ECON 333 Exam 3, Bowes

federal reserve bank

the central bank for the US

Federal Reserve Act

1913

Federal reserve bank is responsible for

bank supervision, monetary policy, services to banks and government

federal reserve bank organization and structure

12 regional banks, decentralized and flexible

headed by presidents chosen by a private board

governers of the fed

chosen by the president and the senate

policy-making at the fed

federal open market committee

federal open market committee consists of

12 members; board of governors, president of NY fed, and 4 others

fed is independent of us government because

control their own budget and earn enough to pay for their operations

regional presidents chosen by private citizens

governors chosen for 14-year terms, non-renewable, not subject to political business cycle

fed is not completely unaccountable because

congress could change laws and take over budget

qualities of good central bank

accountability, transparency of policy decisions, decisions by committee, independence, good policy framework

banking system in the US is a

fractional reserve system

reserve ratio

fraction of deposits set aside

money creation process

banks create funds by making loans

loans create new deposits

new money

new money (M1)

demand deposits + currency in circulation

total amount of lending is found using

the deposit multiplier

deposit multiplier

1 / reserve ratio

maximum total deposits

total reserves x deposit multiplier

new loans =

maximum deposits - existing deposits

a fraction of each new deposit must be set aside as required reserves because

ensures that lending is repeated until all reserves are held as required reserves

fed is responsible for monetary policy =

changing money supply

fed does not directly control

M1

fed controls

the relationship between bank reserves and demand deposits

ways fed can influence money creation

setting reserve requirements (determines the multiplier)

open market operation

setting the discount rate and federal funds rate target

multiplier is less effective when

banks hold more excess reserves, people hold more currency

change in reserve ratio =

changes in the multiplier

open market operations changes

reserves and creates new loans

discount/federal funds rate change either

encourages or discourages bank lending

economic growth =

low unemployment

price stability =

low inflation

conflict among goals of employment and price stability

negative relationship between inflation and unemployment

expansionary monetary policy

increase money supply; lower reserve ratio, buy securities, lower federal funds and discount rates

contractionary monetary policy

decrease money supply; raise reserve ratio, sell securities, raise the federal funds and discount rates

expansionary policy is intended to

lower borrowing costs and encourage investment and consumption, increase GDP, create growth in output and employment

contractionary policy is intended to

raise borrowing costs, discourage investment and consumption, slow down growth in GDP, and reduce inflation

if the US economy were to have only electronic payments and no physical currency

the dollar would not be a good store of value

when money is used to indicate prices of goods it is said to function as a

store of value

if dave buys stock from carnival cruise line, which uses funds to build a new cruise ship, then in macroeconomics terms

carnival is investing and dave is saving

in one year you will receive a $100 bill. if interest rate rises today from 5% to 10%, the bill you receive a year form now becomes worth

less today (lower present value)

simulative monetary policy

expected to improve economy’s rate of growth output

restrictive monetary policy

expected to slow the economy down to potentially offset inflationary pressure

bond prices and interest rates

change in opposite directions

based on the bond market model, interest rates will rise during economic expansion because

the supply of bonds increases more than the demand for bonds

capital requirements for banks

encourage banks to limit their holding of risky assets by putting some of the banks own money at risk

the liquidity premium theory was developed because the expectations theory does a poor job of explaining

why interest rates for longer maturities are usually higher