Federal Reserve

Introduction

• through its influence over the money supply, the Federal Reserve has more influence over aggregate demand than any other institution
• shifts in aggregate demand can greatly influence the economy in the short run

What is the Federal Reserve System?

• federal reserve has the power to create money
  • doesn’t have to literally print money, it can add reserves to bank accounts held at the Federal Reserve
  • this new money can be given away or lent out in a way that increases aggregate demand
• Federal Reserve’s most important job is to regulate the US money supply
• Federal Reserve is the government’s bank
  • maintains the US Treasury account
  • manages government borrowing through US Treasury bonds, bills, and notes
• Federal Reserve is also the banker’s bank
  • regulates banks and lends them money
  • manages nations payment system
  • protects financial consumers with disclosure regulations

The US Money Supplies

• money: a widely accepted means of payment
• most important assets that serve as means of payment in the US today:
  • currency (paper bills and coins)
  • total reserves held by banks at the Federal
  • checkable deposits (your checking or debit account)
  • savings deposits, money market mutual funds, and small-time deposits
• liquid asset: an asset that can be used for payments or, quickly and without loss of value, can be converted into an asset that can be used for payments
  • assets differ in their degree of liquidity depending on how quickly they can be converted into an asset that can be used for payment
• currency: coins and paper bills held by people and nonbank firms
• a lot of US cash is used on other countries
  • Panama, Ecuador, El Salvador, and others use the US dollar as their official currency
• dollars are often used unofficially in unstable countries as a means of preserving wealth
• total reserves play an important role in the financial system
• all major banks have accounts at the Federal Reserve
  • they use them to trade with other banks and the Federal Reserve itself
  • it’s not currency, but electronic claims that can be converted into currency if the bank wishes
• checkable deposits: deposits that you can write checks on or access with a debit card
  • these are deposits used most often in making daily transactions
  • aka demand deposits
  • you can access this money “on demand”

\