chapter 4: functions of the fed.. 1-2 chapter 4: functions of the fed. chapter outline: organization...
TRANSCRIPT
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Chapter 4: Functions of the Fed.
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1-2
Chapter 4: Functions of the Fed.
Chapter Outline:
• Organization of the Fed.
• Monetary Policy Tools.
• Global Monetary Policy.
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The Federal Reserve System
• The Federal Reserve System (the Fed) is the central bank of the United States.
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Organization of the Fed
• Federal Reserve District Banks.
• Member Banks.
• Board of Governors.
• Federal Open Market Committee (FOMC)
• Advisory Committees.
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Organization of theFederal Reserve System
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The Federal Reserve System
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Organization of the Federal Reserve System
• Federal Reserve System created by action of the U.S. Congress in 1913
• Prior to 1913, U.S. had no Central Banking System
• Occasional Financial Panics (1880’s, 1890’s, and finally, 1907) – Public demanded that government take steps to prevent such panics
• The Federal Reserve System to become the “lender of last resort” should commercial banks begin to fail
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Organization of the Federal Reserve System
• Each of the Twelve Federal Reserve District Banks are owned by the member commercial District Banks in their District.
• Fed is a quasi public-private enterprise, not controlled by the President or Congress.
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The Board of Governors
• Seven Members appointed by the President & Confirmed by the Senate
• Appointed for a single fourteen year term
• A Board positions is scheduled for replacement every two years
• Oftentimes, however, board members do not remain for the full term, giving a sitting president opportunity to choose several board members during his term of office
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Independence of the Board of Governors
• The only control a sitting president has over the Board of Governors is the opportunity to fill positions as terms expire
• Once a Board member has received Senate confirmation, he is not subject to the control of either the President or the Congress
• This gives the Board both independence and tremendous power
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Federal Open Market Committee (FOMC)
• The Federal Open Market Committee (FOMC) sets goals regarding the money supply and interest rates and directs the operations of the Open Market Desk in New York.
• The Open Market Desk is an office in the New York Federal Reserve Bank from which government securities are bought and sold by the Fed.
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Functions of the Federal Reserve
• Conduct Monetary Policy
• First and Foremost, maintain price stability
• Secondly, to promote full employment and economic growth
• Serve as a lender of last resort to commercial banks within the District
• Issue Currency
• Provide Banking Services to the U.S. Government
• Supervise and regulate our financial institutions (Banks)
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Monetary Policy Tools
• Open Market Operations.
• Adjustments in the discount rate.
• Adjustments in the reserve requirement ratio.
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Open Market Operations
• Open market operations is the purchase and sale by the Fed of government securities in the open market; a tool used to expand or contract the amount of reserves in the system and thus the money supply.
• Open market operations is by far the most significant tool of the Fed for controlling the supply of money.
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Open Market Operations
• An open market purchase of securities by the Fed results in an increase in reserves and an increase in the supply of money.
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Open Market Operations
• An open market sale of securities by the Fed results in a decrease in reserves and a decrease in the supply of money.
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Tools of Monetary Policy Open Market Transactions
If the Fed wishes to stimulate the economy it will purchase U.S. Government Securities in the bond market (U.S. Treasury Notes) – Raises bond prices; reduces interest rates
• Cash flows from the Fed to sellers of bonds; sellers deposit cash in their banks, thereby increasing the nations deposits and the excess reserves of the banking industry
• If the Fed wishes to restrain the economy it will buy U.S. Government Securities in the bond market (U.S. Treasury Notes) – Lowers bond prices; increases interest rates
• Cash flows from the banks to buyers of bonds and ultimately to the Fed, thereby reducing the deposit accounts and restricting the ability of commercial banks to loan money
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Open Market Operations
• Fed Use of the Repurchase Agreements.
• The effect of the Open Market Operations on Interest Rate.
• Open Market Operations in Response to the Crash.
• Open Market Operations in Response to the Weak U.S. Economy.
• Open Market Operations in Response to the September 11 Attacks.
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The Discount Rate
• The discount rate is the interest rate that banks pay to the Fed to borrow from it.
• Bank borrowing from the Fed leads to an increase in the money supply.
• The higher the discount rate, the higher the cost of borrowing, and the less borrowing banks will want to do.
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The Required Reserve Ratio
• The required reserve ratio establishes a link between the reserves of the commercial banks and the deposits (money) that commercial banks are allowed to create.
• If the Fed wants to increase the money supply, the Fed can decrease the required reserve ratio, which allows the bank to create more deposits by making loans.
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Tools of Monetary Policy Changing the Reserve Requirements
• The Fed’s Ultimate Weapon, but rarely used
• Generally, the Fed has not changed reserve requirements but once a decade or so
• The limits for checking deposits are between 8-14%
• Use of this tool would be perceived as a reaction to extraordinary events
• Fed will be very cautious and publicize its intentions well in advance
• Last time required reserves changed – 1980 – resulted in a credit crunch that plunged the economy into the worst recession since the Great Depression
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Tools of Monetary Policy Summary
• To Restrain the Economy• Raise the Fed Funds and Discount Rates
• Sell U.S. Government Securities on the Open Market Declining Securities Values and Increasing Bond Yield Rates
• Raise the Reserve Requirements
• To Stimulate the Economy• Lower the Fed Funds and Discount Rates
• Buy U.S. Government Securities on the Open Market Increasing Securities Values and Decreasing Bond Yield Rates
• Lower the Reserve Requirements
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The Fed’s Effectiveness in Fighting Inflation & Recession
• The Fed has a much harder time igniting the economic engine
• Although it is true, the Fed can lower interest rates, increase the banks’ deposits, but . . .
• It cannot force a broke man (business) to borrow
• Good risks in prosperous times become poor risks in recessionary times
• Fed ability to stimulate is often compared to the problem of trying to push a string – no matter how much effort you give it, it just doesn’t move much
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Fed Tools for Regulatingthe Money Supply
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Global Monetary Policy
• A Single Eurozone Monetary Policy.
• Impact of the Euro on Monetary Policy.
• Variations in the Value of the Euro.
• Global Central Bank Coordination.
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Conclusions
• Fiscal Policy and Monetary Policy should mesh
• Fed is given primary praise or criticism for management of the economy, but
• The Fed is still only one set of variables in an ocean of variables
• The direction of the economy itself must be considered
• New innovations, globalization, and demographics create fundamental forces that weigh heavily on the economy and its future
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End of Chapter 4