Key Concept and Functions of the FED

Functions of the FED: 

• Presidential appointment
• Issues paper money
• Sets Reserve Requirements and holds reserves of the bank
• Lends money to the banks and charges them interest
• Check clearing service for banks
•  Acts as personal bank for the government
• Supervises member banks
• Controls the Money Supply

·         Reserve Requirement - Only a small % of your bank deposit is in the safe. The rest of your money has been loaned out. 

·         Fractional Reserve Banking- FED sets amount banks must hold -RR is the % of deposits that banks must hold in reserve and NOT loan out –

·         FED increases the MS by increases in the amount of money held in bank deposits

                                   

• Recession- what should FED do to RR?
•  Decrease the RRatio, banks hold less money which means more ER.
• Banks create more money loaning out excess MS increases, interest rate fall, AD increases
• Inflation-
• Banks hold more money which  measn less ER
• Banks create less money MS decreases, interest rate increases, AD decreases 
• Discount Rate - is the interest rate that the FED charges commercial banks
• To increase the MS, the FED should decrease the discount Rate (Ex:Monetary Policy)
• To decrease the MS, the FED should increase the Discount Rate (Ex:Tight Money Policy)

Open Market Operations (OMO)

• FED buys/sells gov't bonds (securities)
• This is money important and widely used monetary policy
• Increase the MS- FED should BUY government securities
• Decrease the MS- FED should SELL government securities