial system
Both the District Banks and Board of Governors examine and regulate commercial banks
Maintain the Stability of Financial System
Provide liquidity to financial institutions
Provided a "discount window" for banks after the evens of 9/11
Conduct Monetary Policy
Chief function of the Federal Reserve
Board of Governors use monetary policy tools to address the macroeconomic fluctuations that occur in the economy
Reserve Requirement and Discount Rate
Reserve Requirement
Banks are required to hold on to 10% of its checkable bank deposits
The Fed will rarely change this rate. Last change occurred in 1992
If money falls below, then banks will borrow from other banks through the federal funds markets
Interest rate that banks borrow from other banks rate is the federal fund rate
If RRR increase, the money supply decreases
If RRR decrease, the money supply increase
Discount rate
Interest rate the Fed charges directly
Rarely used to actively manage money supply
Open Market Operations
The Fed will buy or sell U.S. Treasury bills through a commercial bank
When the Fed buys bonds, the money supply increases
Buying bonds will "bloat" the money supply
When the Fed sells bonds, the money supply decreases
Selling bonds will "shrink" the money supply
How does the Fed purchase U.S. Treasury bills from banks?
Fed will create money that heretofore never existed into existence
Remember, we have a fiat currency
Money supply increases via the monetary base
The Financial Crisis of 2008
Practice Questions
Which of the following is NOT a role of the Federal Reserve System?
a. Controlling monetary policy
b. Controlling fiscal policy
c. Setting a target federal funds rate
d. Supervising and regulating banks
e. Determining the Required Reserve Ratio
Answer: b
When the Fed makes a loan to a commercial bank, it charges
a. No interest
b. The federal funds rate
c. The discount rate
d. The prime rate
e. A fixed interest rate of 10%
Answer: c
If the Fed purchases U.S. Treasury bills from a commercial bank, what happens to bank reserves and the money supply?
a. Both increase
b. Both decrease
c. Bank reserves increase, money supply decreases
d. Bank reserves decrease, money supply increases
e. Bank reserves increases, no change in money supply
Answer: a
What are the three traditional tools of monetary policy used by the Fed? Which method is preferred?
Discount Rate
rate that banks are charge directly by the Fed
↑ Discount Rate, ↓ money supply
↓ Discount Rate, ↑ money supply
Required Reserve Ration (RRR)
↑ RRR, ↓ money supply
↓ RRR, ↑ money supply
Open-Market Operation (Preferred method)
Buy government securities will increases money supply (BUY=BLOAT)
Sell government securities will decrease money supply (SELL=SHRINK)