The Federal The Federal Reserve SystemReserve SystemChapter 15Chapter 15

Goals & ObjectivesGoals & Objectives

1.1. Structure of the Federal Reserve.Structure of the Federal Reserve.

2.2. Regulatory responsibilities of the Fed.Regulatory responsibilities of the Fed.

3.3. Fractional Reserves.Fractional Reserves.

4.4. Monetary tools of the Fed.Monetary tools of the Fed.

5.5. Monetary policy and interest rates.Monetary policy and interest rates.

6.6. Monetary policy and inflation.Monetary policy and inflation.

7.7. Monetary policy and politics.Monetary policy and politics.

Creation of the FEDCreation of the FED

1913?1913? Economic ChangesEconomic Changes::

1.1. Federal Trade CommissionFederal Trade Commission -regulates all trade -regulates all trade commerce.commerce.

2.2. 1616thth amendment amendment – income taxes are indirect taxes– income taxes are indirect taxes3.3. Federal Reserve Federal Reserve – Private Central Banking System– Private Central Banking System4.4. Revenue Act of 1913Revenue Act of 1913: Underwood Tariff reinstated.: Underwood Tariff reinstated.

Structure of the Federal Structure of the Federal ReserveReserve• 1. 1. Private Ownership Private Ownership – A private – A private

Bank. Operated by bank members in Bank. Operated by bank members in the stock market, or nationally the stock market, or nationally chartered banks.chartered banks.

• a. State Banks are not required to a. State Banks are not required to join.join.

• 2. Member Banks are required to 2. Member Banks are required to purchase purchase sharesshares of the Federal of the Federal Reserve stock.Reserve stock.

Regulatory ResponsibilitiesRegulatory Responsibilities

1.1. Regulates the Supply of MoneyRegulates the Supply of Money by by establishing Reserve Requirements on all establishing Reserve Requirements on all banking institutions.banking institutions.

2.2. Bank Holding CompaniesBank Holding Companies-Stock owned -Stock owned banks (no deposits or loans).banks (no deposits or loans).

3.3. International OperationsInternational Operations: 20% of banking in : 20% of banking in the U.S.the U.S.

4.4. Member Bank MergersMember Bank Mergers: :

Fed ResponsibilitiesFed Responsibilities

1.1. Check clearing.Check clearing.

2.2. Currency maintenance.Currency maintenance.

3.3. Coin maintenance.Coin maintenance.

4.4. Financial Services to the gov’t.Financial Services to the gov’t.

5.5. Regulation ZRegulation Z: Federal Truth in Lending : Federal Truth in Lending Act; disclosure of contract details to Act; disclosure of contract details to borrowers.borrowers.

6.6. IRS account of individual & business IRS account of individual & business taxes.taxes.

Monetary PolicyMonetary Policy

Monetary PolicyMonetary Policy: expansion or contraction of : expansion or contraction of the money supply to effect the availability of the money supply to effect the availability of creditcredit

1.1. Reserve RequirementReserve Requirement: : 1.1. Fractional reserve: Fractional reserve: deposit requirements.deposit requirements.

2.2. Legal ReservesLegal Reserves: coins & currency in vaults.: coins & currency in vaults.

3.3. Excess reservesExcess reserves: lending to borrowers.: lending to borrowers.

Fed & Monetary PolicyFed & Monetary Policy

How Banks OperateHow Banks Operate

1. 1. LiabilitiesLiabilities: : 2. 2. AssetsAssets: : 3. 3. Balance sheetBalance sheet: : 4. 4. Net WorthNet Worth::

1. 20014 BMW-liability 1. 20014 BMW-liability or asset?or asset?

2. Home-asset or 2. Home-asset or liability?liability?

3. Owe vs. Own3. Owe vs. Own 4. Upside down or 4. Upside down or

liquidliquid

Credit (Debt) vs. WagesCredit (Debt) vs. Wages

Balance SheetBalance Sheet

1. New Car $30,0001. New Car $30,000 2. Home owe $250,0002. Home owe $250,000 3. Credit Cards $15,0003. Credit Cards $15,000

Liabilities: $295,000Liabilities: $295,000

Net WorthNet Worth: -$7,000 in the : -$7,000 in the Red not credit worthyRed not credit worthy

1. Car Worth: $18,0001. Car Worth: $18,000 2. HomeValue $265,0002. HomeValue $265,000 3. Checking $5,0003. Checking $5,000

Assets: $288,000Assets: $288,000

Devaluation & Tight Money PolicyDevaluation & Tight Money Policy

Liquidity

• The potential to convert assets into cash quickly: House? Car?

• Stocks, Bonds, Mutual Funds• IRA’s, Whole Life Insurance

Tools of Monetary Policy

1. Easy Money Policy: Quantitative Easing, low interest rates, print more money

2. Tight Money Policy: restricts supply of money, increases interest rates.

• Discount rate: 3rd tool of monetary policy

Easy Money Policy & Fed

Tools of Monetary Policy

1. Reserve Requirement: 2. Open Market Operations:

1. Buying of gov’t securities increases money supply

2. Selling of gov’t securities decreases money supply

3. Discount Rate: interest charged to lending institutions.

Tools of Monetary Policy

4. Margin Requirements: minimum deposits to buy securities.5. Moral suasion: Federal Reserve press releases on market health.6. Selective Credit Controls: credit rules on loans.

Monetary Policy, Banking & Monetary Policy, Banking & the Economythe Economy

1.1. Short Run ImpactShort Run Impact: : 1.1. Prime RatePrime Rate::

1.1. The Politics of Interest Rates:The Politics of Interest Rates:

2.2. Long-Run ImpactLong-Run Impact: : 1.1. Monetizing the debtMonetizing the debt: increase money : increase money

supply to keep interest rates low.supply to keep interest rates low.1.1. Loose Monetary Policy and Loose Monetary Policy and InflationInflation. .