Chapter 16 Section 2

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Chapter 16 Section 2

• Functions of the Federal Reserve

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Functions of the Federal Reserve

• Lending Money
• Banks often lend to each other on short-term
  basis
• In natural disaster, all banks in region lack
  cash flow
• Fed lends to banks with enough assets and capital
  to qualify
• Small banks with seasonal cash flow needs may
  borrow from Fed
• Fed serves as lender of last resort to prevent
  banking crisis

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Functions of the Federal Reserve

• Regulating and Supervising Banks
• Fed banks supervise state-chartered members, bank
  holding companies
• bank holding company owns, has controlling
  interest in several banks
• Fed banks enforce truth-in-lending laws
• Conduct bank examsaudit financial practices of
  banks in district
• Monitor bank mergers to ensure competition

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Serving the Federal Government

• KEY CONCEPTS
• Fed serves as federal governments banker
• helps carry out taxation and spending activities

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Serving the Federal Government

• Service 1 Paying Government Bills
• Tax revenues are deposited with the Fed
• Fed issues checks, makes electronic payments via
  U.S. Treasury
• for transfer payments, employee wages, direct
  spending, tax refunds
• deducts amounts from governments account
• Processes postal money orders, food stamps

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Serving the Federal Government

• Service 2 Selling Government Securities
• Fed processes U.S. savings bonds, auctions other
  securities
• provides information, collects payment, credits
  funds, delivers bonds
• Pays interest on bonds
• Federal Open Market Committee (FOMC) supervises
  sales of securities
• purpose is to stabilize the economy

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Serving the Federal Government

• Service 3 Distributing Currency
• Federal Reserve notes are official paper currency
  of U.S. fiat money
• Treasury Department prints notes that go to Fed
  district banks
• Fed banks distribute notes to depository
  institutions in amounts needed
• currency then goes to people and businesses
• Fed also distributes coins produced by U.S. Mint

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Creating Money

• Creating moneyhow money enters circulation
  through deposits, loans
• Fed establishes required reserve ratio (RRR) for
  banks
• fraction of banks deposits that it must keep in
  reserve
• Reserve may be stored as cash in banks vault or
  deposited with Fed

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Creating Money

• Example Money Creation
• Banking system creates money whenever banks get
  deposit and make loan
• Level of the RRR determines how much money may be
  loaned
• Money supply increases by total loans made after
  initial cash deposit
• deposit multiplier formula tells how much money
  supply will increase

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Questions

• Why might the Fed help a small bank in an
  agricultural region stabilize its cash flow?
• How are the banking services the fed provides to
  the government similar to the services it
  provides to banks?
• If the Fed raised the RRR from 10 to 12, how
  would it affect the money supply?
• You have been planning your college finances and
  you know that youll have to take a bank loan to
  cover tuition costs. You read that the Fed
  intends to raise the RRR rate from 10 to 20.
  How will this change affect the money supply and
  your ability to borrow money for college tuition?