CHAPTER 14

Vince Arthur Misa

Angelica Beltran
Jodie Mae Lagrimas

BSA- First Year

THE FEDERAL RESERVE
AND MONETARY POLICY
Monetary policy is the manipulation of the money supply.
The Federal Reserve determines how much money should be
circulating in our economy.
THE FEDERAL RESERVE SYSTEM
• It is the central banking of the United States of
America.

• It was created after a series of financial panics

particularly the Panic of 1907 happened.

• After 6 years, Congress finally passed the Federal

Reserve Act of 1913.
THE FEDERAL RESERVE SYSTEM

• It’s main objective is to provide for the establishment of

Federal reserve banks, to furnish an elastic currency, to
afford means of rediscounting commercial paper to
establish a more effective supervision of banking in the
US and for other purpose.
 THE FEDERAL RESERVE HAS 5
MAIN JOBS
1. Conduct monetary policy,
which is, by far, the most 3. Issue currency
important job.
4. Provide banking service
2. Serve as a lender of last to U.S. government
resort to commercial banks,
savings bank, saving and 5. Supervise and regulates
loan associations, and credit financial institutions
unions.
 THE FEDERAL RESERVE
DISTRICT BANKS
• There are 12 Federal Reserve District Banks, one in
each of the nation’s Federal Reserve Districts.

• Each of these issue currency to accomodate the

business needs of its district.

• Each Federal District Bank is owned by the several

hundred member banks in that district.
 THE FEDERAL RESERVE
DISTRICT BANKS
• A bank becomes a member by buying stock in
the Federal Reserve District Bank.

• Fed is a quasi public-private enterprise, not

controlled by the president or congress.
Effective control is exercised by the Federal
Board of Governors.
 THE BOARD OF GOVERNORS
• There are 7 members nominated by the president,
subject to confirmation by the Senate.

• Each is appointed for one 14-year term and is

ineligible to serve a second term.

• The Chairman of the Board, who generally exercise

considerable influences, serves a 4-year term
 INDEPENDENCE OF THE
BOARD OF GOVERNORS
• The president does not control the Board of
Governors and its chairman

• The president does get to appoint a chairman at

some time during his/her term

• Once a board member is confirmed by the senate,

he/she is not answerable to the president or congress
 LEGAL RESERVE
REQUIREMENT
• The Federal Reserve has various jobs, the
most important of which is to control money
supply.

• Every financial institution in the country is

legally required to hold a certrain percentage
of its deposit on reserve.
Required reserves
The minimum amount of vault cash and deposits at the
Federal Reserves District Bank that must be held by the
financial institution.

Actual reserves
What the bank is holding. If the bank is holding more
than required, it has excess reserves.

actual reserves – required reserves = excess reserves

Federal funds
The reserves a bank borrows from other banks that
has some excess reserves

Federal funds rate

the interest rate charged

A bank short of reserves may also borrow at the discount

window of its Federal Reserve District Bank.
 PRIMARY AND SECONDARY
PRIMARY RESERVES
- Vault cash and deposits at the
Federal Reserve District Bank
• These reserves pay no interest;
therefore the banks try to hold no
more than the Federal Reserve
requires
RESERVES
SECONDARY RESERVES
- Treasury bills, notes, certificates and
bonds(that will mature in less than a
year)
• These can quickly be converted to
cash without loss if a bank suddenly
needs money
THE CREATION AND DESTRUCTION OF
MONEY
 THE CREATION
OF MONEY

• Money consist of checking

deposits, checklike deposits and
currency in hands of the public

• To ceate money, banks must

increase either currency held by
the public or checkable deposits
THE CREATION
OF MONEY

• It is like a license to print

money but it is a very restricted
license.

• A bank can only make loans if it

has some available reserves.
THE DESTRUCTION OF
MONEY
• Whoever creates can usually
destroy as well

• Money is destroyed when the

business-person pays back
the loan
 LIMITS TO DEPOSIT CREATION
- Most banks loans involve giving the borrower an
additional deposit in his/her checking account;
therefore, it would apear that banks can create all the
money they wanted.

• The first limit would be prudence.

DEPOSIT EXPANSION
HOW DEPOSIT EXPANSION
WORKS
The Deposit Expansion multiplier
• Any money injected into the banking system will have
multiplied effect on the money supply.

• When the reserve ratio is low, the multiplier will be high

and vice versa

1
____________
Deposit Expansion Multiplier =
Reserve ratio
 CASH, CHECKS AND
ELECTRONIC MONEY
One of the job of the Federal Reserve is called check clearing. Through
this process, once the checks you write are deposited by the people
you gave them in, they make their way through financial system
facilitated by Fed and eventually wind up photocopied on the back of
your monthly bank statement.
 TOOLS OF MONETARY POLICY
• Open – Market Operations
• Discount Rate
• Reserve Requirements
How Open-Market Operations Work

- The Federal Reserve purchases a security bonds

to increase money supply and to reduce the money
supply the FED sells the bonds.
 THE FEDERAL OPEN-MARKET
COMMITTEE
• Open – market operations are conducted by the
Federal Open – Market Committee.

• The Federal Open – Market Committee is the group

within the Federal reserve that creates monetary
policy.

• The Federal Open - Market Committee consist of 12

people.
 DISCOUNT RATE AND FEDERAL
FUNDS RATE CHANGES
• Discount rate
- interest rate paid by member banks when they
borrow at the Federal reserve district bank.

• Federal Funds Rate

-Is the interest rate that depository institution ,banks,
savings and loans, and credit unions,
charge each other for overnight loans.
 CHANGING RESERVE
REQUIREMENTS
• Increasing reserve requirements, the Federal Reserve is
essentially taking money out of the money supply and
increasing the cost credit.

• Lowering the reserve requirements pumps money into the

economy by giving bank excess reserve, which expands the
bank credit and lowers rate.
THE FED’S EFFECTIVENESS IN FIGHTING
INFLATION AND RECESSION

• When the Fed increase the rate of monetary growth, this

tends to raise GDP growth.

• The monetary policy is having some difficulty in handling

recession, because business
 TRANSMISSION MECHANISM:
EXPANSIONARY MONETARY POLICY
TRANSMISION MECHANISM: CONTRACTIONARY
 THE LIQUIDITY TRAP
• Liquidity Trap
- when monetary policy becomes ineffective
due to a very low interest rates combined
with consumers who prefer to save raher
than invest in higher – yielding bonds or other
investments.

• John Maynard Keynes determined that at a very low interest rates

people would not lend out their money.
 The Depository
Institutions Deregulation and
Monetary Control Act of 1980
 Key Provisions

1. All depository institutions are now subject to the

Fed’s legal reserve requirements.
2. All depository institutions are now authorized to
issue checking deposits.
3. All depository institutions now enjoy all the
advantages that only Federal Reserve member banks
formerly enjoyed.
 THE BANKING ACT OF 1999
In 1980 the jurisdiction of the Federal Reserve had been extended to all
commercial banks and thrift institutions. In 1999 it was further extended
to insurance companies, pension funds, investment companies, securities
brokers, and finance companies.

The new law repealed sections of the Glass-Steagall Act of 1933, which
was based on the premise that America’s financial house could best be
restored if bankers and brokers stayed in separate rooms.
 MONETARY POLICY LAGS
Monetary policy is also subject to the recognition, decision, and impact lags.

• The recognition lag is the time it takes for policy makers to realize that a
business cycle turning point has been passed. It usually shorter for
monetary than for fiscal policy.
• The decision lag is the time it takes for policy makers to decide what to do
and to take action.
• The impact lag is the time it takes for the policy action to have a
substantial effect.
 WHO CONTROLS OUR INTEREST
RATES?

The Fed controls our interest rates.

THANK YOU FOR LISTENING!