Functions and Structure of the Federal Reserve System

Function of Money

Unit of value, expresses the value of goods, store of value, does not lose value over time, doesn't expire, allows a period of time to pass between earning and spending income.

Medium of Exchange

Exchange money for goods and services; must be easily recognizable, easy to carry, generally accepted, and something people have confidence in.

M1

Includes items directly and immediately usable as a medium of exchange; the narrowest measure of the money supply includes currency, traveller's checks, checking account/demand deposit account, credit cards, and money orders.

Currency

Coins and bills.

Money Order

A written order for the payment of a sum to a named individual; usually obtainable and payable at a post office, bank or 7-11.

M2

A broader measure of the money supply than M1 that includes savings accounts, CDs, and IRAs.

Certificates of Deposit (CDs)

Money invested for a specific amount of time at a fixed interest rate; if you withdraw money earlier, you face a penalty.

IRA (Individual Retirement Accounts)

Place to set aside income for retirement; not taxable.

Depository

Includes commercial banks and mutual savings banks; commercial banks make a profit and cater to business and commerce, while mutual savings banks are for depositor benefit and owned by depositors.

Commercial Banks

Make a profit and cater to business and commerce.

Mutual Savings Bank

For depositor benefit and depositor owned; unlike commercial banks, they have no stockholders.

Non-Depository

Includes securities brokers, mutual funds, insurance companies, and finance companies.

Securities Brokers

Place orders and charge commissions for stocks and bonds.

Mutual Funds

Invest in a wide variety of companies.

Insurance Companies

Premiums paid by customers; the company lends surplus to others or invests money.

Finance Companies

Offer bill consolidation loans enabling consumers to pay off other bills.

Pension Funds

Funds set aside for retirement benefits.

Federal Reserve System

Responsible for monetary policy, including expanding or contracting money supply.

Stagflation

A situation characterized by high unemployment and inflation.

Monetary Policy

Includes reserve requirements established by the Fed to ensure banks maintain enough money.

Reserve Requirements

Minimum amount of money banks must keep in the Federal Reserve, dictated by a percentage of the bank's total money.

Excess Reserves

The amount of money banks can loan out beyond the reserve requirement.

Example of Reserve Requirement

If the reserve requirement is 12%, then the bank keeps $12 on reserve and $88 to loan out.

Reserve Requirement

The higher the reserve requirement = the less money in the money supply/circulation; the lower the reserve requirement = the more money in the money supply/circulation.

Open Market Operations

Buying or selling of government securities in financial markets by the Federal Open Market Committee (FOMC).

Effect of Fed Buying Securities

When the Fed buys securities, it increases the supply of money, leading to lower interest rates.

Effect of Fed Selling Securities

When the Fed sells government securities, it decreases the supply of money, leading to higher interest rates.

Discount Rate

The interest the Fed charges on loans to financial institutions.

Impact of Increasing Discount Rate

If the discount rate goes up, fewer banks will borrow from the Fed, resulting in less money to loan to customers and higher interest rates.

Impact of Decreasing Discount Rate

If the discount rate goes down, more banks will borrow from the Fed, resulting in more money to loan to customers and lower interest rates.

The Federal Reserve

The Federal Reserve was created to avoid booms and busts and panics.

Federal Reserve Act of 1913

An act of Congress that created and set up the Federal Reserve System, the central banking system of the USA.

Purpose of the Federal Reserve

Regulate the money supply and provide supervision for the banking system.

Board of Governors

7 members appointed by the president, confirmed by the Senate, serving a term of 14 years, with staggered terms.

Chairman of the Board

Jerome Powell was sworn in on February 5, 2018.

Federal Reserve District Banks

These banks carry out the same functions for banks and thrift institutions as those institutions carry out for people.

Number of Federal Reserve Districts

12 districts.

Directors of Federal Reserve District Banks

9 directors for each district bank: 3 appointed by the Board of Governors, 6 chosen by member banks.

Federal Open Market Committee (FOMC)

Includes 7 members of the Board of Governors and Presidents of 5 Federal Reserve Districts, with the NY District President always on the committee.

StagFlation

Characterized by high unemployment, an economy that stagnates, and increasing prices.

Member Banks

Own shares of the Fed; national banks belong to the Fed, while state banks can choose whether to join.

Six Major Functions of the Fed

Holding required reserves, clearing checks, supplying the economy with paper currency, acting as a fiscal agent for the federal government, supervising member banks, and regulating the supply of money.

Clearing Checks

An order to transfer money where the Fed switches money in the books of the two accounts involved.

Federal Reserve Notes

Paper money printed by the Bureau of Engraving and Imprinting.

Fiscal Agent for the Federal Government

Holds the checking account for the US Treasury, including federal pensions, veteran benefits, tax refunds, and payments for government purchases.

Supervising Member Banks

Ensures they follow federal laws and sound banking principles, including adequate capital.

Comptroller of the Currency

The head bank examiner.

Regulating the Supply of Money

Smooths out the ups and downs of the business cycle, expanding during recessions and contracting during peaks.