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The U.S. Federal Reserve and the
Creation of Money
Chapter 4
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Central Banks and Their Purpose
Monetary authority
Reserve banks
Many countries have central banks
European Central Bank
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Functions of Central Banks
Risk assessment
Risks reduction
Oversight of payment systems
Crisis management
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The Federal Reserve System
Board of Governors
Federal Reserve Banks
Member Banks
Federal Open Market Committee
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Instruments of Monetary Policy
Reserve Requirements
Open Market Operations
Open Market Repurchase
Agreements
Discount Rate
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Reserve Requirements
Fractional Reserve Banking SystemRequired reserve ratio
Demand depositsTime deposits
Total reservesRequired reservesExcess reserves
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Open Market OperationsFed purchases and sales of
government securitiesFed purchases
Increase excess reservesIncrease new loansIncrease money supply
Fed salesDecrease excess reservesDecrease loansDecrease money supply
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Open Market Repurchase AgreementsRepurchase Agreement
Fed buys securities from a seller who agrees to repurchase them at a higher price
Reverse Repurchase AgreementFed sells securities and agrees to
repurchase them at a higher price
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Discount RateRate charged on loans from the Fed’s
discount window.Administratively set by Board of
GovernorsAn increase in the discount rate
discourages banks from borrowing from the Fed
A decrease in the discount rate encourages banks to borrow from the Fed
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Different Uses of MoneyUnit of Account
Numeraire
Medium of ExchangeCurrency and demand deposits
Store of ValueTime deposits
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Monetary AggregatesMonetary Base: Currency in
circulationCurrency and coins plus total reserves
M1 Money SupplyCurrency plus demand deposits
M2 Money SupplyM1 plus short-term time deposits
M3 Money SupplyM2 plus long-term time deposits
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Money MultiplierProcess by which changes in bank
reserves generate larger changes in the money supply.
Size of Multiplier Influenced by:Reserve requirement ratioPublic’s demand for cashBanks’ willingness to make loansLevel of interest Rates
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Annual Rates of Growth of Monetary Aggregates
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The Money Supply Process in an Open EconomyForeign Exchange Market
InterventionThe Fed’s purchase and sale of foreign currencies
Purchase of foreign currenciesIncreases monetary baseReduces value of the U.S. currency
Sale of foreign currenciesDecreases monetary baseIncreases value of the U.S. currency
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