The Federal Reserve System Chapter 14. Objectives How did the Panic of 1907 affect U.S. banking? How did the Panic of 1907 affect U.S. banking? What is.

The Federal Reserve The Federal Reserve SystemSystem

Chapter 14Chapter 14

ObjectivesObjectives

How did the Panic of 1907 affect U.S. How did the Panic of 1907 affect U.S. banking?banking?

What is the purpose of the Federal What is the purpose of the Federal Reserve System?Reserve System?

How is the Fed organized?How is the Fed organized? What services does the Fed provide to What services does the Fed provide to

banks?banks? How do economist measure the money How do economist measure the money

supply?supply? Easy-money policy v. tight-money policyEasy-money policy v. tight-money policy How is monetary policy made?How is monetary policy made?

Central BankCentral Bank

Many of the founders were Many of the founders were distrustful of a central bankdistrustful of a central bank

The Second Bank of the United The Second Bank of the United States had its charter expire States had its charter expire under Andrew Jackson.under Andrew Jackson.

No central bank was proposed No central bank was proposed again until the Panic of 1907again until the Panic of 1907

Panic of 1907Panic of 1907

CausesCauses No ability to expand the nation’s No ability to expand the nation’s

money supplymoney supply The system of pyramided reserves The system of pyramided reserves

failedfailed

Money SupplyMoney Supply

Businesses and individuals Businesses and individuals competed for a fixed supply of competed for a fixed supply of funds available as loansfunds available as loans

When these were not available, When these were not available, withdrawals were made from withdrawals were made from savings accountssavings accounts

““Runs” on banks would occur.Runs” on banks would occur.

Pyramided ReservesPyramided Reserves

Smaller banks deposit with Smaller banks deposit with larger banks who deposit with larger banks who deposit with large commercial banks in New large commercial banks in New York, Chicago or San FranciscoYork, Chicago or San Francisco

Even small financial panics Even small financial panics could cause serious “runs” on could cause serious “runs” on even the commercial banking even the commercial banking houses.houses.

Federal ReserveFederal Reserve

1908 – establishment of the 1908 – establishment of the National Monetary CommissionNational Monetary Commission Federal Proposed the Federal Proposed the

establishment of a new central establishment of a new central bankbank

Reserve Act passed in 1913Reserve Act passed in 1913

Role of the Federal ReserveRole of the Federal Reserve

Fed supervises member banksFed supervises member banks Holds cash reservesHolds cash reserves Moves money in and out of Moves money in and out of

circulationcirculation

Characteristics of the FedCharacteristics of the Fed

There is no central bank. There is no central bank. District banks carry on the District banks carry on the policiespolicies

The government owns no The government owns no shares in the Fed—Congress shares in the Fed—Congress does have oversightdoes have oversight

Only nationally chartered banks Only nationally chartered banks are required to join the Federal are required to join the Federal Reserve System.Reserve System.

OrganizationOrganization

National LevelNational Level Decisions made by the Board of Decisions made by the Board of

Governors and Federal Open Governors and Federal Open Market CommitteeMarket Committee

District LevelDistrict Level 12 separate federal reserve banks12 separate federal reserve banks

National LevelNational Level

The Board of Governors supervises policy The Board of Governors supervises policy and controls the supply of moneyand controls the supply of money

There are 7 members on the board. They There are 7 members on the board. They are nominated by the president and are nominated by the president and confirmed by the senate and serve a term confirmed by the senate and serve a term of 14 years.of 14 years.

The 7 members of the board and the The 7 members of the board and the president of the Federal Reserve Bank of president of the Federal Reserve Bank of New York are permanent members of the New York are permanent members of the FOMC.FOMC.

The remaining 4 members are district The remaining 4 members are district federal reserve bank presidents who serve federal reserve bank presidents who serve one rotating termsone rotating terms

District LevelDistrict Level

12 District Federal Reserve Banks each 12 District Federal Reserve Banks each serving a particular geographic region.serving a particular geographic region.

There are 25 branch offices located There are 25 branch offices located throughout the countrythroughout the country

All commercial banks are nationally All commercial banks are nationally chartered and belong to the Fedschartered and belong to the Feds

Each district has a board of 9.Each district has a board of 9. The federal reserve district elect 6 The federal reserve district elect 6

members (3 may be bankers). The Board members (3 may be bankers). The Board of Governors appoint the remaining 3 of Governors appoint the remaining 3 members.members.

Federal Reserve Services to Federal Reserve Services to BanksBanks

Services offered by Fed Reserve Banks making your banking Services offered by Fed Reserve Banks making your banking easiereasier

The Fed clears checksThe Fed clears checks 1. Mrs. Pacheco writes a check to Macy’s1. Mrs. Pacheco writes a check to Macy’s 2. Macy’s deposits the check in their account with Bank of 2. Macy’s deposits the check in their account with Bank of

New YorkNew York 3. Bank of New York credits Macy’s account for the amount 3. Bank of New York credits Macy’s account for the amount

of the check and sends the check to the District Fed of the check and sends the check to the District Fed Reserve Bank of New YorkReserve Bank of New York

4. The Fed Reserve Bank of New York credits the Bank of 4. The Fed Reserve Bank of New York credits the Bank of New York and sends the check to Federal Reserve Bank in New York and sends the check to Federal Reserve Bank in San FranciscoSan Francisco

5. The Federal Reserve Bank in San Francisco credits the 5. The Federal Reserve Bank in San Francisco credits the Federal Reserve Bank of New York for the value of the Federal Reserve Bank of New York for the value of the check and sends the check on to Mrs. Pacheco’s bankcheck and sends the check on to Mrs. Pacheco’s bank

6. Mrs. Pacheco’s bank credit the Federal Reserve Bank in 6. Mrs. Pacheco’s bank credit the Federal Reserve Bank in San Francisco and debits the amount of the check from her San Francisco and debits the amount of the check from her accountaccount

Loans to BanksLoans to Banks Federal Reserve Banks make Federal Reserve Banks make

loans to state or regional banks loans to state or regional banks for the short termfor the short term

Often small banks need loans to Often small banks need loans to cover short term increases in cover short term increases in withdrawalswithdrawals

Sometimes the Fed make loans Sometimes the Fed make loans to help in times of national to help in times of national emergenciesemergencies

Services to GovernmentServices to Government

Serves as the Government’s Serves as the Government’s BankBank Depository of RevenuesDepository of Revenues Provide a government checking Provide a government checking

accountaccount Keeps records of deposits and Keeps records of deposits and

withdrawals and conducts withdrawals and conducts purchase and sales of T-Billspurchase and sales of T-Bills

Acts as advisor to the executive Acts as advisor to the executive and legislative branchesand legislative branches

The Federal Reserve acts as a The Federal Reserve acts as a “watchdog” over the 12 District “watchdog” over the 12 District Federal Reserve BanksFederal Reserve Banks

The District Banks have bank The District Banks have bank examiners who audit member examiners who audit member banks to ensure proper banks to ensure proper procedures and an adequate procedures and an adequate amount of cash is available to amount of cash is available to depositorsdepositors

Regulate bank mergers and Regulate bank mergers and charters of bank holding charters of bank holding companies companies

The Fed’s regulate the nation’s The Fed’s regulate the nation’s money supplymoney supply Paper money is printed by the Treasury Paper money is printed by the Treasury

Department’s Bureau of Engraving and Department’s Bureau of Engraving and PrintingPrinting

Coins are minted at the U.S. mintsCoins are minted at the U.S. mints New Currency is placed in circulation New Currency is placed in circulation

to:to: Replace worn out notesReplace worn out notes Increase the amount of money in Increase the amount of money in

circulationcirculation The Fed’s increase or decrease the The Fed’s increase or decrease the

money supply by trading in U.S. money supply by trading in U.S. SecuritiesSecurities

Money SupplyMoney Supply

Economist determine how much Economist determine how much money is in circulation by money is in circulation by several means:several means:

M1M1 M2M2 M3 and LM3 and L

M1M1

The simplest of the measuresThe simplest of the measures Considered in the measure areConsidered in the measure are All of the currency in circulationAll of the currency in circulation All deposits in checking All deposits in checking

accountsaccounts All Traveler’s checksAll Traveler’s checks

M2M2

Is a broader and more Is a broader and more encompassing measure of moneyencompassing measure of money

It includes everything in M1 andIt includes everything in M1 and Money market accountsMoney market accounts Money market mutual fund sharesMoney market mutual fund shares Savings accountsSavings accounts Certificates of Deposit that are less Certificates of Deposit that are less

than $100,000.than $100,000.

M3 and LM3 and L

These are the most inclusive of These are the most inclusive of the measuresthe measures

M3 include all aspects of M1 M3 include all aspects of M1 and M2 and and M2 and CDs over $100,00CDs over $100,00

L include M1, M2 and M3 and L include M1, M2 and M3 and Savings bondsSavings bonds Short-term treasury securitiesShort-term treasury securities

Monetary Policy and Monetary Policy and Aggregate DemandAggregate Demand

Fed regulates the amount of Fed regulates the amount of money and credit available.money and credit available.

Monetary policy effects the cost Monetary policy effects the cost of credit via money supplyof credit via money supply

Aggregate demand is the Aggregate demand is the demand for all goods and demand for all goods and servicesservices

Easy Money PolicyEasy Money Policy

Designed to expand the money Designed to expand the money supply. This willsupply. This will

Increase jobs, aggregate Increase jobs, aggregate demand demand

This policy is used to aid the This policy is used to aid the economy during a recessioneconomy during a recession

Tight Money PolicyTight Money Policy

Slows business growth and Slows business growth and stabilizes the economystabilizes the economy

Inflation may develop if there is Inflation may develop if there is too much money in circulationtoo much money in circulation

Higher interest rates, reduced Higher interest rates, reduced aggregate demand, decreased aggregate demand, decreased money supplymoney supply

Components of Monetary PolicyComponents of Monetary Policy

Open Market OperationsOpen Market Operations The buying and selling of The buying and selling of

government securitiesgovernment securities FOMC makes the decision to buy FOMC makes the decision to buy

or sell securitiesor sell securities The Federal Reserve Bank of New The Federal Reserve Bank of New

York handles the transactionsYork handles the transactions Selling – contracts money supplySelling – contracts money supply Buying – expands money supplyBuying – expands money supply

Discount Rate is the interest Discount Rate is the interest rate that the Fed charges rate that the Fed charges member banksmember banks

Adjustments are done to Adjustments are done to encourage or discourage encourage or discourage borrowingborrowing

The prime rate is the interest The prime rate is the interest rate that commercial banks rate that commercial banks charge their best customerscharge their best customers

Reserve Requirement is the Reserve Requirement is the money that must be held by money that must be held by banks banks

It is a percentage of a bank’s It is a percentage of a bank’s total net transaction accountstotal net transaction accounts

This percentage is on fluid This percentage is on fluid accountsaccounts

The Fed can increase or The Fed can increase or decrease the money supply by decrease the money supply by adjusting the reserve adjusting the reserve requirementrequirement

The SEC can adjust the margin The SEC can adjust the margin requirement to increase or requirement to increase or decrease the money supply and decrease the money supply and investmentinvestment

As the margin increases, As the margin increases, investment decreasesinvestment decreases

Credit Regulation is the power Credit Regulation is the power to regulate consumer credit to regulate consumer credit during times of nation during times of nation emergencyemergency

This power was revoked in This power was revoked in 1952.1952.

Moral SuasionMoral Suasion The indirect method of the Fed The indirect method of the Fed

exerting pressure on the economyexerting pressure on the economy Done through direct appeal to Done through direct appeal to

banking, congress and the publicbanking, congress and the public The Fed can change the lending The Fed can change the lending

policies of banks.policies of banks.

Policy LimitationsPolicy Limitations

Economic forecastingEconomic forecasting Used to develop monetary policy based on Used to develop monetary policy based on

educated guesseseducated guesses Time LagsTime Lags Period of time between forecast and implementation Period of time between forecast and implementation

of policyof policy Priorities and Trade OffsPriorities and Trade Offs Monetary policy can fight inflation or recessionMonetary policy can fight inflation or recession Lack of CoordinationLack of Coordination Government agencies sometimes have agendas Government agencies sometimes have agendas

that differ from those of the Fedthat differ from those of the Fed Conflicting OpinionConflicting Opinion Economists and government agencies often have Economists and government agencies often have

different ideas about what will positively effect the different ideas about what will positively effect the economyeconomy