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Understanding the Federal Reserve System and its Role in the US Economy

Learn about the Federal Reserve System, its purpose, organization, and responsibilities in regulating banks and ensuring a stable economy. Explore the roles of the Board of Governors and District Federal Reserve Banks.

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Understanding the Federal Reserve System and its Role in the US Economy

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  1. 4.0 Understand the Role of Finance in Business Competency 4.02Understand the Banking System Objective 4.02-A Analyze the roles/responsibilities of the Federal Reserve. http://www.federalreserveeducation.org/, go to website, learn more about Fed, visit Richmond, visit the bank, tour virtual money museum.

  2. The Federal Reserve System • What is the Federal Reserve System? • Why does it exist? • Who participates? • How is it organized?

  3. The Federal Reserve (The Fed)A Centralized Banking System • Federal Reserve Act signed into law by President Woodrow Wilson • Organized by the Federal Government in 1913 • Why have “ The Fed” ? Purpose: • To establish and maintain confidence in the US monetary system • To ensure and safe, healthy and stable economy • To supervise and regulate member banks and help serve the public efficiently. * Prior to the Federal Reserve Act anyone could issue currency or coin money

  4. Who Participates in Federal Reserve? • All National Banks are required to be part of the Fed • Optional for state banks • Divisions are called DISTRICTS • There are 12 DISTRICTS in the United States • Every state comes under a district • Each Federal Reserve Bank is a corporation, owned by its member banks NC is in District 5, the Richmond District. Charlotte has a regional office.

  5. The Federal Reserve • What are the two arms of “The Fed”? • Board of Governors • Represents the government (public) sector • District Federal Reserve Banks • Represents the business (private) sector

  6. Board of Governors • Usually meet about twice a week, ordinarily on Mondays and Wednesdays • Public is invited to look into the meetings of the Board of Governors • Usually discuss monetary policy such as lowering and raising interest rates The Board Room at the Federal Reserve in Washington, DC

  7. Members of the Board of Governors • Ben S. Bernanke, Current Chairman • Alan Greenspan, Retired Chairman • Chairman is appointed by President and confirmed by Senate • Similar to procedure for Supreme Court Justices

  8. Purpose of Federal Reserve • Established to supervise and regulate banks • Known as the “Bank’s bank” • The central bank of the United States • Assists banks with serving the public more efficiently • All national banksare required to join the Federal Reserve System • State banks have the option of joining the system

  9. The Federal Reserve System Services • Supervision of banks • Agent for the federal government • Regulates monetary policy • Lends money to member banks • Acting as a clearinghouse • Participation in open market activities • Sets loan limits & standards • Supplies currency

  10. 1. Fed Supervision: Set Reserve Requirements • Member banks are required to keep a certain percentage (10% for many years) of all deposits in the bank’s vault or on deposit with the district federal reserve bank • Reserves: funds set aside for emergencies • Example: a rush of withdrawals by customers • Purpose: to reduce risk of bank panics and protect depositor’s money

  11. 1. Fed Supervision: Audits Member Banks Inspects banks by auditing financial records • Audit -an inspection of records to verify the: 1. accuracy of books (records) of the bank 2. bank is complying with banking laws Similar to Individuals/corporations who are audited by the IRS to review the accuracy of a tax return.

  12. 1. FED Supervision: Approves Bank Mergers Q: Why do banks merge? To be more competitive -to offer customers more locations (local, regional, national, international) -to offer a variety of services more efficiently -to compete with a growing array of other financial service companies such as: *money market and other mutual funds *mortgage companies *credit unions and *credit arms of industrial firms (General Electric and Ford Motor) Here are some recent bank mergers approved by “The Fed” in 2007-2008 • Bank of New York bought Mellon Financial Corporation for $18.3 Billion • JPMorgan Chase bought Bear Stearns for $1.1 Billion • Bank of America bought Merrill LynchBank of America for $50 Billion • Wells Fargo bought Wachovia for $15.1 Billion

  13. 2. Fed Acts as Agent for Federal Government • The Fed holds a checking account for the US Treasury • Disburses social security benefits and other transfer payments using the direct deposit system • Accepts some types of federal tax money Example: Federal tax depositories Payroll taxes - federal income tax, FUTA, and social security taxes are deposited using federal deposit coupon into a national bank

  14. 3. FED Regulates Monetary Policy • What is Monetary Policy?When the Federal Reserve influences money and credit conditions in the economy to achieve economic goals • How? The Fed determines amount of money in circulation and available for loans, then either increases or decreases to stabilize/stimulate the economy • Tight money- policy when less money is available at higher interest rates, slows (stabilizes) economy • Loose money- policy when more money is available at lower interest rates, increases (stimulates) economy

  15. 4. FED Lends Money to Member Banks Monitors the discount rate of interest - rate used by the Fed to loan money to member banks • Compare banks to intermediaries (go-betweens) trading in money at “wholesale” prices The Fed changing interest rates affect borrowers (member banks) who pass rates to consumers • Raising rate - discourages borrowing • Reducing rate - encourages borrowing • Note: the Federal Reserve does not loan money to individuals or businesses (only member banks) HOWEVER, rates the Fed charges member banks “trickle down” and affect the interest rates for consumers

  16. 5. FED Acts as Clearing House Clears/Processes/Settles checks for member banks • Federal Reserve uses the Automated Clearing House (ACH) to electronically complete fund transfers (check settlements) between banks • Interdistrict Settlement Fund in Washington, DC used for between district transfers • Checks/deposit slips have MICR coding • Magnetic Ink Character Recognition • Scanners read MICR on checks to electronically process data accurately and rapidly through the ACH and Interdistrict Settlement Fund

  17. 6. FED Participates in Open Market Participates in open market operations by buying and selling government securities Q: What are government securities? A: Treasury bills and bonds – loans to government in various denominations (amounts) and for various time periods • Advantages and Disadvantages + offer a fixed rate of interest over a fixed period of time + attractive because not subject to income taxes - cannot be easily transferred and are non-negotiable

  18. Open Market Operations Government securities are sold at a discount (from face value), but are redeemed (cashed in) for face value on the maturity (due) date Examples: • Purchase treasury note for $7500 (discount price), redeem at maturity date for $10,000 (face value) • Purchase Series EE savings bond for $25, redeem in 7 years at maturity for $50

  19. Government Securities • Savings bonds - Example Series EE- • Denomination minimum $25 • Payable after 6 months • Earns interest up to 30 years • Short-term obligation of the U.S. TreasuryTreasury bill – maturity in one year or less • Issued to mature in 13 weeks, 26 weeks, 52 weeks • Long-term obligation of the U.S. Treasury • Treasury note – maturity at 1 to 10 years, minimum $1000 • Treasury bond - maturity at 10 + years

  20. Open Market Operations Bank discount rates encourages borrowing by member banks, and therefore encourages borrowing by consumers • Purpose of open market operations • Regulate money supply Most frequent method of controlling the economy • Who controls open market operations? • Federal Open Market Committee (FOMC)- A committee within the Federal Reserve

  21. 7. The FED Sets Lending Standards Sets standards for consumer legislation dealing with lending and credit • Sets limits for loans and investments by member banks News: Federal Reserve revised bank lending rules since banking crisis • Ex: Lower % of total loans for land/acreage

  22. 8. The Fed Supplies Currency • Money defined: • a medium of exchange for value • US money = currency and coins Federal Reserve supplies paper currency • Legal Tender for all debts, public and private • Paper currency supplied is “Federal Reserve Notes” Printing currency (paper money, bills) • Bureau of Printing and Engraving • Counterfeiting - federal crime Coinage • Minting supplied and regulated by the Department of Treasury, US Mint

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