Page 518 - Introduction to Business

492 PART 5 Finance

victims of ID theft restore their good names. The FTC’s website, http://www.ftc.gov/
bcp/conline/pubs/credit/idtheft.htm, contains detailed instructions on forms and
steps to take if you become a victim. The FTC puts your information into a secure
consumer fraud database where it can be used to help other law enforcement agen-
cies and private entities in their investigations and victim assistance.

reality What forms of money do you use? How do you keep your money
CH ECK secure from theft?

Central Banks and Monetary Policy

LEARNING OBJECTIVE 5
Explain what central banks do to control money and achieve economic goals.
Central banks are government entities that conduct the country’s monetary policy,
supervise and regulate its financial institutions, maintain the stability of its financial
system, and provide certain financial services needed by the government, the pub-
lic, financial institutions, and foreign institutions. The U.S. Federal Reserve System,
the European Central Bank, and the Bank of Japan are examples of central banks.
Setting monetary policy is the most important role of central banks. Because it
has major implications to the world economy, many times central banks from dif-
ferent countries hold joint meetings to discuss monetary policy. The objective of
monetary policy is to achieve productivity of the business sector, employment of cit-
izens, stable prices of goods and services (or low inflation), and international trade
and commerce. Because monetary policy is so important to the economy, it can
affect the future success or failure of business firms as well as the everyday lives of
most people in a country. Here we focus on the Federal Reserve System, or Fed, for
purposes of illustration. However, the discussion is equally relevant to most central
banks of large industrial countries, which are similar in structure and operation.
The Fed has a seven-member Board of Governors headed by a chairperson who
oversees policy issues. The Fed’s most powerful method of influencing the financial
open market operations The purchase and economic systems is open market operations involving the purchase and
and sale of government securities from sale of government securities from banks. The Federal Open Market Committee
banks by the central bank to control (FOMC), made up of the seven board members and five Fed district bank presi-
bank reserves and federal funds rates
dents, regularly meets to discuss open market operations. If the Fed purchases gov-
bank reserves The amount of cash held ernment securities from banks, the amount of cash, or so-called bank reserves,
by commercial banks held by banks increases as new funds are transferred from the Fed to the banks.
These new reserves can be used by banks to make loans to their customers. Alter-
natively, the Fed can sell securities to banks in exchange for cash, so that bank
reserves and the amount of loans banks can make decrease.
The Fed can influence interest rates by increasing or decreasing the cash
reserves held by banks. The reason for this is that banks constantly lend money to
one another throughout the day. Banks that are short on cash borrow reserves from
other banks with excess reserves. The rate that banks charge one another for these
federal funds rate The interest rates reserves is known as the federal funds rate. If the Fed purchases securities from
that banks charge one another for banks and there is an increase in the supply of cash reserves held by banks, the
borrowing money
interest rate that banks charge one another in the money market tends to decrease.
Alternatively, if the Fed sells securities to banks and decreases banks’ reserves, the
greater scarcity of reserves causes banks to charge a higher federal funds rate.
Notice that the federal funds rate is essentially the price of so-called federal funds
set by banks that are borrowing and lending these funds. This pricing mechanism
is no different from prices set by grocery stores for apples as determined by buyers
and sellers of apples. As the supply of apples increases, holding demand constant,

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