Federal Reserve 101


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An explanation of the basic instruments and limitations of Federal Reserve monetary policy.

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Federal Reserve 101

  1. 1. Federal Reserve 101
  2. 2. Three Basic Tools <ul><li>The Discount Window Rate
  3. 3. Reserve Requirements
  4. 4. Open Market Operations </li></ul>
  5. 5. The Discount Window
  6. 6. <ul><li>Just as individual banks lend to people, the Federal Reserve can lend to individual banks.
  7. 7. The interest that the Fed charges on these loans is known as the Discount Window Rate
  8. 8. The Fed directly controls the Discount Window Rate. </li></ul>
  9. 9. Reserve Requirements <ul><li>Just as individuals deposit their money in banks, banks deposit money at the Fed.
  10. 10. These deposts are known as bank Reserves .
  11. 11. Banks are required by the Fed to keep a certain amount of their money in these reserves.
  12. 12. The Fed determines, and can change at any time, the specific proportion that banks must keep in reserves–the banks' Reserve Requirements . </li></ul>
  13. 13. Open Market Operations <ul>This is by far the most significant tool employed by the Fed in practice. </ul>
  14. 14. Putting Money In <ul><li>The Fed buys assets with newly created money
  15. 15. In theory, it could buy anything
  16. 16. In practice, it usually buys treasury bills from banks.
  17. 17. In order to pay a bank, it need not print more money: it simply increases the recorded size of that bank's reserve.
  18. 18. The bank eventually lends the extra money out, putting it in circulation. </li></ul>
  19. 20. Taking Money Out <ul><li>In order to get money out of the economy, the Fed sells its assets.
  20. 21. Its capabilities are more limited in this area </li><ul><li>In order to put money in, they could theoretically buy anything, and have at times gone beyond the traditional purchasing of treasuries
  21. 22. Conversely, it can only sell what assets it has. </li></ul></ul>
  22. 23. Interest Rates <ul>But wait! Aren't people always talking about the Fed increasing or lowering ”interest rates” or ”the interest rate”? Are they making things up? Am I making things up? Am I just stupid? </ul>
  23. 24. The Federal Funds Rate <ul><li>The interest on very short term, overnight loans that banks make to one another is called the Federal Funds Rate .
  24. 25. The Fed sets a target for the federal funds rate and uses this as a guide to how much money it should take out of or put into the economy.
  25. 26. The Fed sets a lower target when it wants a looser monetary policy, and a higher target when it wants a tighter one. </li></ul>
  26. 27. How it Works in Practice <ul><li>Unlike the Discount Window Rate, the Fed does not set the Federal Funds Rate directly.
  27. 28. When it is higher than they want it to be, they put more money into the economy.
  28. 29. When it is lower than they want it to be, they take more money out of the economy. </li></ul>
  29. 30. That's It! <ul>It's not an exhaustive explanation of what the Fed does all the time, but this presentation should be sufficient to give you a good idea of what the Fed is doing 90% of the time. </ul>
  30. 31. Recommended Further Reading <ul><li>Federal Reserve System , at the Concise Encyclopedia of Economics
  31. 32. Open Market Operations , from the Federal Reserve Website
  32. 33. Monetary Policy , from the Federal Reserve website
  33. 34. Federal Reserve 101 , at my blog Sophistpundit </li></ul>
  34. 35. Image Attribution <ul><li>Federal Reserve Building from Wikipedia
  35. 36. Drive Through Bank Teller from frankh's photostream
  36. 37. Dollar Bill from Wikipedia
  37. 38. Bernanke Action Figure from Commodity Bull Market blog
  38. 39. Percentage Sign from Wikipedia </li></ul>
  39. 40. This work is licensed under a Creative Commons Attribution 3.0 United States License Presentation Created by Adam Gurri