ap economics: module 27 terms

4 functions of the federal reserve system

4 functions of the federal reserve system

1. provides financial services to depository institutions

2. supervise + regulate banking institutions

3. maintain the stability of the financial system

4. conduct monetary policy

depository institutions

banks, U.S. government, etc.

why is the FED called the “banker’s bank”?

conducts the services of banks: holding reserves, clearing checks, providing cash, and transferring funds

how does the FED maintain stability in the financial system?

provide liquidity

why does the FED supervise + regulate banking institutions?

to ensure the safety and soundness of the financial system

3 tools of the FED

1. the reserve requirement

2. the discount rate

3. open market operations

federal funds market

a financial market that allows banks that fall short of the reserve requirement to borrow reserves from banks holding excess reserves

federal funds rate

IR that banks charge other banks for loans

how is the MS altered through changing the RR?

lower RR —> more loans —> increase in MS via the MM (and vice-versa)

discount rate

IR the FED charges on loans to banks who don’t meet the reserve requirement

• goes through the discount window

• set by indiv. reserve banks + approved by the BOG

• usually 1 pt. higher than the FFR (so banks go to each other for money first before the FED) + move with short-term IR

how is the MS altered through changing the DR?

lowered spread between DR and FFR —> cost to banks short of reserves decreases —> more lending —> increased MS via MM (and vice-versa)

FED’s assets

government debt (U.S. treasury bills)

U.S. treasury bills

short-term U.S. government bonds w/ a maturity of less than one year

FED’s liabilities

monetary base (cic + reserves)

open market operations

FED buys/sells bonds

• usually done through commerical banks

• how the FOMC indirectly sets a target FFR

how is the MS altered through buying/selling bonds?

buy —> greater monetary base (due to greater reserves) —> greater MS via MM (and vice-versa)

IMPORTANT INFO

the FED can add to the monetary base at its own discretion, since fiat money isn’t backed by anything

• can only control MB, not MS, but by changing the MB, MS (and IR) is influenced

eurozone

European countries who have adopted the euro as their currency

compare the FED vs. ECB (similarities, differences)

1. both aren’t privately-owned or part of the govt.

2. BOG = ECB executive board

3. 12 regional FED banks = national central banks

4. FOMC = ECB governing council

t or f: when the FED sells T-bills to commercial banks, those banks’ reserves decrease

t