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The Federal Reserve System. Chapter 14. Objectives. How did the Panic of 1907 affect U.S. banking? What is the purpose of the Federal Reserve System? How is the Fed organized? What services does the Fed provide to banks? How do economist measure the money supply?

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  • How did the Panic of 1907 affect U.S. banking?

  • What is the purpose of the Federal Reserve System?

  • How is the Fed organized?

  • What services does the Fed provide to banks?

  • How do economist measure the money supply?

  • Easy-money policy v. tight-money policy

  • How is monetary policy made?

Central bank
Central Bank

  • Many of the founders were distrustful of a central bank

  • The Second Bank of the United States had its charter expire under Andrew Jackson.

  • No central bank was proposed again until the Panic of 1907

Panic of 1907
Panic of 1907

  • Causes

    • No ability to expand the nation’s money supply

    • The system of pyramided reserves failed

Money supply
Money Supply

  • Businesses and individuals competed for a fixed supply of funds available as loans

  • When these were not available, withdrawals were made from savings accounts

  • “Runs” on banks would occur.

Pyramided reserves
Pyramided Reserves

  • Smaller banks deposit with larger banks who deposit with large commercial banks in New York, Chicago or San Francisco

  • Even small financial panics could cause serious “runs” on even the commercial banking houses.

Federal reserve
Federal Reserve

  • 1908 – establishment of the National Monetary Commission

    • Federal Proposed the establishment of a new central bank

    • Reserve Act passed in 1913

Role of the federal reserve
Role of the Federal Reserve

  • Fed supervises member banks

  • Holds cash reserves

  • Moves money in and out of circulation

Characteristics of the fed
Characteristics of the Fed

  • There is no central bank. District banks carry on the policies

  • The government owns no shares in the Fed—Congress does have oversight

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


  • National Level

    • Decisions made by the Board of Governors and Federal Open Market Committee

  • District Level

    • 12 separate federal reserve banks

National level
National Level

  • The Board of Governors supervises policy and controls the supply of money

  • There are 7 members on the board. They are nominated by the president and confirmed by the senate and serve a term of 14 years.

  • The 7 members of the board and the president of the Federal Reserve Bank of New York are permanent members of the FOMC.

  • The remaining 4 members are district federal reserve bank presidents who serve one rotating terms

District level
District Level

  • 12 District Federal Reserve Banks each serving a particular geographic region.

  • There are 25 branch offices located throughout the country

  • All commercial banks are nationally chartered and belong to the Feds

  • Each district has a board of 9.

  • The federal reserve district elect 6 members (3 may be bankers). The Board of Governors appoint the remaining 3 members.

Federal reserve services to banks
Federal Reserve Services to Banks

  • Services offered by Fed Reserve Banks making your banking easier

  • The Fed clears checks

    • 1. Mrs. Pacheco writes a check to Macy’s

    • 2. Macy’s deposits the check in their account with Bank of New York

    • 3. Bank of New York credits Macy’s account for the amount of the check and sends the check to the District Fed Reserve Bank of New York

    • 4. The Fed Reserve Bank of New York credits the Bank of New York and sends the check to Federal Reserve Bank in San Francisco

    • 5. The Federal Reserve Bank in San Francisco credits the Federal Reserve Bank of New York for the value of the check and sends the check on to Mrs. Pacheco’s bank

    • 6. Mrs. Pacheco’s bank credit the Federal Reserve Bank in San Francisco and debits the amount of the check from her account

  • Loans to Banks

  • Federal Reserve Banks make loans to state or regional banks for the short term

  • Often small banks need loans to cover short term increases in withdrawals

  • Sometimes the Fed make loans to help in times of national emergencies

Services to government
Services to Government

  • Serves as the Government’s Bank

    • Depository of Revenues

    • Provide a government checking account

    • Keeps records of deposits and withdrawals and conducts purchase and sales of T-Bills

    • Acts as advisor to the executive and legislative branches

  • The Federal Reserve acts as a “watchdog” over the 12 District Federal Reserve Banks

  • The District Banks have bank examiners who audit member banks to ensure proper procedures and an adequate amount of cash is available to depositors

  • Regulate bank mergers and charters of bank holding companies

  • The Fed’s regulate the nation’s money supply District Federal Reserve Banks

    • Paper money is printed by the Treasury Department’s Bureau of Engraving and Printing

    • Coins are minted at the U.S. mints

  • New Currency is placed in circulation to:

    • Replace worn out notes

    • Increase the amount of money in circulation

  • The Fed’s increase or decrease the money supply by trading in U.S. Securities

Money supply1
Money Supply District Federal Reserve Banks

  • Economist determine how much money is in circulation by several means:

  • M1

  • M2

  • M3 and L

M1 District Federal Reserve Banks

  • The simplest of the measures

  • Considered in the measure are

  • All of the currency in circulation

  • All deposits in checking accounts

  • All Traveler’s checks

M2 District Federal Reserve Banks

  • Is a broader and more encompassing measure of money

  • It includes everything in M1 and

  • Money market accounts

  • Money market mutual fund shares

  • Savings accounts

  • Certificates of Deposit that are less than $100,000.

M3 and l
M3 and L District Federal Reserve Banks

  • These are the most inclusive of the measures

  • M3 include all aspects of M1 and M2 and

    • CDs over $100,00

  • L include M1, M2 and M3 and

    • Savings bonds

    • Short-term treasury securities

Monetary policy and aggregate demand
Monetary Policy and Aggregate Demand District Federal Reserve Banks

  • Fed regulates the amount of money and credit available.

  • Monetary policy effects the cost of credit via money supply

  • Aggregate demand is the demand for all goods and services

Easy money policy
Easy Money Policy District Federal Reserve Banks

  • Designed to expand the money supply. This will

  • Increase jobs, aggregate demand

  • This policy is used to aid the economy during a recession

Tight money policy
Tight Money Policy District Federal Reserve Banks

  • Slows business growth and stabilizes the economy

  • Inflation may develop if there is too much money in circulation

  • Higher interest rates, reduced aggregate demand, decreased money supply

Components of monetary policy
Components of Monetary Policy District Federal Reserve Banks

  • Open Market Operations

    • The buying and selling of government securities

    • FOMC makes the decision to buy or sell securities

    • The Federal Reserve Bank of New York handles the transactions

    • Selling – contracts money supply

    • Buying – expands money supply

  • Moral Suasion during times of nation emergency

    • The indirect method of the Fed exerting pressure on the economy

    • Done through direct appeal to banking, congress and the public

    • The Fed can change the lending policies of banks.

Policy limitations
Policy Limitations during times of nation emergency

  • Economic forecasting

  • Used to develop monetary policy based on educated guesses

  • Time Lags

  • Period of time between forecast and implementation of policy

  • Priorities and Trade Offs

  • Monetary policy can fight inflation or recession

  • Lack of Coordination

  • Government agencies sometimes have agendas that differ from those of the Fed

  • Conflicting Opinion

  • Economists and government agencies often have different ideas about what will positively effect the economy