Monetary Policy

Federal Reserve & Monetary Policy

Monetary Policy

• Government action manipulating the money supply; used by the government to intervene in the economy.

• Leading role in monetary policy played by the Federal Reserve Board and the Federal Open Market Committee.

Federal Reserve System(FED)

• The nation’s central bank.

• Controls the quantity of money.

• Provides facilities for collection of checks

• Supplies the public with currency

• Supervises the operation of commercial banks.

Legal Reserve Limit

• 1980 Financial Reform Act set the percentage of deposits that a bank must hold as reserves between the limits of 8 and 14% for checkable deposits. (An additional reserve of 4% can be imposed by the Board of Governors).

Organization of the Federal Reserve System

Fed. Advisory Council

Fed. Open Market

Committee (FOMC)

Federal Reserve Banks

Commercial Banks

Board of Governors

Commercial Banks (Member Banks)

• All national banks are members of Reserve.• Benefits

– Obtain funds by borrowing from their district reserve bank

– Make use of variety of services provided by Reserve.

– Obtain financial advice and assistance

– Take part in electing members of the board of district banks

– Receive dividend of stock

Federal Reserve Banks

• 12 districts of “banker’s banks”• Located in San Francisco, Boston, Cleveland, St. Louis,

Kansas City, Atlanta, Richmond, Minneapolis, and Dallas.

• Each Reserve Bank is a corporation, owned by the commercial banks. (commercial banks do not act as owners – they are public agents)

• Functions:– Hold deposits of banks– Make loans to member banks– Issue Federal Reserve notes (nation’s currency)

Board of Governors(Federal Reserve Board)

• Located in Washington, DC

• 7 members appointed by the President for 14 year terms

• Creates policy, independent non-partisan

Functions of Federal Reserve

• Check clearing services– Centralized clearinghouse for checks.

• Federal Reserve bank for each district clears the check, decreasing the deposit account in the bank it was drawn and increasing the deposit account in the bank that collected.

• Federal Deposit Insurance Corporation (FDIC)– Established by Congress in 1933 to insure bank

depositors.

– FDIC guarantees deposits up to $100,000

Functions of Federal Reserve

• Regulating Money Supply– Used to stabilize the economy– Increases money supply during recession, decreases

money supply during inflation.

• Reserve requirement• Open Market Operations

– Buys & sells government securities in order to control the quantity of bank reserves.

• Discount Rate– Interest Rate charged by FED to member banks.

Tool To Stimulate Economy

To Cool Economy

Reserve Requirement

Decrease Increase

Open Market

Buy Sell

Discount Rate

Lower Raise