the money supply and fed.pptx

8/19/2019 The Money Supply and fed.pptx

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The Money Supply and

the Federal Reserve System


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Standard measures of the money supply

• Monetary baseThe monetary base is defined as the sum of currency in circulation andreserve balances (deposits held by banks and other depository institutions

in their accounts at the Federal Reserve).• M1

Currency held outside banks + demand deposits + traveler’s checks + othercheckable deposits

• M2! + savin"s accounts + money market accounts + other near monies


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The Federal Reserve System

• The Federal Reserve #ystem (also kno$n as theFederal Reserve% and informally as the Fed) is thecentral bankin" system of the &nited #tates. 't

$as created on ecember *% !!*% $ith theenactment of the Federal Reserve ,ct% lar"ely inresponse to a series of financial panics%particularly a severe panic in !-. /ver time% theroles and responsibilities of the Federal Reserve#ystem have e0panded% and its structure has

evolved.


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The Fed's Structure

• The Federal Reserve #ystem consists of a seven1member board of directors in 2ashin"ton% .C.% and! re"ional banks% each controlled by its o$n directors.

• These re"ional institutions% o$ned by commercial banks $ithin their 3urisdictions% only do business $iththe Treasury and their member banks% not $ith thepublic at lar"e.

• They do not lend money for automobiles or homes%and their main assets are &.#. "overnment securities(such as Treasury bonds).


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The Fed's Operations

• 4ven thou"h the Constitution authori5es the"overnment to 6coin money%6 it $ould be

impractical to control its supply by speedin" up orslo$in" do$n the printin" presses.

• ,fter all% if enou"h $ere printed it $ould soon be $orthless.

• 't is also impractical to tie the value of papermoney to precious commodities such as "old orsilver% since the supply of these commodities doesnot al$ays keep pace $ith economic "ro$th.


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The Federal Reserve System manages the money supply in

three ways:

• Reserve ratios7anks are re8uired to maintain a certain proportion of theirdeposits as a 6reserve6 a"ainst potential $ithdra$als. 7y varyin"this amount% called the reserve ratio.

• the Fed controls the 8uantity of money in circulation.• #uppose% for e0ample% it orders banks to han" on to an e0tra !

percent of their deposits. They $ould then have ! percent less tolend.

• /ne percent may not sound like a lot% but it translates into billions

of dollars that are siphoned out of the economy.


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• Discount rate• 2hen banks temporarily overcommit themselves%

they occasionally have to borro$ from the Fed tosecure the necessary funds to meet their reserve

re8uirements. The interest rate char"ed for theseloans is the discount rate% and it too affects themoney supply

• 'f the Fed raises the discount rate% banks cannot

afford to borro$ as heavily as before and have tocurtail their lendin" and raise their o$n interestrates. That results in less money flo$in" into theeconomy


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• Open-market operations 7y far the most important of the Fed9s activities are open1marketoperations% the buyin" and sellin" of "overnment securities.

• The process $orks this $ay: 'f the Fed decides to increase themoney supply% its open1market mana"er buys back treasurysecurities from private dealers% payin" for them by simply

creditin" their bank accounts.• 't does not transfer any actual cash. (This po$er distin"uishes itfrom all other financial institutions and "ives it its clout.) Thedealers9 banks no$ have more money to lend% and these loansultimately find their $ay into more banks% $hich pass a portion

of them on to additional borro$ers.• The Fed9s initial purchase thus has a multiplier effect as moneyripples throu"hout the economy.

• /f course% the process is reversed $hen the Fed sells off some ofits securities% because it in effect deducts the price from the

purchasers9 accounts% leavin" their banks $ith fe$er deposits.


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The Fed and the Political System

• /n paper the Federal Reserve #ystem appears to be relatively autonomous% since it receives itsoperatin" revenues from its constituent banks%not from con"ressional appropriations% andsince its "overnors% once in office% cannot be

dismissed by the president.• The "overnors9 lon" terms mean that anoccupant of the 2hite ;ouse cannot e0pect topick a ma3ority of the "overnors.


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Fed creation of Congress

•


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oo!ing for a "ero

• Today% the Fed uses its tools to control thesupply of money to help stabili5e the economy.

2hen the economy is slumpin"% the Fedincreases the supply of money to spur "ro$th.Conversely% $hen inflation is threatenin"% theFed reduces the risk by shrinkin" the supply.

• 2hile the Fed9s mission of 6lender of last resort6is still important% the Fed9s role in mana"in" theeconomy has e0panded since its ori"in.


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Thanks a lot

the money supply and fed.pptx

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