The Federal Reserve

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The Federal Reserve

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Lecture Note
University of Texas at Austin
Fin 320f - Foundations of Finance

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Lecture 5 Outline of Current Lecture  Responsibilities of the Fed  Monetary Policy  Reserve requirement  Discount rate  Market operations  Treasuries Current Lecture  The Federal Reserve System • Controlled by 7-member Board of Governors  Appointed by the US President to staggered 14-year terms; confirmed by the Senate  Current Chairman is Janet Yellen  Former Chairman is Ben Bernanke  Responsibilities of the Fed • Regulate depository institutions: to protect depositors from poor financial management • Serve the banking industry: check clearing services, loans, worn bill replacement, etc. • Hold US Treasury’s checking account: tax receipts are deposited; expenses withdrawn • Conduct monetary policy: that is, control the US money supply  How the Fed conducts monetary policy • Option 1: Change the reserve requirement • The reserve requirement determines the percentage of deposits that banks are allowed to lend • Reserve requirements are rarely changed • By decreasing the reserve requirement, the Fed increases banks’ capacity to lend (thus to “create” money)  Example: Today the reserve requirement is 10%  For every $100 on deposit, banks can lend $90  Now assume the Fed lowers the reserve requirement to 5%  Banks can lend $95 of every $100 on deposit  More money is lent; thus, more money is in circulation (more money has been “created”)  Decreasing reserve requirements serves to increase the money supply • Option 2: Change the discount rate • This is the rate the Fed charges banks when banks borrow money to meet temporary shortages in required reserves • Rose from 6.5% in 1978 to 13% in 1980; currently 0.75% per year FIN 320F

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