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Chapter 4 – Federal Reserve and Money

Chapter 4 – Federal Reserve and Money. BA 543 Financial Markets and Institutions. Chapter 4 – Federal Reserve. Purpose of Central Banks (Government Banks) – Maintain the stability and supply of the currency Risk Assessment Risk Reduction Oversight of Payment System

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Chapter 4 – Federal Reserve and Money

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  1. Chapter 4 – Federal Reserve and Money BA 543 Financial Markets and Institutions

  2. Chapter 4 – Federal Reserve • Purpose of Central Banks (Government Banks) – Maintain the stability and supply of the currency • Risk Assessment • Risk Reduction • Oversight of Payment System • Crisis Management (Lender of last resort) • Printer of Money • Central Bank of the United States (Created 1913) • Federal Reserve System – Independent Agency • Board of Governors (Seven members) • Twelve Districts (President of each district) • Monetary Policy

  3. Chapter 4 – Federal Reserve • Reserve Requirement of Members • Fractional reserve banking system • Mandatory deposits are the required reserve ratio • Congress took over role via DIDMCA 1980 • Set rates for different classes of accounts • Open Market Operations • Buy or sell government securities • FOMC – Federal Open Market Committee • Repurchase agreements • Discount Rate • The rate banks can borrow from the Fed

  4. Chapter 4 – Federal Reserve • Money • Numeraire – unit to measure wealth • Money is any instrument that serves as a medium of exchange • Accepted as payment for goods and services • Stores of value (carries wealth through time) • Money Aggregates • Monetary Base – coins and currency in circulation plus total reserves (M1) • M2 = M1 plus savings accounts and money market accounts • Also M3 and L which are M2 plus other deposits

  5. Chapter 4 – Federal Reserve • Money Multiplier – Expansion of Money Supply • Link between M1 and banking system reserves • Four parties involved • Fed • Banks • Savers • Borrowers • How does it work… • Mathematical formula: ΔTDD = ΔR / REQ • TDD is total demand deposits • R is reserves injected by Fed into system • REQ is the required reserve ratio

  6. Chapter 4 – Federal Reserve • Interest Rates • Impact the bank’s reserves • Low rates increase excess reserves • High rates lower or eliminate reserves • Impact’s borrower’s cash holdings • Both Impact M1 • Money Supply in Open Economy • Foreigners hold US currency and impact exchange rate (for transactions and investing) • Fed participates in (intervenes) foreign currencies (buy and sells foreign currencies)

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