Return

This lesson focuses on the January 26, 2011, press release by the Federal Reserve System's Federal Open Market Committee (FOMC) on the current Federal Reserve monetary policy actions and goals. Specifically, the lesson reports the target rate for the federal funds rate. This lesson is intended to guide students and teachers through an analysis of the actions the Federal Reserve is taking and can take in influencing prices, employment, and economic growth. Through this lesson, students will better understand the dynamics of the U.S. economy, current economic conditions, and monetary policies.

KEY CONCEPTS

Business Cycles, Discount Rate, Federal Reserve, Federal Reserve Structure, Macroeconomic Indicators, Monetary Policy, Open Market Operations, Recession, Reserve Requirements

STUDENTS WILL

  • Explain the meaning of the January 26, 2011, Federal Open Market Committee decision concerning the target for the federal funds rate.
  • Identify the current monetary policy goals of the Federal Reserve and the factors that have recently influenced monetary policy goals.
  • Explain the structure and functions of the Federal Reserve System, Federal Reserve banks, and the Federal Open Market Committee.
  • Identify the monetary policy options and other tools available to the Federal Reserve to stimulate or contract the economy.

Current Key Economic Indicators

as of May 5, 2013

Inflation

On a seasonally adjusted basis, the Consumer Price Index for All Urban Consumers decreased 0.2 percent in March after increasing 0.7 percent in February. The index for all items less food and energy rose 0.1 percent in March after rising 0.2 percent in February.

Employment and Unemployment

Total nonfarm payroll employment rose by 165,000 in April, and the unemployment rate was little changed at 7.5 percent. Employment increased in professional and business services, food services and drinking places, retail trade, and health care.

Real GDP

Real gross domestic product increased at an annual rate of 2.5 percent in the first quarter of 2013 (that is, from the fourth quarter to the first quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the fourth quarter, real GDP increased 0.4 percent.

Federal Reserve

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent...

INTRODUCTION

The Federal Open Market Committee (FOMC) of the Federal Reserve System (Fed) meets approximately every six weeks to determine the nation's monetary policy goals and, specifically, to set the target for the federal funds rate (fed funds rate). The fed funds rate is the interest rate at which banks lend their balances at the Federal Reserve to other banks, usually overnight.

The FOMC has maintained the target federal funds rate at a range of 0 to 1/4 percent since its December 16, 2008 meeting.  The fed funds rate has been kept at this historically low level due to a long period of low and often negative real GDP growth, significant numbers of non-farm employment losses, and a high unemployment rate.

This lesson focuses on the January 26, 2011, press release by the Federal Open Market Committee on the current Federal Reserve monetary policy actions and goals.

[Note: In the second semester of the 2010-2011 school year (January-May), there will be three Focus on Economic Data lessons regarding the Federal Reserve and Monetary Policy. In addition to reporting the most recent FOMC decision, this focus on economic data will include an introduction to the structure and functions of the Federal Reserve System, the FOMC and monetary policy tools.

Lessons about the scheduled March 15 and April 26-27 FOMC meetings, will address more specific issues of Fed policy tools, policy options, and new Fed programs to counter recessionary pressures and the current financial market problems.

On occasion, the FOMC holds unscheduled face-to-face or conference call meetings to make more timely policy decisions in response to unusual economic events or conditions.  The policy decisions made as a result of any of these unscheduled meetings will be included in the lesson on the next scheduled meeting.]

MATERIALS


Key Economic Indicators

as of January 26, 2011

Inflation

The U.S. Consumer Price Index for All Urban Consumers (CPI-U) increased 0.5 percent in December on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.5 percent before seasonal adjustment.

Employment and Unemployment

The U.S. unemployment rate fell by 0.4 percentage point to 9.4 percent in December, and non-farm payroll employment increased by 103,000. Employment rose in leisure and hospitality and in health care but was little changed in other major industries.

Real GDP

Real gross domestic product increased at an annual rate of 2.6 percent in the third quarter of 2010, according to the "third" estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 1.7 percent.

Federal Reserve

The FOMC will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.

PROCESS

U.S. Monetary Policy - January 26, 2011

The purpose of the Federal Reserve System's Federal Open Market Committee (FOMC) is to undertake monetary policy actions to "influence the availability and cost of money and credit to help promote national economic goals."  The FOMC meets approximately every six weeks to review and recommend monetary policy goals and actions.

The nation's overall economic goals, as established by the "Employment Act of 1946," are to "promote maximum employment, production, and purchasing power."  Monetary policies are intended to achieve these goals.  The Federal Reserve Act of 1913 had previously given the Federal Reserve responsibility for establishing monetary policy.

Take a look at the FOMC's January 26, 2011, monetary policy announcement for a better understanding of the current health and future prospects for the U.S. economy

[Teacher Note: An overview of the Federal Reserve and monetary policy is included in this lesson after comments on the current FOMC monetary policy actions.  For details about the FOMC, go to: www.federalreserve.gov/monetarypolicy/fomc.htm .]

Federal Open Market Committee Monetary Policy Press Release

Released: January 26, 2011

"Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, while investment in nonresidential structures is still weak. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Although commodity prices have risen, longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward."

The first paragraph of many recent FOMC announcements has begun, "Information received since the Federal Open Market Committee met in..."  Since each announcement may signal a change in policy since the last meeting, the any economic changes since that meeting are the focus of the FOMC's policy decision. In this case, the FOMC specifically cited employment, income growth, housing wealth and credit.  The good news - very low inflation.

Next, the FOMC provided a rational for its policy decision, based on its Congressional mandate.  The focus was on persistently high unemployment.

"Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow."

"To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability."

In November, 2010, the Fed announced a plan to purchase $600 billion in securities in order to increase liquidity in financial markets and stimulate the economy.  Though this plan has critics, the Fed has stuck with the strategy.

"The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period."

No change in the federal funds rate.  Given the FOMC's rationale and dim view of the economic recovery, the low interest rate policy makes sense.  The federal funds rate has been at this historic low (o to 1/4 percent) since 2008.  At the end, the FOMC, as usual, left their options open, should economic conditions change.

"The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate."

[Teacher Note:  Students can read the FOMC announcement from the FOMC webpage  . It may be more interesting and effective to read it from the original source  Note the careful use of language by the FOMC.  In several week, the minutes of the September 21 meeting will be released.  The minutes often explain the points of agreement and disagreement among the committee.]

Link: www.federalreserve.gov/newsevents/press/monetary/20110126a.htm

The FOMC has nine members.   The vote on the January 26, 2010 announcement was unanimous.  Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

In summary, this announcement was very similar to those of the FOMC meetings over the past year and a half, since the end of the recession.   Keep interest rates low, provide greater liquidity, and keep an eye out for any changes in economic conditions. 

Introduction to The Federal Reserve System, the FOMC, and Monetary Policy

The Federal Reserve System was created by Congress in 1913 "to provide the nation with a safer, more flexible, and more stable monetary and financial system." It is a federal system, composed of a central, governmental agency, the Board of Governors, in Washington, D.C., and twelve regional Federal Reserve Banks, located in major cities throughout the nation.

[Teacher Note: Much of the following is summarized from the Federal Reserve publication: "The Federal Reserve System: Purposes and Functions ," which is available online.]

The Federal Reserve’s duties fall into four general areas:

  1. Conducting the nation’s monetary policy by influencing monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates.
     
  2. Supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers.  
     
  3. Maintaining the stability of the financial system and containing systemic risk that may arise in financial markets.
     
  4. Providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation’s payments system.

A Brief History of Central Banks

Most developed countries have a central bank whose functions are broadly similar to those of the Federal Reserve. The oldest, Sweden’s Riksbank, has existed since 1668 and the Bank of England since 1694. Napoleon I established the Banque de France in 1800, and the Bank of Canada began operations in 1935. The German Bundesbank was reestablished after World War II and is loosely modeled on the Federal Reserve. More recently, some functions of the Banque de France and the Bundesbank have been assumed by the European Central Bank, formed in 1998.

The Creation of the Federal Reserve System

During the nineteenth century and the beginning of the twentieth century, financial panics plagued the nation, leading to bank failures and business bankruptcies that severely disrupted the economy. The failure of the nation’s banking system to effectively provide funding to troubled depository institutions contributed significantly to the economy’s vulnerability to financial panics. After the crisis of 1907, Congress established a commission and institution that would help prevent and contain financial disruptions.

Congress passed the Federal Reserve Act in “to provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of re-discounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.” President Woodrow Wilson signed the act into law on December 23, 1913.

The twelve regional Federal Reserve Banks and their Branches carry out a variety of System functions, including operating a nationwide payments system, distributing the nation’s currency and coin, supervising and regulating member banks and bank holding companies, and serving as banker for the U.S. Treasury. The twelve Reserve Banks are each responsible for a particular geographic area or district of the United States. Each Reserve District is identified by a number and a letter. Besides carrying out functions for the System as a whole, such as administering nationwide banking and credit policies, each Reserve Bank acts as a depository for the banks in its own District and fulfills other District responsibilities.

Federal Reserve Bank Districts
District
Number
District
Letter

Location

   1    A    Boston, Massachusetts
   2    B    New York, New York
   3    C    Philadelphia, Pennsylvania
   4    D    Cleveland, Ohio
   5    E    Richmond, Virginia
   6    F    Atlanta, Georgia
   7    G    Chicago, Illinois
   8    H    St. Louis, Missouri
   9    I    Minneapolis, Minnesota
   10    J    Kansas City, Missouri
   11    K    Dallas, Texas
   12    L    San Francisco, California


[Teacher Note:  Students should know which Federal Reserve District bank serves their school's area.  Look at the Federal Reserve System map .]

The Twelve Federal Reserve Districts

The Federal Reserve Board of Governors

The seven members of the Board of Governors are appointed by the President and confirmed by the Senate to serve 14-year terms of office. Members may serve only one full term, but a member who has been appointed to complete an unexpired term may be reappointed to a full term. The President designates, and the Senate confirms, two members of the Board to be Chairman and Vice Chairman of the Federal Reserve, for four-year terms.

The current chairman of the Federal Reserve is Ben S. Bernanke, Ph.D. Dr. Bernanke was sworn in on February 1, 2006, as Chairman and a member of the Board of Governors of the Federal Reserve System. Dr. Bernanke also serves as Chairman of the Federal Open Market Committee. He was appointed as a member of the Board to a full 14-year term, which expires January 31, 2020, and to a four-year term as Chairman.  He was reappointed for four years as chairman, as of February 1, 2010. Before his appointment as Chairman, Dr. Bernanke had been Chairman of the President's Council of Economic Advisers, from June 2005 to January 2006. 

The Federal Open Market Committee (FOMC)

An important component of the Federal Reserve System is the Federal Open Market Committee (FOMC), which is made up of the members of the Board of Governors, the president of the Federal Reserve Bank of New York, and presidents of four other Federal Reserve Banks, who serve on a rotating basis. The FOMC oversees open market operations, which is the main tool used by the Federal Reserve to influence money market conditions and the growth of money and credit. Traditionally, the Chairman of the Board of Governors serves as the Chairman of the FOMC. 

[Teacher note:  What do your students think is the rationale for the mix of voting members on the FOMC - seven FRB Governors, the NY Fed president and four other reserve bank presidents?  Some have a "national" view and others represent regional views. It is important that these perspectives all be represented and that economic power not be too concentrated  or too dispersed.

From the Fed webpage: "The Federal Open Market Committee (FOMC) consists of twelve members--the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis. The rotating seats are filled from the following four groups of Banks, one Bank president from each group: Boston, Philadelphia, and Richmond; Cleveland and Chicago; Atlanta, St. Louis, and Dallas; and Minneapolis, Kansas City, and San Francisco. Nonvoting Reserve Bank presidents attend the meetings of the Committee, participate in the discussions, and contribute to the Committee's assessment of the economy and policy options."]

Federal Reserve Policy Tools

The Federal Reserve implements monetary policy through its control over the federal funds rate, the rate at which depository institutions trade balances at the Federal Reserve. It exercises this control by influencing the demand for and supply of these balances through the following means:

  • Open market operations: the purchase or sale of securities, primarily U.S. Treasury securities, in the open market to influence the level of balances that depository institutions hold at the Federal Reserve Banks. Open market operations are used to meet the goal of the target federal funds rate. Open market operations are conducted by the Domestic Trading Desk at the Federal Reserve Bank of New York.  
  • Reserve requirements: requirements regarding the percentage of certain deposits that depository institutions must hold in reserve in the form of cash or in an account at a Federal Reserve Bank.  
  • Contractual clearing balances: an amount that a depository institution agrees to hold at its Federal Reserve Bank in addition to any required reserve balance.  
  • Discount window lending (discount rate): extensions of credit to depository institutions made through the primary, secondary, or seasonal lending programs.

By trading government securities, the New York Fed affects the federal funds rate, which is the interest rate at which depository institutions lend balances to each other overnight. The Federal Open Market Committee establishes the target rate for trading in the federal funds market. The target rate is currently set at a 0 to 1/4 percent range (since December, 2008.)

Figure 1 shows the recent history of the target federal funds rate through current period. Notice how the target rate has normally moved up and down in a cyclical pattern. This pattern of change is strongly correlated with the business cycles, generally increasing during expansionary periods and decreasing during contractions. The fed funds rate target has been set at 0 to 1/4 percent since December 2008.

Figure 1 Federal Reserve

For detailed information about "Open Market Operations "

For more information about the U.S. Federal Reserve System and the Board of Governors of the Federal Reserve System

For more information about the FOMC, go to "About the FOMC "

How Monetary Policy Affects the Economy

The initial link in the chain between monetary policy and the economy is the market for balances held at the Federal Reserve Banks. Depository institutions have accounts at their Reserve Banks, and they actively trade balances held in these accounts in the federal funds market at an interest rate known as the federal funds rate. The Federal Reserve exercises considerable control over the federal funds rate through its influence over the supply of and demand for balances at the Reserve Banks.

The FOMC sets the federal funds rate at a level it believes will foster financial and monetary conditions consistent with achieving its monetary policy objectives, and it adjusts that target in line with evolving economic developments. A change in the federal funds rate, or even a change in expectations about the future level of the federal funds rate, can set off a chain of events that will affect other short-term interest rates, longer-term interest rates, the foreign exchange value of the dollar, and stock prices. In turn, changes in these variables will affect households’ and businesses’ spending decisions, thereby affecting growth in aggregate demand and the economy.

Short-term interest rates, such as those on Treasury bills and commercial paper, are affected not only by the current level of the federal funds rate but also by expectations about the overnight federal funds rate over the duration of the short-term contract. As a result, short-term interest rates could decline if the Federal Reserve surprised market participants with a reduction in the federal funds rate, or if unfolding events convinced participants that the Federal Reserve was going to be holding the federal funds rate lower than had been anticipated. Similarly, short-term interest rates would increase if the Federal Reserve surprised market participants by announcing an increase in the federal funds rate, or if some event prompted market participants to believe that the Federal Reserve was going to be holding the federal funds rate at higher levels than had been anticipated.

Expansionary monetary policy actions: Decrease interest rates

  • Reduce the target fed funds rate
  • Open market operations: buy securities
  • Reduce reserve requirements
  • Decrease the discount rate

Contractionary monetary policy actions: Increase interest rates

  • Increase the target fed funds rate
  • Open market operations: sell securities
  • Increase reserve requirements
  • Increase the discount rate

[Teacher Note:  A great classroom lesson to illustrate the impact of these monetary policy options is: "Lesson 10: "Macroeconomic Stabilization Policies and Institutions," Focus: Institutions and Markets, Council for Economic Education, 2003 (also in the "Virtual Economics CD Rom.")]

Changes in short-term interest rates will influence long-term interest rates, such as those on Treasury notes, corporate bonds, fixed-rate mortgages, and auto and other consumer loans. Long-term rates are affected not only by changes in current short-term rates but also by expectations about short-term rates over the rest of the life of the long-term contract. Generally, economic news or statements by officials will have a greater impact on short-term interest rates than on longer rates because they typically have a bearing on the course of the economy and monetary policy over a shorter period; however, the impact on long rates can also be considerable because the news has clear implications for the expected course of short-term rates over a longer time period.

In the current economic environment of slow growth, high unemployment , and slow credit markets, the Fed has adopted a stimulatory policy. Given the very low level of interest rates, over the last year, the Federal Reserve has taken additional measures to open up financial markets and stimulate spending.

[Note: Students should be able to identify the intended impact when the Fed uses its various policy options and tools.  If the Fed sells securities, what will happen?  If the Fed reduces rates, what will happen?  If the Fed increases reserve requirements, what will happen?]

During the recession, the Federal Reserve established several new programs to counter the "liquidity crisis" and the tight credit markets. These programs are intended to provide capital to different types of financial institutions "to strengthen market stability, improve the strength of financial institutions, and enhance market liquidity.  Most of these special program have been ended or "wound down" in the past year.

The first of these new Fed programs was the Term Auction Facility (TAF), created to improve bank liquidity. The TAF "allows a depository institution to place a bid for an advance from its local Federal Reserve Bank at an interest rate that is determined as the result of an auction. By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could help ensure that liquidity provisions can be disseminated efficiently even when the unsecured interbank markets are under stress."

The common thread in these Fed programs' goals is to improve the balance sheets of financial institutions by supporting the value of their assets. One of the problems with bank holding has been uncertainty about the underlying value of the securities they hold. By replacing the banks' securities, such as mortgaged-backed securities, with those with more secure values, confidence in the banks will increase. In a more stable market with more predictable asset values, more narrowing and lending should result.

What is QE2?

In November, 2010, the Federal Reserve announced a second major program of asset repurchases, a program commonly called quantitative easing or “QE2.” The Fed planned to purchase up to $600 billion in U.S. Treasury securities, buying $75-$100 billion per month by the summer of 2011.

Why QE2?

The Fed has two mandates, established by the Congress with the Employment Act of 1946. They are price stability (low inflation) and full employment. These two goals are often in conflict. When the economy is growing too slowly, demand for goods/services is low, and there is no anticipation of inflation. When growth is slow or negative, unemployment tends to be higher. When the economy is growing too quickly, the opposite tends to result, higher inflation and low unemployment.

Recently, the unemployment rate has remained over 9 percent, well above an acceptable level, and inflation has been very low. The CPI-U increased just 1.5 percent in 2010. A 2 percent rate of inflation is considered by the Fed and others to be optimal – just enough to signal economic growth. With low inflation, Fed policy can focus on growth and stimulating employment. Thus, the Fed adopted the stimulatory policy of QE2.

How Will QE2 Work?

Since November, the Fed has been purchasing about $100 billion in Treasury notes each month. What happens when the Fed purchases securities? It adds to the liquidity pool – available funds for loans - in the economy. Hopefully, the new funds will be made available as loans for investment and job creation. Possibly, the funds will go to the bond market and the stock market and asset values will increase. As the funds enter the private financial system, interest rates should fall.

Lower interest rates, mortgage rates, for example, should have a simulative effect on the economy and stock market prices. One well-accepted theory is that as stock prices rise, the “wealth effect” influences the people who now feel more able to increase their consumption of goods and services. The wealth effect may be a short-term phenomenon, but it seems to stimulate consumer behavior.

Thus, QE2 is intended to jump-start the economy.

CONCLUSION

Once again, the Federal Open Market Committee concluded that although it sees a "gradual return to higher levels of resource utilization...progress toward its objectives has been disappointingly slow."

The Federal Reserve is charged with promoting employment growth and price stability.  Current policies - extremely low interest rates and purchasing hundreds of billions of dollars of government securities, have, so far, not resulted in the intended growth and employment.

Can monetary policy help to create the growth and jobs the U.S. economy needs?  It can facilitate growth by making it easier (cheaper) to borrow, consume, and invest.  It can be ready to act, should inflation happen.  But, it can't make people buy things and producers hire employees.  That will happen when people have more faith in their future income and businesses have more faith in their future profits.

ASSESSMENT ACTIVITY

Have your students complete this interactive quiz.

1. As a result of its January 26, 2011 meeting, what policy action was taken by the FOMC?

a. increase the target fed funds rate
b. decrease the target fed funds rate
c.  keep the rate the same [CORRECT]

[See the announcement: "The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period."]

2. How did the FOMC's January 26 announcement characterize the pace of the economic recovery?

a. Robust
b. insufficient  [CORRECT]
c. better

[See the announcement: "Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions."]

3.  How did the announcement characterize the prospects for inflation in the U.S. economy in the near-term?

a.  stable  [CORRECT]
b.  imminent
c.  non-existent

[See the announcement: "...low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.."]


4. Which of these Federal Reserve monetary policy actions will make more loanable funds available to banks?

a. buy government securities [CORRECT]
b. sell government securities
c. decrease interest rates on securities

[Buying securities gives bank more excess reserves to create more loans.]

5. Is a Federal Reserve policy intended to decrease interest rates an expansionary or a contractionary policy?

a. contractionary
b. expansionary [CORRECT]

[A policy of decreasing interest rates is intended to expand the economy by increasing spending and investment. Lower interest rates make it less expensive to spend and invest.]

6. What is the most commonly used monetary policy tool of the federal Reserve?

a. discount rate changes
b. reserve requirement changes
c. open market operations [CORRECT]

[Open market operations (buying and selling securities) is the primary tool for influencing the levels of bank reserves and the federal funds rate. Reserve requirements are less often changed and the discount rate is changed to reflect changes in the federal funds rate target.]

7. What are two statutory mandates of the Federal Reserve System ?

1. economic growth and balanced trade
2. maximum employment and price stability [CORRECT]
3. Imorove housing and keep prices low

[See the announcement: "Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability."]

8. How many Federal Reserve Bank districts make up the U.S. Federal Reserve System?

a. 9
b. 10
c. 12 [CORRECT]

[There are 12 Federal Reserve Banks. For a map, go to the Map of the Twelve Federal Reserve Districts .]

9. Who is the current chairman of the Federal Reserve Board?

a. Ben Bernanke [CORRECT]
b. Alan Greenspan
c. Timothy Geithner

[Ben S. Bernanke was reappointed in January, 2010, as Chairman and is a member of the Board of Governors of the Federal Reserve System.]

10. Which Federal Reserve Bank is charged with the responsibility to implement the Fed's open market operations?

a. Boston
b. New York [CORRECT]
c. It rotates between banks

["Open market operations are arranged by the Domestic Trading Desk at the Federal Reserve Bank of New York (the Desk) under authorization from the FOMC, which was created by statute to direct open market operations. Source: Federal Reserve Bulletin.]

Essay Questions:


1. During a recessionary period, why would the Federal Reserve and FOMC choose to keep interest rates low?

[Lower interest rates are an incentive for consumers to purchase and for businesses to invest in new productive capacity.]

2. 
How do low interest rates help to achieve the Fed's goal to stimulate the economy and help banks?

[If banks have more excess reserves to lend, other market rates will fall. When credit markets are tight, either because funds are not available or lenders are reluctant to take risks, economic activity (output) slows, unemployment increases and people are uncertain about their economic futures. The Fed's stimulatory policies seek to encourage people to spend, businesses to invest and banks to make more loans.]

EXTENSION ACTIVITY

Take a look at data about your school's regional Federal Reserve district bank. 12 regional Federal Reserve Banks serve the United States.

From the Map of the Twelve Federal Reserve System Districts , students should identify the Federal Reserve Bank that serves their school's geographic area.

Students can explore their Federal Reserve Bank's web site for information about the economic health of their region and programs available to area businesses and consumers. 

  • Are economic conditions in your region of the United States similar, better or worse than national economic conditions? Growth? Employment/unemployment? Price level changes?
  • Are there any particular characteristics about your region that impact it's economic health - better or worse than other regions?
  • What do the president and/or other leaders of your Federal Reserve Bank have say about current regional economic conditions?
  • What programs and information services does your Federal Reserve Bank offer to businesses, consumers or schools?

Take another look at the map of the regional Federal Reserve Banks.  Do the sizes and boundaries of the twelve regions make sense to you?  Remember, this map was drawn in 1913 when the population and level of economic activity of the western and southern regions was very much smaller. 

Do you think the map would look different if the regions were established and the map was drawn today?

[Note: Some Federal Reserve district banks have extensive educational resources and others do not.  Go to www.federalreserveeducation.org to access these publications.]