WHAT IS IT AND WHAT ARE ITS FUNCTIONS?

The Federal Reserve System

The Fed

● Created in 1913 by Congress, “The Fed” is a central bank○ Jobs include determining the money supply and supervising

banks○ Principal components are the Board of Governors and the 12

Federal Reserve district banks

Board of Governors

● Controls and coordinates the Fed’s activities● Made up of seven members, each appointed to a 14

year term by the President with the Senate’s approval● President also chooses one member as chairperson

of the board for a four year term

District Banks

● US is broken into 12 Federal Reserve districts, each of which has a Federal Reserve district bank○ Ours is located in Boston

● Each of the 12 Federal Reserve district banks has a President

FOMC

● The Federal Open Market Committee is the major policy-making group within the Fed

● Made up of 12 members○ Seven from the Board of Governors, five from Federal district

banks

What does the Fed do?

● Control the money supply● Supply the economy with paper money

○ Printed in DC and issued to the 12 district banks, which then use the money to meet the demands of the banks and the public

● Hold bank reserves○ All commercial banks are required to keep a reserve account

with their district bank

What does the Fed do? Cont.

● Provide check- clearing services○ When you write a check, the Fed controls the process by which

the funds change hands○ When John (Boston) writes a check to Joe (New York), he

records the amount in his checkbook- if he writes a check for $500, he deletes that amount from his balance

○ When Joe gets the check, he endorses it and cashes it at his bank. The balance in his account goes up by $500

○ Joe’s NY district bank increases the reserve account of his bank by $500 and decreases the reserve account of John’s bank by $500

○ The NY district bank sends the check back to John’s bank, which reduces his account by $500

What does the Fed do? Cont.

● Supervise member banks○ The Fed examines the books of member banks to ensure they

have followed safe loaning practices and followed all regulations

● Serve as the lender of last resort○ The fed can help ailing banks that may be in financial straits

when no one else is willing to help them

Fed Tools for Changing the Money Supply

● The Fed has three tools that it can use to raise or lower the money supply○ the reserve requirement○ open market operations○ the discount rate

Changing the Reserve Requirement

● The Fed can increase or decrease the money supply by changing the reserve requirement.○ Lower reserve requirement = Increase in money supply.○ Higher reserve requirement = Decrease in money supply.

Open Market Operations

● The Federal Open Market Committee (FOMC) conducts open market operations by buying and selling government securities.

● When the FOMC makes an open market purchase, it increases the money supply. When an open market sale is made, the money supply falls.

Changing the Discount Rate

● The federal funds rate is the interest rate one bank charges another for a loan.

● The discount rate is the interest rate the Fed charges a bank for a loan.

● When the discount rate is decreased, the money supply rises. When the discount rate is increased, the money supply falls.