Federal Reserve System and Monetary

Policy

• The amount of _______ in an economy is important because it affects the level of __________ in a country.

• Too much spending can cause ________ while too little spending can cause ____________ and declining levels of _________.

• In the United States, Congress has assigned the responsibility for controlling the money supply to the _______ ________ ________

MONEY

SPENDING

INFLATION

UNEMPLOYMENTPRODUCTION

FEDERAL RESERVE SYSTEM

• The Federal Reserve System or “____” has functioned as the central bank of the United States since ____.

• It consists of a ___-member Board of Governors in Washington, D.C., plus ___ regional banks throughout the country. Our Federal Reserve Bank is in Dallas.

Ben Bernanke, Chairmen of the Federal Reserve

Federal Reserve Bank of Dallas, Houston Branch

FED

1913

712

How do we print money?

• The Federal Reserve System is designed to be as ____________ as possible.

• We achieve this by…– The Governors serve staggered 14 year terms– The Fed does not rely on appropriations from

congress (that is money to run it)– The governors’ terms end in January of even

numbered years, so one president does not get to appoint many governors

NON-POLITICAL

A Central Bank• As a central bank, the Fed manages

the ______ _______ by influencing the lending activity of commercial banks and other financial institutions.

• But the major part of its direct influence comes about through its relationship and dealings with _________ ______, from which the effects spill over to the financial system as a ______.

MONEY SUPPLY

COMMERCIAL BANKS

WHOLE

• The deliberate actions of the Federal Reserve System to ______ or _______ the money supply are called ________ ______. They purpose of monetary policy is to maintain the trend of _______ _______, __________ and _______ at desired levels. The Board of Governors and twelve heads of the regional banks regularly meet ___ times a year to decide on Federal Reserve monetary policy.

EXPAND CONTRACTMONETARY

POLICY

ECONOMIC OUTPUT EMPLOYMENT

PRICES

8

Expansionary or Contractionary

• A policy of Fed designed to expand the growth of money and credit in the economy is known as an _____________ (or loose) monetary policy.

• A policy to restrict the growth of money and credit in the economy is known as a _______________ (or _____) monetary policy.

• The creation of too much ______ can cause _________, and the creation of too little money can cause a ___________.

EXPANSIONARY

CONTRACTIONARY TIGHT

INFLATIONMONEY

RECESSION

What is Inflation or Deflation?

• The Fed has three primary tools with which to carry out monetary policy. These are:– (1) _____ ________ __________, – (2) ________ ___________, – and (3) the _________ _____.

OPEN MARKET OPERATIONS

RESERVE REQUIRMENTDISCOUNT RATE

Open Market Operations• Open market operations refer to the Fed’s

buying and selling of U.S. government __________ (like savings bonds) in order to ____ (+) or to ________ (-) from the reserves of the nation’s commercial banking system.

• Government securities, such as U.S. Treasury _____, ______, and ______, are issued by the U.S. Treasury in return for money borrowed from individuals and businesses in order to finance government spending.

SECURITIESADD

SUBTRACT

BILLS NOTES BONDS

• If the Federal Reserve wants to put money into the economy, it _____ some of these government securities by writing a check to itself. If for instance, the Fed buys _______ worth of government with such a check, it creates the _______ used to pay them.

• The sellers are not $10,000 richer, since they no longer own the securities, but the money supply grows because there is $10,000 of ____ ______ in the economy.

BUYS

$10,000

$10,000

NEW MONEY

• If the Fed wants to purse a ____________ monetary policy, it ______ some of the government securities it owns.

• The money that is paid to the Federal Reserve for these securities is ________ from the economy, so the money supply _______.

• Open Market Operations are the most frequent used _____ of the monetary policy

CONTRACTIONARY SELLS

REMOVED SHRINKS

TOOL

Reserve Requirement• A second important tool of monetary

policy consists of ________ ____________ for bank deposits. The Federal Reserve requires that banks keep as reserves a certain ________ of the deposits they hold. These reserves must be kept as balances at Federal Reserve banks or as ______ the banks have on hand (i.e., ______ ______). Banks that fail to meet their reserves are subject to monetary penalties. These reserves cannot be _______ to borrowers.

RESERVEREQUIREMENTS

FRACTION

CASHVAULT CASH

LENT

Reserve Requirements

• If the Fed wants to pursue a _____________ monetary policy, it can ______ reserve requirements, thereby restricting the amount of funds bank can lend.

• If the Fed wants to pursue an ______________ monetary policy, it can ________ reserve requirements.

CONTRACTIONARY

LOWER

EXPANSIONARY

RAISE

• Let’s say you deposit ______ at your local bank and the reserve requirement on deposits is ____ percent. This means that your bank would have to keep ______ on reserve at the Fed (.15 x $10,000 = _______). It could lend the other _____ to borrowers. If the Fed were to ______ the reserve requirement to ___ percent, then the bank could lend ____ more of your $10,000 deposit or a total of ______. Such an expansion of lending causes the money supply in the economy to _________.

$10,000

15

LOWER

$1,500$8,500

$1,500

10$500

$9,000

INCREASE

• However, if the Fed were to _______ its reserve requirements to ___ percent, the bank could lend only _____ of your $10,000 deposit, thus curbing the possible increase in the money supply. Changes in reserve requirements can be a very powerful _____ of monetary policy but this tool is used infrequently precisely because it is so powerful. Most often, the Fed desires to make ________ or minor changes in policy, aims for which changes in reserve requirement are ____ suitable.

RAISE20

$8000

TOOL

GRADUAL

NOT

• The __________ _____ , the third tool of monetary policy, is the interest rate the Federal Reserve charges ______ that borrow money.

• If a bank borrows from the Federal Reserve, the reserves lent to the bank are _________ by the Fed.

• This process _________ the amount of money and credit in the economy.

Discount Rate

DISCOUNT RATE

BANKS

CREATED

INCREASES

• The Federal Reserve does not automatically allow a bank to borrow from it whenever the bank wants to. The Fed can _______ such a loan.

• IF the discount rate is _____ and the Fed does not discourage banks form borrowing form it, the Federal Reserve will foster an ______________ monetary policy.

REFUSE

LOW

EXPANSIONARY

• IF the discount rate is _____ and the Fed discourages banks from borrowing from it, the Federal Reserve will foster a ________ monetary policy.

• This discount rate is probably the least strong of the ___ principles of monetary policy, but the Federal Reserve does use a change in it to indicate an overall ____________ or _____________ of monetary policy

HIGH

TIGHT

3

TIGHTENINGLOOSENING