The FED and Monetary Policy

1. The FED and Monetary Policy

2. The Federal Reserve Bank (the Fed) • Federal Reserve Act passed in 1913 • Goal was to create safer, more stable monetary and banking system

3. CHAIRMAN OF THE BOARD Dr. Janet Yellen When she talks, people listen. Chairman of the Board

4. Structure of the FED • The FED functions as a central bank…they are the watchdog of our nation’s $ • 12 District Banks set up in 12 cities around the country • Set interest rates and regulates amount of money and credit in economy (avoid 1929)

6. Main Resposibilities… 1. Provides financial institutions with currency and coin…it also processes checks and takes care of electronic payments 2. Promotes safety within our banking system • Emerging democracies (new countries) have used the Fed as a model

7. Fiscal vs. Monetary Policy • Fiscal Policy = gov’t power to tax and spend…to get a stagnant economy moving again or to address inflation **Congressional Responsibility • Monetary Policy = a central bank’s control over the money supply and interest rates ** no government involvement

8. FOMC • The Fed’s open-market operation (most used tool) • Fed sells securities/bonds on the market • people pay for them with $ taken out of the banks, thus shrinking the $ supply

9. Warm Up 1/13/17 Name something the FED can do to either increase or decrease the money supply in the economy. What is the difference between fiscal and monetary policy?

10. Fractional Reserves • Fractional reserve banking – the term is the definition…..bank keeps a % of deposits in reserve and makes loans with the rest. • expand the money supply if slipping into recession. • decrease the money supply if they think rising prices will threaten to trigger inflationary wage price spiral.

11. 3 tools of the FED • Control interest rates • higher rates = tight money supply • Lower rates = loose money supply • Open Market Operations (FOMC) • Sells bonds/securities on NYSE = tight money • Buys bonds/securities = loose money • Reserve Requirement • Banks have higher Reserve Req= tight money • Lower reserve req = loose money

12. Warm-up 1/14/15 What are the three tools the FED can use to influence the money supply? What is tight money policy and what is loose money policy?

13. Reserve Requirement • One of Fed's tools for promoting healthy economy is through setting the reserve requirements • RESERVE REQUIRMENT: % of deposits that must be set aside by a bank • Banks may not lend these required reserves. • Extra Reserves = EXCESS RESERVES • Can be loaned out to customers

14. 1. If $1,000 is deposited in the bank, calculate how much the bank must hold in reserve for each of the following reserve requirements. How much is the required reserve? A. 1%___________ C. 10% ___________ E. 15% ____________ B. 5% ___________ D. 12.5%___________ F. 25% ____________ 2. If $1,000 is deposited in the bank, calculate how much the bank can lend for each of the following reserve requirements. How much is the excess reserve? A. 1%___________ C. 10% ___________ E. 15% ____________ B. 5% ___________ D. 12.5%___________ F. 25% ____________

15. Money is created when the bank makes loans to customers. The reserve requirement is 10 % , bank will lend all of its excess reserves. Total New Deposits Column _____________ = M1: banks money supply

16. The money multiplier determines how much money can be created in the economy from an initial deposit. The formula for the money multiplier is: In this example, the Federal Reserve set the reserve requirement at 10 percent. So the money multiplier in this example would be: To find out the total increase in the money supply, the formula is: Total increase = Multiplier x deposit

17. The multiplier is 10 and the deposit is $1,000. So the total increase of the money supply would be: Total increase = 10 x $1,000 = $10,000 To find out how much money can be created following an initial deposit, the formula is: Expansion of the Money Supply = Multiplier x Excess Reserves 4. Calculate the money multiplier for each of the following reserve requirements. A. 1% ___________ C. 10% ___________ E. 15% ____________ B. 5% ___________ D. 12.5%___________ F. 25% ____________ 5. If a bank holds $1,000 in excess reserves, calculate the total amount of money that could be created for each of the following reserve requirements. A. 1% ___________ C. 10% ___________ E. 15% ____________ B. 5% ___________ D.  12.5% __________  F. 25% ___________

18. You make the call… If the Reserve Requirement increases from 10% to 12%, what does that do to the money supply? If the reserve requirement decreases from 10% to 7%, what does that do the money supply? Which represents a loose money policy and which represents a tight money policy?

19. Connections Chart • Time to put it all together… • GDP • BUSINESS CYCLE • FEDERAL RESERVE SYSTEM • MONETARY POLICY • FISCAL POLICY Each listed above are part of measuring and regulating our money supply and overall health of the economy. Create a chart that explains the following for each: • Define each • Explain main goals/tools/measures on the health of the economy (ex. If it is this…. It means this …) • Make a connection to each of the others on the list…