Chapter 16 Section 2

Functions of the Federal Reserve

Functions of the Federal Reserve

Lending Money Banks often lend to each other on short-term basis

In natural disaster, all banks in region lack cash flowFed lends to banks with enough assets and

capital to qualifySmall banks with seasonal cash flow needs may borrow from Fed

Fed serves as lender of last resort to prevent banking crisis

Functions of the Federal Reserve

Regulating and Supervising BanksFed banks supervise state-chartered members, bank holding companies bank holding company owns, has

controlling interest in several banksFed banks enforce truth-in-lending laws Conduct bank exams—audit financial practices of banks in district

Monitor bank mergers to ensure competition

Serving the Federal GovernmentKEY CONCEPTS

Fed serves as federal government’s bankerhelps carry out taxation and spending activities

Serving the Federal GovernmentService 1: Paying Government Bills

Tax revenues are deposited with the Fed

Fed issues checks, makes electronic payments via U.S. Treasuryfor transfer payments, employee wages,

direct spending, tax refundsdeducts amounts from government’s

accountProcesses postal money orders, food stamps

Serving the Federal GovernmentService 2: Selling Government

SecuritiesFed processes U.S. savings bonds, auctions other securitiesprovides information, collects payment,

credits funds, delivers bondsPays interest on bondsFederal Open Market Committee (FOMC) supervises sales of securitiespurpose is to stabilize the economy

Serving the Federal Government

Service 3: Distributing CurrencyFederal Reserve notes are official paper currency of U.S.: fiat money

Treasury Department prints notes that go to Fed district banks

Fed banks distribute notes to depository institutions in amounts neededcurrency then goes to people and businesses

Fed also distributes coins produced by U.S. Mint

Creating MoneyCreating money—how money enters circulation through deposits, loansFed establishes required reserve ratio

(RRR) for banksfraction of bank’s deposits that it must

keep in reserve Reserve may be stored as cash in bank’s

vault or deposited with Fed

Creating MoneyExample: Money Creation

Banking system creates money whenever banks get deposit and make loan

Level of the RRR determines how much money may be loaned

Money supply increases by total loans made after initial cash deposit deposit multiplier formula tells how

much money supply will increase

QuestionsWhy might the Fed help a small bank in an

agricultural region stabilize its cash flow?How are the banking services the fed provides to

the government similar to the services it provides to banks?

If the Fed raised the RRR from 10% to 12%, how would it affect the money supply?

You have been planning your college finances and you know that you’ll have to take a bank loan to cover tuition costs. You read that the Fed intends to raise the RRR rate from 10% to 20%. How will this change affect the money supply and your ability to borrow money for college tuition?