Okay, we're going to start Unit 8, Lesson 1 with the Federal Reserve. So the  Federal Reserve System was formally established as an act of Congress on  December 23, 1913 called the Federal Reserve Act. The stated purpose of the  act was to provide the establishment of the Federal Reserve Banks to furnish an elastic currency, which means the ability to expand the money supply or contract the money supply as they needed to, to afford means of re-discounting  commercial paper to establish a more effective supervision of banking in the  United States and for other purposes. 

All right, so the Federal Reserve System is built around a seven-member board  of governors together with 12 regional banks. The members of the board are  appointed by the President and approved by Congress to serve for 14 years.  The FOMC, which is the instrumental, which is instrumental in the conduct of  monetary policy has 12 members. 

Although the President and Congress play a role in the appointment of members of the Fed, their direct control stops there. The Fed is an independent body. The  executive and congressional branches of the government have no formal input  into the determination of monetary policy. 

So the Fed acts as an independent body from the government. It controls the  monetary and money supply, controls interest rates by itself as an unbiased  independent body. So it cannot be influenced by politics or lobby money, things  of that nature. 

So it's an independent, you know, board that is put together and appointed by  the President and Congress. They are appointed, approved, they are put on the  board, and they are independent of the Congress and the government and the  executive branch, and therefore that allows them to have some autonomy and  no political pressure on how to implement monetary policy. Congressional  control is limited to the fact that the chair of the Fed is required to report to  Congress periodically, and to Congress eventually having the power to change  the laws governing the Fed's conduct. 

The goals of the Fed are specified in the section of the Monetary Reserve Act  titled Monetary Policy Objectives. The Board of Governors of the Federal  Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the  economy's long-run potential to increase production. So as to promote  effectively the goals of maximum employment, stable prices, and moderate long term interest rates.

So they want to control the monetary supply and the overall condition of the  market with consistent monetary policy, contracting or expanding the money  supply, contracting or expanding interest rates in order to control inflation,  employment rates. You know, sometimes the economy can heat up too fast and, you know, you want to put a damper on it so that we don't, you know, have a  huge buildup and then see a big crash underneath it. That happens a lot of  times when you see markets get too hot. 

So the Federal Reserve really wants to be the oversight of the market and the  market conditions and be able to control it by, you know, contract and expand  policies. These objectives provide guidance to the Fed. It is required to pay  attention to the level of economic activity or maximum employment and the level of inflation, which represents stable prices. 

Exactly how the Fed promotes these goals and chooses among them is  necessary, if necessary is not specified. In some cases, the different aims of the  Fed may conflict. For example, promoting employment may not be consistent  with low inflation. 

So if they want to heat the economy up and they want to have, you know,  employment gain ground or they want to, you know, gain on unemployment,  they want to reduce the unemployment rate, you know, that's going to heat the  economy up because you have to expand the economy in order to grow jobs  and that's going to cause the economy to heat up. So when the economy heats  up, asset prices go up, which means the price of anything that you have or own  a house, a car, food, gas, et cetera, those will inflate. Asset prices have no  choice but to go up when, you know, the economy is growing. 

So the quicker that those prices go up, you know, that's going to put pressure on inflation figures, right? They're going to put in place, you know, the inflation will  go up, prices will inflate as the economy heats up. The Fed is responsible for  controlling that with interest rates. So if the economy heats up too, too fast and  it's starting to really grow at a quick level, you know, in order for most  businesses to grow at a rapid rate, they have to go to banks and borrow cash. 

So when they borrow the cash, there's an interest rate attached to that cash that they borrow. So banks have to stay consistent with what the Federal Reserve  puts out there as this is the marginal interest rate that we charge on these loans. 

So if the Federal Reserve raises the interest rates, right, for their baseline level  for what they require banks to charge, right, then that's going to diminish the  demand or the desire by companies to borrow money because as interest rates 

go up, you know, the amount of money they have to pay back on those loans  also goes up. 

So if, you know, if the economy heats up too fast, interest rates go up, then, you  know, businesses will contract or, you know, not grow as fast. So therefore,  that'll be able to meet the expectations for employment and inflation. So they  control the employment and inflation through interest rates. 

And interest rates allows the economy to contract and expand. The lower the  interest rate is, the more willing people are going to want to go out there and  borrow. The higher the interest rate, the less willing people are going to want to  go out there and borrow money. 

So through interest rates, the Federal Reserve controls how the economy  contracts and expands. So okay, the Fed has three main ways of affecting what  goes on in the economy. The first is called open market operations and  represents the main way that the Fed influences interest rates. 

A second tool, the discount rate, was mentioned explicitly in the policy  announcement. You can go back and read that. The third tool, reserve  requirements, the amount of funds that a depository institution must hold in  reserve against the specified deposit liabilities. 

Within limits specified by law, the Board of Governors has sole authority over  changes in reserve requirements. Depository institutions, which are regular  banks and commercial banks, must hold reserves in the form of vault cash or  deposits with the Federal Reserve. So let's just kind of explain that a little bit  more. 

You know, there's a reserve requirement that the Federal Reserve has on each  bank. There's a commercial bank that is a depository institution that we can walk into and deposit cash. There is a percentage of their deposits that must be left  with the Federal Reserve. 

So if their deposits go up, they have to take a piece of that cash that has been  deposited into their bank and leave it with the Federal Reserve. That gives them  some flexibility on, you know, the Federal Reserve not only sets interest rates,  they also buy assets. They buy stocks. 

They buy bonds. They buy government treasuries. They are an independent  institution.

They are not a part of our government. So they also hold assets along with, you  know, maintaining the market through interest rates, through employment policy, and through inflation policy. 



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