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The Federal Reserve and Monetary Policy. Chapter 16. Banking History. Monetary Policy: the actions the FED takes to influence the level of real GDP and the rate of inflation in the economy. The Federal Reserve Act of 1913. Passed by Congress to deal with problems of bank runs and panics.

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The Federal Reserve and Monetary Policy

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The federal reserve and monetary policy

The Federal Reserve and Monetary Policy

Chapter 16

Banking history

Banking History

  • Monetary Policy: the actions the FED takes to influence the level of real GDP and the rate of inflation in the economy

The federal reserve act of 1913

The Federal Reserve Act of 1913

  • Passed by Congress to deal with problems of bank runs and panics.

  • Creates “the FED”

    • 12 independent regional banks that can lend to other banks in times of need.

The great depression

The Great Depression

  • The FED fails during this period because the banks still acted independently

A stronger fed

A Stronger Fed

  • 1935 the Fed’s structure was reorganized by Congress.

    • Allowed for better handling of crises.

Structure of the federal reserve

Structure of the Federal Reserve

  • Oversee the Fed

  • 7 members, 14 year terms, staggered



  • Chosen from the 7 members by the president.

  • Serves a 4 year term

  • Specialist in keeping

    crises from getting out

    of control.

Twelve federal reserve banks

Twelve Federal Reserve Banks

Twelve federal reserve banks1

Twelve Federal Reserve Banks

  • Each bank has a board of nine directors.

  • Chicago Board of Directors

Member banks

Member Banks

  • All nationally chartered banks are required to join the Federal Reserve System.

  • Some state chartered banks voluntarily join.

  • 2,600 total banks

The federal open market committee fomc

Adjust interest rates and the money supply

Consist of the Board of Governors (7) and then 5 of the twelve regional bank presidents.

NY Permanent, others rotate 1 year terms

The Federal Open Market Committee (FOMC)

The federal reserve functions

The Federal Reserve Functions

Chapter 16 Section 2

Serving government

Handles their banking

Medicare, social security, and veteran benefits.

Banker and Agent

Has treasury department checking account

Agent by handling bonds, bills, notes and interest payments.

Serving Government

Issuing currency

Issuing Currency

  • Federal Reserve Notes

    • In charge of circulation



Serving banks

Check Clearing

Supervising Lending Practices

Lender of Last Resort

Expanded role due to financial crisis of 2008

Serving Banks

Regulating the banking system

Regulating the Banking System

  • Each financial institution must report daily its reserves.

    • Must maintain 10%

  • Bank Examinations

Regulating the money supply

Watch the Demand for Money and use this info to stabilize the economy.

Prevent inflation and keep real GDP growing

Regulating the Money Supply

Monetary policy tools

Monetary Policy Tools

Chapter 16 Section 3

Money creation

Money Creation

  • Treasury manufactures money

  • FED puts it into circulation

How banks create money

How Banks Create Money

  • Fractional Reserve (RRR) Required Reserve Ration

  • Loans with interest payments

  • Money Multiplier Formula

    • Increase in money supply = initial deposit x 1/RRR

Reserve requirements

Reserve Requirements

  • Easiest way to change money supply is for FED to adjust reserve ratio.

  • RRRM1

  • RRRM1

Discount rate

Discount Rate

  • The rate the FED charges banks on loans.

    • Also affects money supply

    • Rare to be used, instead use other banks and the federal funds rate.

Open market operations

Open Market Operations

  • The buying and selling of government securities in order to alter the supply of money.

  • Sell bonds to decrease money supply.

  • Buy bonds to increase money supply.

Monetary policy and macroeconomic stabilization

Monetary Policy and Macroeconomic Stabilization

Chapter16 Section 4

How monetary policy works

How Monetary Policy Works

  • Monetary policy affects money supply which in turn affects interest rates, which then affects investment and spending.

  • A lot of money = low interest

  • No money = high interest

The problem of timing

Good timing smoothes out the business cycle.

Bad timing intensifies the cycles

The Problem of Timing

The federal reserve and monetary policy


  • Inside lag is the time it takes to implement monetary policy

  • Outside lag is the time it takes for monetary policy to have an effect.

How quickly does the economy self correct

How Quickly Does the Economy Self-Correct?

  • Economists Disagree

  • Estimates 2-6 years



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