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Splash Screen
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Chapter Menu
Chapter Introduction
Section 1: Organization and Functions of the Fed
Section 2: Money Supply and the Economy
Section 3: Regulating the Money Supply
Visual Summary
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Chapter Intro 1
Governments strive for a balance between the costs and benefits of their economic policies to promote economic stability and growth.
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Chapter Intro 2
In this chapter, read to learn about who is in charge of the U.S. money supply and how they decide how much currency to put into circulation.
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Section 1-Main Idea
Section Preview
In this section, you will learn about how the Federal Reserve System, or Fed, is organized, and its role in determining the nation’s monetary policy.
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Section 1
Organization of the Federal Reserve System
The Federal Open Market Committee of the Federal Reserve is responsible for implementing monetary policy.
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Section 1
• The Federal Reserve System, or Fed, is a system, or network, of banks that share power.
• The Fed is responsible for monetary policy in the United States.
Organization of the Federal Reserve System (cont.)
View: Organization of the Fed
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Section 1
• The Board of Governors, consisting of 7 full-time members appointed by the president, directs the operation of the Fed.
• They are assisted by the Federal Advisory Council (FAC)—12 members elected by the directors of each Federal Reserve district bank.
Organization of the Federal Reserve System (cont.)
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Section 1
• The Federal Open Market Committee (FOMC) has 12-voting members that meet 8 times a year to decide the course of action that the Fed should take to control the money supply.
Organization of the Federal Reserve System (cont.)
• The nation is divided into 12 Federal Reserve districts, with each district having a Fed district bank.
View: The Federal Reserve System
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Section 1
• Each district bank is set up as a corporation owned by its member banks.
Organization of the Federal Reserve System (cont.)
• The system also includes 25 Federal Reserve branch banks.
• All national banks are required to become members of the Federal Reserve System.
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Section 1
Functions of the Fed
The primary function of the Federal Reserve is to control the money supply.
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Section 1
Functions of the Fed (cont.)
• Functions of the Federal Reserve:
– Check clearing
– Acting as the federal government’s fiscal agent
– Supervising banks
– Holding reserves and setting reserve requirements
View: How a Check Clears
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Section 1
Functions of the Fed (cont.)
– Supplying paper currency
– Regulating the money supply
– Sets standards for certain types of consumer legislation
View: Functions of the Fed
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Section 2-Main Idea
Section Preview
In this section, you will learn how the Fed controls the money supply and interest rates.
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Section 2-Key Terms
• loose money policy
• tight money policy
• fractional reserve banking
• reserve requirements
Content Vocabulary
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Section 2
Loose and Tight Money Policies
The goal of monetary policy is to promote economic growth and employment without causing inflation.
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Section 2
Loose and Tight Money Policies (cont.)
• Credit, like any good or service, has a cost—the interest that is paid to obtain it.
• If the Fed implements a loose money policy (often called expansionary) credit is abundant and inexpensive to obtain, possibly leading to inflation.
View: Balancing Monetary Policy
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Section 2
Loose and Tight Money Policies (cont.)
• If the Fed implements a tight money policy (also called “contractionary”), credit is in short supply and is expensive to obtain, which slows the economy.
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A. A
B. B
Section 2
If more people are employed, borrowing is easy, and people spend more, which type of policy is in effect?
A. Loose
B. Tight
A B
0%0%
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Section 2
Fractional Reserve Banking
Banks are not required to keep 100 percent reserves to back their deposits.
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Section 2
Fractional Reserve Banking (cont.)
• The banking system is based on fractional reserve banking.
• Many banks have reserve requirements.
• A larger portion of the money supply consists of funds that the Feds and customers deposit in banks.
• Banks may only keep 10% of the deposits in reserve, so they use the remaining 90% in reserves to create new money.
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Section 2
Fractional Reserve Banking (cont.)
• When each bank uses the non-required reserve portion of money deposits to make loans to businesses and individuals, the process is known as the multiple expansion of the money supply.
View: Expanding the Money Supply
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Section 3-Main Idea
Section Preview
In this section, you will learn about several tools that the Fed uses to control the size of the U.S. money supply
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A. A
B. B
C. C
Section 3-Polling Question
Do you feel that the actions of the Fed impact your daily life?
A. Yes
B. Somewhat
C. Not at all
A B C
0% 0%0%
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Section 3
Changing Reserve Requirements
The Fed can change the growth rate of the money supply by changing reserve requirements on bank deposits.
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Section 3
Changing Reserve Requirements (cont.)
• The Federal Reserve can choose to control the money supply by changing the reserve requirements of financial institutions.
– If the Fed raises the reserve requirements, it would decrease the amount of money in the economy.
– If the Fed lowers the reserve requirements, it would increase the amount of money in the economy.
View: Raising and Lowering Reserve Requirements
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Section 3
Changing the Discount Rate
The Fed can change the growth rate of the money supply by changing short-term interest rates.
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Section 3
Changing the Discount Rate (cont.)
• If a bank does not have enough reserves to meet its reserve requirement, it can ask the Federal Reserve district bank for a loan.
• If the discount rate is high, the bank passes its increased costs on to customers in the form of higher interest rates on loans.
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Section 3
Changing the Discount Rate (cont.)
• Banks might raise their prime rate.
– High interest rates discourage borrowers and may keep down the growth of the money supply.
– Low interest rates encourage borrowers and may lead to growth of the money supply.
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Section 3
Changing the Discount Rate (cont.)
• Changing the reserve requirement or the discount rate is now rarely used by the Fed.
• Rather, the Fed states periodically that it is going to change the federal funds rate.
• If the Fed causes the federal funds rate to drop, banks will borrow more and, thus, lend more—and vice versa.
View: Federal Funds Rate
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Section 3
Open-Market Operations
The Fed controls the money supply primarily through the purchase and sale of government securities.
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Section 3
Open-Market Operations (cont.)
• The major tool the Fed uses to control the money supply is a practice known as open-market operations.
• When the Fed buys securities—such as Treasury bills, notes, and bonds—it pays for them by making a deposit in the dealer’s bank.
• This increases the bank’s reserves, thus increasing the money supply.
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Section 3
Open-Market Operations (cont.)
• When the Fed sells Treasury bills to a dealer, the dealer’s bank must use its deposits to purchase securities.
• This decreases the bank’s reserves, thus decreasing the money supply.
• Some people feel that the Fed should not engage in monetary policy due to misjudgments in the past.
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Section 3
Open-Market Operations (cont.)
• The spending and taxing policies of the federal government also affect the economy.
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VS 1
The primary function of the Federal Reserve System is to control the money supply, but it has other responsibilities as well.
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VS 2
The Fed can implement either a loose or tight money policy to try to promote economic growth and employment.
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VS 3
The Fed has several tools at its disposal to use to regulate the money supply.
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Figure 1
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Figure 2
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Figure 3
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Figure 4
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Figure 5
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Figure 6
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Figure 7
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Figure 8
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Economic Concepts Transparencies
Transparency 18 Monetary Policy
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Vocab1
Fed: the Federal Reserve System created by Congress in 1913 as the nation’s central banking organization
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Vocab2
monetary policy: policy that involves changing the rate of growth of the supply of money in circulation in order to affect the cost and availability of credit
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Vocab3
Federal Open Market Committee (FOMC): 12-member committee in the Federal Reserve System that meets 8 times a year to decide the course of action that the Fed should take to control the money supply
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Vocab4
check clearing: method by which a check that has been deposited in one institution is transferred to the issuer’s depository institution
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Vocab5
loose money policy: monetary policy that makes credit inexpensive and abundant, possibly leading to inflation
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Vocab6
tight money policy: monetary policy that makes credit expensive and in short supply in an effort to slow the economy
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Vocab7
fractional reserve banking: system in which only a fraction of the deposits in a bank is kept on hand, or in reserve; the remainder is available to lend
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Vocab8
reserve requirements: regulations set by the Fed requiring banks to keep a certain percentage of their checkable deposits as cash in their own vaults or as deposits in their Federal Reserve district bank
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Vocab9
discount rate: interest rate that the Fed charges on loans to commercial banks and other depository institutions
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Vocab10
prime rate: rate of interest that banks charge on loans to their best business customers
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Vocab11
federal funds rate: interest rate that banks charge each other on loans (usually overnight)
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Vocab12
open-market operations: buying and selling of United States securities by the Fed to affect the money supply
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