1

SenateHouse

53Democrats45Republicans2 independent(Vice-president votes in case of a tie)

200 Democrats232 Republicans0 Independent

100 Senators17 women

435 Members78 women

Interactive journey through the Federal Reserve: Fed 101

2

3

Ben S. Bernanke, Board of Governors, Chairman William C. Dudley, New York, Vice Chairman James Bullard, St. Louis Elizabeth A. Duke, Board of Governors Charles L. Evans, Chicago Esther L. George, Kansas City Jerome H. Powell, Board of Governors Sarah Bloom Raskin, Board of Governors Eric S. Rosengren, Boston Jeremy C. Stein, Board of Governors Daniel K. Tarullo, Board of Governors Janet L. Yellen, Board of Governors

4

President reviews requests for funding and formulates his budget

February–December 2009

Budget preparation and transmittal to Congress

December 2009 -February 2010

Congress reviews President’s budget develops its own budget for the president to sign.

March– September 2010

Fiscal Year beginsOctober first 2010

Agency program managers execute the budget.

October 1st 2010 – September 30, 2011

From February

2009 when the decision is made….

To October 2010 when the

actual spending takes

place!.

Profits of each Federal Reserve Bank are distributed to the U.S. Treasury.

The Federal Reserve paid ~$78.4 billion of their estimated 2010 net income of $80.9 billion to the U.S. Treasury.

5

6

The Government and Congress

The Federal Reserve Bank

Changing taxes and spending

Changing credit conditions in the economy.

The Federal Reserve SystemCreated on December 23,

1913 by an Act of Congress.

District Banks are owned by member banks in the district.

District Banks are owned by member banks in the district.

Board of Governors (7)

Federal Open Market

Committee (FOMC) (5)

4 bank presidents and President of the New York Fed

4 bank presidents and President of the New York Fed

12 Regional Bank

Presidents

(7+5)

Members are appointed by the President and confirmed by the senate to 14 year terms.

Chairman and Vice-chairman are appointed by the president and confirmed by the senate to 4 year terms.

The president is directed by law to select “a fair representation of the financial, agricultural, industrial and commercial interests and geographical divisions of the country” 10

Board of

Governors (7)

12 Regio

nal Banks

Federal Open

Market Committee (FOMC)

(7+5)

Janet L. Yellen: Chairman

(7)Members of the Board of Governors of the Federal Reserve System Appointed by president confirmed by senate

(1)President of the Federal Reserve Bank of New York.

(4) On a rotating basis: presidents of the eleven other reserve banks. Appointed by the board of directors of each

bank.

Since January 10, 2000 the FOMC issues a statement on its assessment of risks to stability in the foreseeable future.

Minutes are available after the next regularly scheduled meeting.

In the 1990s after pressure from Congress, the Fed began releasing transcripts of its interest-rate deliberations after a five year lag.

12

Fiscal Policy makers

Democratically elected More than 500

representatives from different states and political inclinations.

Fiscal Policy decisions are debated and made open to the public.

Monetary policy makers

Not Democratically elected but appointed for 14 years!

12 members all tied to financial institutions.

Monetary Policy decisions are not debated, nor are they open to the public.

13

Decisions are made

very slowly

Decisions can be made quickly to

respond to the day to day

events as they develop.

Stabilize the business cycle: Promote economic growth, full employment, stable prices and sustainable international trade.

Supervise and regulate financial institutions. The Constitution gives Congress the power

"to coin money and regulate the value thereof." Congress delegated that power to the FED

when it created the central bank in 1913 Serve as the bank for the U.S. government

14

15

Goldsmith

Certificate = 5 gold pieces

16

Goldsmith

Certificate = 5 gold pieces

Loan = 1 gold piece

Loan = 1 gold piece

Loan = 1 gold piece

Loan = 5 gold pieces

Loan = 5 gold piece

Loan = 5 gold pieces

Loan = 5 gold pieces

17

First National Bank

Your deposit$20,000

The bank makes loans and holds a portion as reserve in vault.

$5,000

$5,000

2,000Reserve

loans

$8,000

Real Money

Bank A

Loan

Loan

Loan

Loan

Loan $

$ $

Loan = 1 gold piece

Loan = 1 gold piece

Loan

Loan

Loan

Loan

Loan

Bank B

Deposit

Deposit

Deposit

Deposit

Deposit

Bank D

Deposit

Deposit

Deposit

Deposit

Deposit

Loan = 1 gold piece

Loan = 1 gold piece

Loan

Loan

Loan

LoanBank

C

Deposit

Deposit

Deposit

Deposit

Deposit

Your deposit

= Money

Now you and other three individuals can write checks up to:

19

20,0005,0005,0008,000

38,000

The bank holds only 2,000

If all these payments must be made at the same time, the bank does not have enough in reserves.

Only 2,000 “support” 38,000 in spending!

Banks allow several individuals to write checks on the same amount of money…

20

Lending Create Money

out of thin air…

21

M1: Most liquid

1,785Billion

M2:less liquid8,752 Billion

Currency (904b)Travelers checks (5b)Demand deposits at banks(495b)Other demand deposits (386b)

M28,752 Billion

M11,785B

Nominal GDP ~ 14,000Billion

Velocity of money: Number of times a dollar bill is

used

M1+Savings deposits Money market deposit accountsSmall time deposits

Dollar value of what we boughtDollar value of

what we boughtNumber of dollars in

circulation

Number of dollars in

circulation

Velocity = Nominal GDP/M1

V = 14,000/1,785 =~ 8Each dollar was used ~ 8

times during the year

The fed considers money only the most ‘liquid’ assets

23

24

+All Commercial Banks

Demand Deposits at

banks

Ms = Currency held outside banks + Demand DepositsThe amount of money in circulation is the Money Supply

25

If r = 10%Loans = 90% of

Deposits

If r = 20%80% of

Deposits

A bank

r

26

These loans become deposits at another bank

(r)

Real Money

Bank A

Loan

Loan

Loan

Loan

Loan $

$ $

Loan = 1 gold piece

Loan = 1 gold piece

Loan

Loan

Loan

Loan

Loan

Bank B

Deposit

Deposit

Deposit

Deposit

Deposit

Bank D

Deposit

Deposit

Deposit

Deposit

Deposit

Loan = 1 gold piece

Loan = 1 gold piece

Loan

Loan

Loan

LoanBank

C

Deposit

Deposit

Deposit

Deposit

Deposit

Your deposit

D

R = D*rR = D*rL =

D-R

L =

D-R

R = D*rR = D*rL =

D-R

L =

D-R

L =

D-R

L =

D-R

R = D*rR = D*r

R = D*rR = D*r

28

Reserves59

Depositsall banks

590

Loans531

59 in reserves allow banks up to 531 in loans

New loans are made.

As loans are paid back,

r = 10%r = 10%

R = D x r

L=D-R

R = 590 x 0.1R = 590 x 0.1

04/19/23© 2002 Claudia Garcia-Szekely

29

Why is secrecy necessary in banking?

30

531B

There are only $59B in banks’ reserves supporting $590B in deposits…if everyone tries to cash $590 at the same time there

is NOT enough money for everyone…

In a business based on confidence, when that

confidence evaporates, so does

the business.

In a dramatic meeting on September 18, 2008, Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke met with key legislators to propose a $700 billion emergency bailout.

Bernanke told them: "If we don't do this, we may not have an economy on Monday.“

The Emergency Economic Stabilization Act, which implemented the Troubled Asset Relief Program (TARP), was signed into law on October 3, 2008

31

By providing these loans to banks, the government expects banks to make loans to the public

32

Bank A

Loan

Loan

Loan

Loan

Loan $

$ $

Loan = 1 gold piece

Loan = 1 gold piece

Loan

Loan

Loan

Loan

Loan

Bank B

Deposit

Deposit

Deposit

Deposit

Deposit

Bank D

Deposit

Deposit

Deposit

Deposit

Deposit

Loan = 1 gold piece

Loan = 1 gold piece

Loan

Loan

Loan

LoanBank

C

Deposit

Deposit

Deposit

Deposit

Deposit

All Banks Deposits=8

00

All Banks Deposits=8

00

Bank A

Loan

Loan

Loan

Loan

Loan $

$ $

Loan = 1 gold piece

Loan = 1 gold piece

Loan

Loan

Loan

Loan

Loan

Bank B

Deposit

Deposit

Deposit

Deposit

Deposit

Bank D

Deposit

Deposit

Deposit

Deposit

Deposit

Loan = 1 gold piece

Loan = 1 gold piece

Loan

Loan

Loan

LoanBank

C

Deposit

Deposit

Deposit

Deposit

Deposit

TARP 700BTARP 700B

Bank A

Loan

Loan

Loan

Loan

Loan $

$ $

Loan = 1 gold piece

Loan = 1 gold piece

Loan

Loan

Loan

Loan

Loan

Bank B

Deposit

Deposit

Deposit

Deposit

Deposit

Bank D

Deposit

Deposit

Deposit

Deposit

Deposit

Loan = 1 gold piece

Loan = 1 gold piece

Loan

Loan

Loan

LoanBank

C

Deposit

Deposit

Deposit

Deposit

Deposit

700700

700(0.9

)

700(0.9

)700(0

.9)

(0.9

)700(0

.9)

(0.9

)

700(0.9

)(0.0

)

(0.9

)

700(0.9

)(0.0

)

(0.9

)

TARP 700BTARP 700B

700(0.9

)

700(0.9

)

700(0.9

)

(0.9

)700(0

.9)

(0.9

)

700(0.9

)(0.0

)

(0.9

)

700(0.9

)(0.0

)

(0.9

)

700700

700(0.9

)

700(0.9

)

700(0.9

)

(0.9

)700(0

.9)

(0.9

)

700(0.9

)(0.0

)

(0.9

)

700(0.9

)(0.0

)

(0.9

)

40

1r D = x Original

Injection

1

r D = x New

Reserves

1

r D = x R

Money

Multiplier

Multiple by which deposits increase for every $1 increase in

reserves

41

1

0.1 D = x 700

L = D - R

Increase in Deposits = 7,000Of these 7,000 in newly created deposits, only

700 is “real reserves” and the rest6,300 are loans: money that does not exist.

L = 7,000- 700 = 6,300

How many loans were created?

Fed injects $700, banks create

$6,300 out of thin air…

Loans generate additional bank deposits causing an increase in the Money Supply:

The increase in the money supply ( Ms) is:

The increase in Deposits + increase in the amount of currency held by the public.

42

Ms = deposits + currency outside banks

Ms = Currency + Deposits

43

Deposits

Bank OWNS

Loans

Reserves

Bank OWESAssets Liabilities

Capital = Assets - Liabilities

All BanksDeposits

D=800bd1= 200bd2= 180bd3=120bd4= 130bd5= 170b

Ms = Currency held outside banks + Demand Deposits(900b) (800b)(1,700b)

900b

7,800b

8,700b)

+1,000

D= 800 + 7,000

New Money

700

+2,000

+2,000+2,000

Ms = Currency held outside banks + Demand Deposits(900b) (800b)(1,700b)

46

In our story, the original 700B deposit would set in motion a chain of loans and deposits at several banks…

What if part of the loans are kept as “cash” and only part of it becomes another deposit at a bank?

The deposit expansion will be smaller than (1/r )*R

The multiplier: 1/r is the same…but

there will be less money for banks to multiply.

Required Reserves (RR). The amount that must be held by law, the required reserve ratio times deposits:

RR = r(D) Actual Reserves (AR). The amount of

reserves actually held by the bank. This could be higher or lower than RR.

Excess Reserves(ER). Any amount held above required reserves.

47

In our story, banks kept ONLY required amount of reserves (r%)

What if one or more banks in the chain hold more reserves than required?

The deposit expansion will be smaller than (1/r )*R

1. The amount of Excess Reserves held by banks.2. Currency leak: loans leaking into currency held

outside banks

49

The Money Multiplier (1/r)

Gives the largest change in deposits that can occur if there is no currency leak no excess reserves.

All BanksDeposits

D=600b

d1= 100bd2= 80bd3=120b

d4= 130bd5= 170b

When checks are used to make a payment, the money simply changes “owner”

Only new money is multiplie

d!

The reward for those who give up spending today in order to spend tomorrowThe cost paid by those who want/need to spend today money they will make in the futureThe return the bank earns on a loan

51