Banking Today

Federal Reserve System

• Created in 1913

• First CENTRAL BANK

- can loan money to other banks

• Privately owned by member banks but publicly controlled by government

• Issues Federal Reserve Notes

Board of Governors, Federal Reserve System

Constitution Avenue, Washington, D. C.

Alan Greenspan

BYE BYE!

January 2006

Ben Bernanke

Congress:

Spends & Taxes

Runs a Deficit:Deficit = G - T

The US Treasury:

Finances the Deficit by issuing T-bills.

A T-bill is an I.O.U.

The Federal Reserve:

Buys and Sells T-bills from commercial banks as a means of changing the level of bank reserves and hence changing the money supply.

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FDIC

• Federal Deposit Insurance Corporation

- Insures individuals bank deposits up to

$100,000.

M = C + D

The Money Supply

Where C is currency and coin

And D is checking account balances

M = C + D

The Money Supply

C = is currency and coin

Currency is produced by the Bureau of Engraving and Printing:

Washington, D. C., and Fort Worth

M = C + D

The Money Supply

C = is currency and coin

Coins are produced by the U.S. Mints:

Philadelphia and Denver

San Francisco and West Point

WHAT’S A TREASURY BILL

A treasury bill is an IOU (“I owe you”) issued by the US Treasury. It’s the federal government’s way of borrowing funds.

The face value of the bill is its maturity value. On the date of issue, the bill sells at a discount. That is, it sells for a price (less than its maturity value) as determined by prevailing market conditions.

Open Market Operations“Open Market Operations” is a term that refers to the Fed’s buying Treasury bills from commercial banks as a means of directly increasing the level of reserves.

Treasury bills in the portfolio of a commercial bank represent “funds lent out.” That is, when the bank bought the Treasury bill (i.e., the IOU) from the Treasury, it lent funds to the Treasury.

When the Fed buys the Treasury bill from the bank, it replaces “funds lent out” with Reserves, which enables the bank to engage in further lending.

WHAT’S A TREASURY BILL

I.O.U. $10,000 ONE YEAR FROM TODAY

Tim Geithner

I.O.U. $10,000 ONE YEAR FROM TODAY

Tim Geithner

Suppose the treasury bill sells in the market for $9,090.90.

What rate of interest would the buyer of that treasury bill earn?

i = (10,000 – 9,090.90)/ 9,090.90 = 0.10 or 10%

Now suppose that the Fed buys T-bills, driving their price up to $9,523.80.

So, now what rate of interest would the buyer of that treasury bill earn?

i = (10,000 – 9,523.80)/ 9,523.80 = 0.05 or 5%

I.O.U. $10,000 ONE YEAR FROM TODAY

Tim Geithner

The Federal Reserve’s buying of Treasury bills has an effect on the rate of return that holders of those bills receive.

More significantly, the Fed’s buying of T-bills has a direct effect on the total amount of bank reserves and hence on the interest rate (the federal-funds rate) at which banks can borrow from one another.

The Fed can increase the money supply by by buying T-bills, and can gauge the magnitude of the increase by watching the federal funds rate.

Printing Money and Spending it.The Federal Reserve

And the Money Supply