Unit 13 - The Federal Reserve Flashcards
This is the central bank of the United States. It is directed by the FRB.
The Federal Reserve System
What are the most common functions of the FRB?
- Conduct the nation’s monetary policy to promote maximum employment
- Promote a stable price environment, keeping inflation under control
The FRB manages
Money supply: The amount of cash available within the US economy. Also called Monetary policy.
He is considered the founder of monetarism theory
Milton Friedman
This tool help the FRB “read” the economy
Diagnostic Tools
This tool helps the FRB understand what is impacting the economy.
Active Tools
This is the measure of the most readily available money to spend: cash and money in demand deposit accounts (DDA), such as checking accounts. This is the money that is closest to being spent and turned into economic activity.
M1
This consists of M1 plus “consumer savings deposits” - those assets that can easily move to a DDA and spend. These consists of savings accounts, retail CDs, money market funds, and overnight repurchase agreements. M1 is a part of this measure.
M2
This consist of M2 plus “large time deposits” - those assets that are a bit harder to move into a DDA and be spend. Examples include, negotiable (jumbo) CDs and multiday repurchase agreements. M2 is a part of this measure/
M3
What are included in the M3 measure?
- Large-denomination time deposits
- M2: M1 + Consumer savings deposits
- M1: Cash and demand deposits
This influences the money supply by buying and selling US government securities in the open market.
FRB
This committee meets regularly to direct the governments open market operations.
The Federal Open Market Committee
When the Fed wants to expand (loosen) the money supply, it
Buys securities from banks which lowers interest rates
When the Fed wants to contract (tighten) the money supply, it
Sells securities to banks which raises interest rates.
The Fed will do this so securities come out of the economy, and money goes into it. The money supply goes up, interest rates go down, borrowing and spending for consumers is easier and the economy expands.
Buying
The Fed will do this so securities go into the economy, and money comes out. The money supply goes down, interest rates go up, borrowing and spending for consumers becomes more difficult and the economy contracts.
Selling
Under this regulation, the current initial deposit is 50% of the purchase price. If the FRB lowers the initial deposit requirement and allowed more borrowing, the extra cash available would likely raise stock prices. The 50% has been in place since 1974.
Regulation T
Banks that need additional capital to meet their reserve requirement may borrow money from the Federal Reserve System. This is often done through a
Repurchase agreement
This is the interest rate the Fed charges the bank
Discount rate
This is seen as the base rate for the nation. Raising this tends to lift interest rates through the economy; lowering the rate tends to cause rates to drop.
Discount rate
This is the amount a bank must maintain on deposit with the Federal Reserve. Reserves dropping below this number indicate that the bank may have insufficient cash to meet depositor’s demands. Lowering this number frees up cash at the banks to fund loan activity, expanding the economy. Raising this number decreased the amount available for loans. The Fed rarely changes this requirement.
The reserve requirement
The cost of money is called
Interest
____ and ____ of money determines the rate of interest that must be paid to borrow it.
Supply and demand
When the money available for loans exceeds demand, interest rates
Fall
When the demand for money exceeds the supply, interest rates
Rise
This is the rate that the commercial money center banks charge each other for overnight loans of $1 millions or more. It is considered a barometer of the direction of short-term interest rates, which fluctuate constantly and can be considered the most volatile rate in the economy.
Federal funds rate
This is the interest rate that large US money center commercial banks charge their most creditworthy corporate borrowers for unsecured loans. Each bank sets its own rate. Banks lower their rates when the FRB eases the money supply, and they raise rates when the FED contracts the money supply.
Prime Rate
This is the interest rate that banks charge BDs on money they borrow to lend to margin account customers. Margin account allow customers to purchase securities without paying in full. The amount not paid is essentially loaned to the customer by banks and BDs. It is also known as the call loan rate or call money rate. It is usually a percentage point or so above other short term rates.
Broker loan rate
This is the rate the Federal Reserve charges for short term loans to member banks. It indicates the direction of FRB monetary policy - a decreasing rate indicates an easing of FRB policy, and an increasing rate indicated a tightening of FRB policy.
Discount Rate
This is the only rate that is set by a unit of the federal government.
Discount rate
Describe the Ease Money Policy
The expand credit during a recession to stimulate a slow economy
- Buy US government securities in the open market
- Lower the discount rate
- Loew the reserve requirements
Describe the Tight Money Policy
To tighten credit to slow economic expansion and prevent inflation
- Sell US government securities in the open market
- Raise the discount rate
- Raise reserve requirements
