AP Economics

1. AP Economics Mr. Bernstein Module 27: The Federal Reserve: Monetary Policy February 27, 2014

2. AP EconomicsMr. Bernstein The Federal Reserve: Monetary Policy • Objectives - Understand each of the following: • The functions of the Federal Reserve System • The major tools used by the Federal Reserve System

3. AP EconomicsMr. Bernstein Functions of the Federal Reserve System • Provide Financial Services • “Banker’s Bank” and also US Treasury’s bank • Supervise and Regulate Banking Institutions • Maintain Stability of the Financial System • Rationale behind providing liquidity to troubled entities • Conduct Monetary Policy • One of most important functions • Often emphasized by AP exam

4. AP EconomicsMr. Bernstein The Fed’s Primary Policy Tools • Reserve Requirements • Increase in RR reduces amount of loans banks can make, which reduces money supply • Banks face penalties for not maintaining adequate reserves • Banks can borrow reserves from each other overnight at Fed Funds market • Not used to actively manage money supply

5. AP EconomicsMr. Bernstein The Fed’s Primary Policy Tools • Discount Rate • Banks in need of reserves can also borrow from the Fed directly via the Discount window • Discount Rate is the interest rate the Fed charges them • Normally the Discount Rate is set above Fed Funds rate to discourage banks from accessing Discount window • Used primarily for liquidity needs and special situations

6. AP EconomicsMr. Bernstein The Fed’s Primary Policy Tools • Open Market Operations • Used to set Fed Funds rate and manage money supply • The New York Fed buys and sells Treasury Bills (short-dated notes) • When they buy T-bills from a bank, this moves the government’s debt from a bank to the Fed balance sheet, but importantly increases the cash at the bank, leading to an increase in money supply • In recent years, the Fed has engaged in QE, or buying longer-dated bonds…has begun tapering this program