Federal Reserve SystemFederal Reserve System

Benjamin BernankeBenjamin Bernanke Former ChairFormer Chair

Janet YellenJanet Yellen Current ChairCurrent Chair

Federal Reserve System Federal Reserve System

The central bank and monetary authority of The central bank and monetary authority of

the United States; known as the United States; known as ““the FEDthe FED””..

A central bank is the government agency that oversees the banking system and is responsible for the amount of money and credit in the economy.

From St. Louis Fed

The Fed’s ObjectivesThe Fed’s Objectives

“Stable prices”

“Maximum employment”

Moderate long-term interest rates

From St. Louis Fed

Decision makers at the Decision makers at the Federal Reserve Federal Reserve

The Board The Board of of

GovernorsGovernors

FOMCFOMCFederal Federal Open Open

Market Market CommitteeCommittee

THE FEDERAL RESERVE AND THE FEDERAL RESERVE AND THE BANKING SYSTEMTHE BANKING SYSTEM

THE FEDERAL RESERVE AND THE FEDERAL RESERVE AND THE BANKING SYSTEMTHE BANKING SYSTEM

Board ofBoard ofGovernorsGovernorsBoard ofBoard of

GovernorsGovernors

12 Federal12 FederalReserve BanksReserve Banks

12 Federal12 FederalReserve BanksReserve Banks

CommercialCommercialBanksBanks

CommercialCommercialBanksBanks

Thrift InstitutionsThrift Institutions(Savings & loan associations,(Savings & loan associations,mutual savings banks, creditmutual savings banks, credit

unions)unions)

Thrift InstitutionsThrift Institutions(Savings & loan associations,(Savings & loan associations,mutual savings banks, creditmutual savings banks, credit

unions)unions)

The PublicThe Public(Households and(Households and

businesses)businesses)

The PublicThe Public(Households and(Households and

businesses)businesses)

Federal Open Federal Open Market CommitteeMarket Committee

From St. Louis Fed

Who owns the Fed?Who owns the Fed?Who owns the Fed?Who owns the Fed?

Each of the 12 district Federal Each of the 12 district Federal Reserve banks is owned by its Reserve banks is owned by its membermember banksbanks

The 12 Federal Reserve Banks

1. To regulate bank holding companies and state

chartered banks.

2. To supply money and credit to the economy to

maintain stable prices and full employment.

3. To ensure the smooth functioning of the

payments system.

4. To act as the government’s bank.From St. Louis Fed

What are the What are the responsibilities of the Fed?responsibilities of the Fed?

What are the What are the responsibilities of the Fed?responsibilities of the Fed?

• Influence our money supplyInfluence our money supply• Issue and maintain our currencyIssue and maintain our currency• Act as a clearing house for checksAct as a clearing house for checks• Serve as a bank for the federal Serve as a bank for the federal

governmentgovernment• Serve as a Serve as a ““bankers bankbankers bank””• Act as a Act as a ““lender of last resortlender of last resort”” to to

member banksmember banks

Does the FED loan money to private companies and

individuals ?

Does the FED loan money to private companies and

individuals ?

No, they only do business No, they only do business with financial institutionswith financial institutions

They are the bankersThey are the bankers’’ bank! bank!

How does the Fed influence the How does the Fed influence the money supply?money supply?

How does the Fed influence the How does the Fed influence the money supply?money supply?

• Discount rateDiscount rate• Open Market Operations Open Market Operations

(Federal Funds Rate)(Federal Funds Rate)

• Reserve requirementsReserve requirements

What is the Discount Rate?

What is the Discount Rate?

The The interest rateinterest rate that that banks are charged banks are charged when they when they borrowborrow money from the Fedmoney from the Fed

Banks have creditable Banks have creditable

customers, but no customers, but no

excess reserves.excess reserves.

Why would the member banks Why would the member banks borrow from FED at the borrow from FED at the

discount rate?discount rate?

Why would the member banks Why would the member banks borrow from FED at the borrow from FED at the

discount rate?discount rate?

• Banks tend to borrow Banks tend to borrow

more from the Fed, more from the Fed,

increasing the growth increasing the growth

of the money supplyof the money supply

What happens when the FED What happens when the FED lowerslowers the discount rate? the discount rate?

What happens when the FED What happens when the FED lowerslowers the discount rate? the discount rate?

MS i% IMS i% Inn C AD PL RGDP C AD PL RGDP

• Banks tend to borrow Banks tend to borrow

less from the Fed, less from the Fed,

slowing the growth of slowing the growth of

the money supplythe money supply

What happens when the FED What happens when the FED raisesraises the discount rate? the discount rate?

What happens when the FED What happens when the FED raisesraises the discount rate? the discount rate?

MS i% IMS i% Inn C AD PL RGDP C AD PL RGDP

Which monetary tool is Which monetary tool is most often used?most often used?

Open Market OperationsOpen Market OperationsOMOOMO

(FOMC)(FOMC)

Open Market OperationsOpen Market Operations

PurchasesPurchases and and salessales of of

government securitiesgovernment securities by by

the Federal Reserve in an the Federal Reserve in an

effort to influence the effort to influence the

money supply.money supply.

What is the role of the Federal Open Market

Committee?

What is the role of the Federal Open Market

Committee?

The FOMC makes decisions The FOMC makes decisions about changing interest rates about changing interest rates

which they can do by the which they can do by the buying and selling of buying and selling of

government securities.government securities.

What happens when the FED What happens when the FED purchasespurchases government securities? government securities?

What happens when the FED What happens when the FED purchasespurchases government securities? government securities?

• The money supply expandsThe money supply expands• Interest Rate dropsInterest Rate drops• New investment and consumer New investment and consumer

spendingspending• AD increasesAD increases• Price level and RGDP increasePrice level and RGDP increase

• The money supply expandsThe money supply expands• Interest Rate dropsInterest Rate drops• New investment and consumer New investment and consumer

spendingspending• AD increasesAD increases• Price level and RGDP increasePrice level and RGDP increase

MS i% IMS i% Inn C AD PL RGDP C AD PL RGDP

What happens when the FED What happens when the FED sellssells government securities? government securities?

What happens when the FED What happens when the FED sellssells government securities? government securities?

• The money supply contactsThe money supply contacts• Interest Rate risesInterest Rate rises• Investment and Consumer Investment and Consumer

spending declinesspending declines• AD decreasesAD decreases• Price level and RGDP decreasePrice level and RGDP decrease

• The money supply contactsThe money supply contacts• Interest Rate risesInterest Rate rises• Investment and Consumer Investment and Consumer

spending declinesspending declines• AD decreasesAD decreases• Price level and RGDP decreasePrice level and RGDP decrease

MS i% IMS i% Inn C AD PL RGDP C AD PL RGDP

What is the What is the Federal Funds Rate? Federal Funds Rate?

What is the What is the Federal Funds Rate? Federal Funds Rate?

The interest rate that one The interest rate that one bank will charge another bank will charge another bank to borrow money bank to borrow money overnight to cover its overnight to cover its reserve requirement.reserve requirement.

If the FED buys bonds, If the FED buys bonds, the federal funds the federal funds

rate…?rate…?

Banks have more Banks have more reserves, so the Federal reserves, so the Federal Funds rate Funds rate fallsfalls

If the FED sells bonds, If the FED sells bonds, the federal funds the federal funds

rate…?rate…?

Banks have fewer Banks have fewer reserves, so the Federal reserves, so the Federal Funds rate Funds rate risesrises

What happens when the Fed, What happens when the Fed, changes in reserve changes in reserve

requirementsrequirements

What happens when the Fed, What happens when the Fed, changes in reserve changes in reserve

requirementsrequirementsLowerLower reserve ratio raises the reserve ratio raises the

money multiplier, thus money multiplier, thus expanding the money supplyexpanding the money supply

LowerLower reserve ratio raises the reserve ratio raises the money multiplier, thus money multiplier, thus expanding the money supplyexpanding the money supply

HigherHigher reserve ratio lowers the reserve ratio lowers the money multiplier, thus slowing money multiplier, thus slowing the growth of the money supplythe growth of the money supply

HigherHigher reserve ratio lowers the reserve ratio lowers the money multiplier, thus slowing money multiplier, thus slowing the growth of the money supplythe growth of the money supply

What is the Prime Interest Rate?

What is the Prime Interest Rate?

The interest rate that big The interest rate that big banks charge their best banks charge their best and most credit worthy and most credit worthy customers.customers.

Interest RatesInterest Rates

Federal Funds RateFederal Funds Rate

Prime Interest RatePrime Interest Rate

Business Loan RateBusiness Loan Rate

Mortgage RateMortgage Rate

Auto RateAuto Rate (new and used)(new and used)

Personal LoansPersonal Loans

The FOMC targets the Federal Funds The FOMC targets the Federal Funds Rate which sets rates for the following: Rate which sets rates for the following: