CHAPTER 14

The Federal Reserve

and Monetary Policy
SECTION 1: The Federal Reserve System
SECTION 2: The Federal Reserve at Work
SECTION 3: Monetary Policy Strategies

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 SECTION 1
The Federal Reserve System

Objectives:
 How did the Panic of 1907 affect U.S.
banking?
 What are the purposes and characteristics of
the Federal Reserve System?
 How is the Fed organized?

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 SECTION 1
The Federal Reserve System
Effects of the Panic of 1907 on U.S.
banking:
 caused the collapse of many banks
 endangered the monetary system
 broke the resistance to central banking

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 SECTION 1
The Federal Reserve System
The Fed
 Roles:
 to supervise member banks
 to hold cash reserves
 to control circulation of money
 Features:
 lacks a single central bank
 is owned and controlled by the member banks
 makes membership optional for some banks
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 SECTION 1
The Federal Reserve System
Structure of the Fed
 National level:
 Board of Governors—highest policy-making body
 Federal Open Market Committee—made up of the
Board of Governors, the Federal Reserve Bank of
New York, and four other district bank members
 District level:
 12 Federal Reserve banks
 25 branch offices
 local member banks
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 SECTION 2
The Federal Reserve at Work

Objectives:
 What services does the Fed provide to
banks?
 How does the Fed serve the federal
government?
 How do economists measure the U.S. money
supply?

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 SECTION 2
The Federal Reserve at Work

Services the Fed provides to banks:

 clearing checks
 lending reserves to banks

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 SECTION 2
The Federal Reserve at Work

Services the Fed provides to the

government:
 serves as the government’s bank
 supervises the Fed’s member banks
 regulates the national money supply

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 SECTION 2
The Federal Reserve at Work

How economists measure the U.S. money supply:

 M1—counts all currency in circulation, the value of
all traveler’s checks, all checking account deposits,
and deposits in all similar accounts in banks
 M2—money counted in M1, plus money in money
market accounts, money market mutual fund shares,
and other savings deposits
 M3—money counted in M2, plus all large time
deposits, repurchase agreements, and some
Eurodollars
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 SECTION 3
Monetary Policy Strategies

Objectives:
 Why does the Fed rely on either an easy-
money or a tight-money policy?
 How does the Fed make monetary policy?
 What are the challenges associated with
determining monetary policy?

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 SECTION 3
Monetary Policy Strategies

Money policy
 Easy-money policy:
 to expand the money supply
 to increase aggregate demand
 to create jobs
 Tight-money policy:
 to slow business activity
 to help stabilize prices
 to restrict money supply
 to reduce aggregate demand

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 SECTION 3
Monetary Policy Strategies

How the Fed makes monetary policy:

 open-market operations—buying and selling of
government securities
 discount rate—the interest rate that the Fed charges
member banks for use of its reserves and which the
Fed adjusts to encourage or discourage borrowing
 reserve requirement—money that banks must hold
in their vaults or accounts to meet demand requests

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 SECTION 3
Monetary Policy Strategies

Challenges associated with

determining monetary policy:
 incorrect economic forecasts
 time lags in enacting monetary policy
 difficulties in establishing priorities and
trade-offs
 lack of coordination among government
agencies

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 CHAPTER 14
Wrap-Up
1. How does the organization of the Federal Reserve
System avoid placing too much power in a single
bank?
2. Why is the Fed considered a “lender of last resort”?
3. How does the Fed put monetary policy to work?
What are the characteristics of easy-money and
tight-money policies?
4. What are the main difficulties the Federal Reserve
encounters when developing monetary policy?
5. What tools does the Fed use to implement
monetary policy?
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