1. Created in 19132. Responsible for:

a. overseeing the money supplyb. coordinating commercial bank operationsc. regulating depository institutions

The Public: Households & businesses

Commercial BanksSavings & Loans

Credit UnionsMutual Savings Banks

• The Board of Governors is at the center of the banking system in the U.S.

• The seven members of the Board of Governors also serve on the Federal Open Market Committee• The FOMC is a 12-member board that establishes Fed policy regarding the buying and selling of government securities.

Federal ReserveBoard of Governors

7 members appointed by the president,with the consent of the U.S. Senate

12 Federal ReserveDistrict Banks (25 branches)

Open MarketCommittee

Board of Governors &5 Federal Reserve Bank

Presidents (alternating terms, New York Bankalways represented).

                                         

                                         

                                         

                                         

                                         

                                         

                                         

2000

2014

2012

2010

2008

2006

2004

2002

1. Board of Governors –7 members appointed by President

- 14 yr terms at 2 yr intervals for continuity & independence

-not more than one from each district

http://www.federalreserve.gov/http://www.federalreserve.gov/

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• Each district bank monitors the commercial banks in their region and assists them with the clearing of checks.

• The Board of Governors of the Federal Reserve System is located in Washington D.C.

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1.____________________2.____________________, ____________________3.____________________4._________________, _________________, _________________5.________________, _________________, _________________, 6._________________, ________________, _________________,

_________________, _________________, _________________7._________________, _________________8._________________, ________________, _________________,

_________________9._________________, _________________10._________________, ________________, ________________,

__________________11._________________, _________________, _______________, 12._________________, ________________, _________________,

_________________, _________________, _________________

1 Boston2 New York City, Buffalo3 Philadelphia4 Cleveland, Pittsburgh, Cincinnati5 Richmond, Baltimore, Charlotte6 Atlanta, Nashville, Birmingham, Miami, Jacksonville, New Orleans7 Chicago, Detroit8 St. Louis, Louisville, Memphis, Little Rock9 Minneapolis, Helena10 KC, Denver, Omaha, Oklahoma City11 Dallas, San Antonio, El Paso12 SF, Salt Lake City, LA, Port., Seattle, Honolulu

2. Federal Open Market Committee -12 members = 7 Governors (for majority) plus

5 Pres or VP from 1 NY

2 Bost, Phila, or Richmond,3 Atl, Dallas, or StL 4 Minn, KC, or SF, LA5 Clev, or Chicago

set policy on buying & selling bonds on open mkt

3. Federal Advisory Council outsiders 12 members - 1 each selected by

Board of each Region

Make sure they are following the rules

Makes clearing check easier

Replace money or increase or decrease money in circulation

Moves checks from region to region

Borrows, writes checks, takes deposits

1. Price stability2. High employment3. Stability of financial

markets and institutions4. Economic growth

1. Monetary Policy Tools:a. The Reserve

Requirement-reducing it encourages loans and increases the money supply-increasing it discourages loans and decreases the money supply

Type of Deposit Current Requirement Limits

Checkable Deposits

$0 - $14.5 million 0 % 3%$14.5 - $130.6 million 3 3

Over 130.6 million 10 8-14

savings 0 0-9

b. The Discount Rate

3 rates1. Discount Rate2. Federal Funds Rate3. Prime Rate

federal reserve to member banksbank to bankbanks to best customers

b. The Discount RateRaising Discount Rate

discourages bank borrowing decreases money supply

Lowering Discount Rateencourages bank borrowing

increases money supply

c. Open Market OperationsBuying and Selling Securities (Bonds)

-selling bonds puts bonds out and take money out of circulation

-buying bonds puts money back in circulation and takes bonds in

What effect will this have on the economy??

What effect will this have on the economy??

Fed Buys

Fed Sells

Changing the Interest Rate

• The original equilibrium occurs at E0. • Expansionary monetary policy shifts supply to the right.• reduces the interest rate from 8% to 6%. • Contractionary monetary policy shifts supply to the left.• raises the interest rate from 8% to 10%.

c. Open Market OperationsBuy or Sell?

a. The Reserve Requirement

Raise or Lower?

Increase or decrease?

b. The Discount Rate

c. Open Market OperationsBuy or Sell?

a. The Reserve Requirement

Raise or Lower?

Increase or decrease?

b. The Discount Rate

Fed’s Past Policies

Episode 11979 and 1980, high inflation (over 10%),the Fed raised interest rates 5.5% in 1977 to 16.4% in 1981.By 1983, inflation was down to 3.2%, (may have caused back-to-back recessions in 1980 and in 1981–1982)

Episode 2In early 1980s, the Fed felt inflation was declining, Fed reduced the federal funds rate from 16.4% in 1981 to 6.8% in 1986. Episode 3From 1986 to 1989, inflation rose from 2% to 5%.the Fed raised the federal funds rates from 6.6% to 9.2%. Inflation fell from above 5% in 1990 to under 3% in 1992(but it helped to cause the recession of 1990–1991, and the unemployment rate rose from 5.3% in 1989 to 7.5% by 1992.)

Episode 4In the early 1990s, the Fed reduced interest rates 8.1% 3.5%.The unemployment rate declined from 7.5% in 1992 to less than 5% by 1997.

Fed’s Past Policies

Episodes 5 and 6With a risk of inflation the federal funds rate was raised from 3% to 5.8%from 1993 to 1995. No Inflation.In 1999 and 2000, the Fed was concerned that inflation seemed to be creeping up so it raised the federal funds rate from 4.6% in 12/98 to 6.5% in 6/00.By early 2001, inflation was declining again, but a recession occurred in 2001.Between 2000 and 2002, the unemployment rate rose from 4.0% to 5.8%.

Episodes 7 and 8the Fed slashed the federal funds rate from 6.2% in 2000 to 1.7% in 2002, and to 1% in 2003. In 2004, the unemployment rate declined and the Federal Reservebegan to raise the federal funds rate until it reached 5% by 2007.

Episode 9Great Recession in 2008, the Fed slashed interest rates 2% to nearly 0%.the economy was still deep in recession

Consumption. Lower interest rates lower the cost of durable goods and reduce the return to

saving, leading households to save less and spend more.

Investment. Lower interest rates increase the demand for stocks and make it less expensive for firms and households to borrow, thereby

increasing investment.

Net exports. If interest rates in the United States decline relative to interest rates in other countries, the value of the dollar will

fall and net exports will rise.

AD1

• If the increase in AD is when the economy is below capacity, the policy will help direct the economy toward long-run full-employment equilibrium YF.

PriceLevel

LRAS

YFY1

AD2

Goods & Services(real GDP)

P2

SRAS1

P1

E2

e1

AD1

If the increase is at full-employment YF, they will lead to excess demand, higher product prices, and temporarily higher output Y2.

PriceLevel

LRAS

YF

P2

Goods & Services(real GDP)

P1

SRAS1

E1

Y2

AD2

e2

AD1

PriceLevel

LRAS

YF

P2

Goods & Services(real GDP)

P1

SRAS1

AD2

E1

e2

Y2

In the long-run, the strong demand pushes up resource prices, shifting short run aggregate supply (from SRAS1 to SRAS2).

P3

SRAS2

The price level rises (from P2 to P3) and output falls back to YF from its temporary high,Y2.

E3

Too Low for Zero: The Fed Tries “Quantitative Easing” and

“Operation Twist”

Quantitative easing - purchasing securities—including certain mortgage-backed securities—beyond the short-term Treasury securities that are usually involved in open market operations. (Nov. 2008 and June 2011)

The economic recovery remained weakOperation Twist - the Fed announced it would purchase $400 billion in long-term Treasury securities while it would sell an equal amount of shorter-term Treasury securities. (Sept 2011)

Both tried to reduce interest rates on long-term Treasury securities, which typically move closely with those on home mortgage loans, in order to increase aggregate demand.

The Federal Reserve can provide reserves for banks to

loan.

They can’t make them loan them out.

Becoming unpredictable.

=* *M V P Y

Velocity Price

Output

- the amount of money in circulation- the number of times each $ is spent in a year (considered to be stable)

- the actual output of goods and services

- the level of prices

MoneyM V P

Y

=* *M V P Y

MoneyVelocity Price

Y =output

• If V and P are constant, then an increase in M will lead to a proportional increase in Y GDP increases.

• but if V and Y are constant (at full employment), then an increase in M will lead to a proportional increase in P =Inflation.

• P Y Total Sales (GDP)

=*

Which to target?

1.It would draw the public’s attention to the fact that the Fed can affect inflation but not real GDP in the long run.,

2. The Fed would make it easier for households and firms to form accurate expectations of future inflation, improving their planning and the efficiency of the economy.

3. It get would help institutionalize good U.S. monetary policy that is subject to fewer abrupt changes as members join and leave the FOMC.

4. It would promote accountability for the Fed by providing a yardstick against which Congress and the public could measure the Fed’s performance.

1.A numeric target reduces the flexibility of monetary policy to address other policy goals.

2.It assumes that the Fed can accurately forecast future inflation rates, which is not always the case.

3.Holding the Fed accountable only for an inflation goal may make it less likely that the Fed will achieve other important policy goals.