Portfolio Management - The Federal Reserve Board

When you were a child, your parents probably told you, "Money doesn't grow on trees." Now that you are all grown up, you should know where it does come from. (It is very likely to be on the exam.)

Learn more about how the Fed is structured, who Alan Greenspan is, monetary policy and more within the Federal Reserve Board tutorial.

Fiscal Policy
First things first: money does not come from the government. By proposing and passing a federal budget, the president and Congress, respectively, control the country's fiscal policy. That is where Keynesian theory lives in the form of government purchases.

Monetary Policy
Monetary policy is the creature of the Federal Reserve, or "the Fed", the U.S. quasi-governmental, independent central bank. Although the greenback bears the signature of the U.S. Secretary of the Treasury and of the Treasurer, it is the Fed that actually authorizes the printing of money.

The Fed controls the level of business activity in the U.S. in order to prevent or limit the effects of recessions - specifically, inflation and unemployment. It does so through the following means:

  • Reserve Requirements: When you deposit money in a savings account, the bank is not bound to keep every penny on hand at the branch in case you want to withdraw your entire savings tomorrow. After all, the bank makes money by taking that deposit and reinvesting it in something with a higher yield.

    • There is a balance to be struck; that is why the Fed requires banks to maintain reserves - either in the bank's vault or in the Fed's - to meet depositors' demands.

    • These reserves are expressed as a percentage of the deposits. If the Fed mandates that a higher proportion of deposits be kept on reserve, then banks will have less cash to invest elsewhere. Thus, increasing the reserve requirements reduces the supply of money. Conversely, lowering these requirements allows banks to lend more money, primarily by extending more loans, thus increasing the money supply.

  • Open-market Operations: Traditionally, the Fed is the biggest buyer of U.S. Treasury securities, that is, of the national debt. But the Fed decides for itself just how much to buy.

    • The more Treasury instruments the Fed buys, the more money it injects into the economy.

    • This is true whether the counterparty is the Treasury itself or whether the transaction takes place on the secondary market.

    • If the Fed decides to decrease the money supply, it sells its current Treasury holdings.

  • Discount Rate: The interest rate that banks pay on loans from the Fed determines the interest rates they can charge their own borrowers. The Fed's board determines this discount rate monthly. Increasing the discount rate decreases the money supply, and reducing the rate increases it.

    Look Out!
    Do not confuse the discount rate with the Fed funds rate. The Fed sets the discount rate. "Fed funds rate" is a misnomer; it is actually the rate the largest U.S. banks charge each other short-term to borrow reserve funds.

    You should be aware that the Fed also sets policies determining how much a brokerage firm can lend its customers.

Restrictive vs. Expansionary Monetary Policy
When the money supply is reduced, the Fed's monetary policy is said to be "restrictive"; when the money supply is increased, the policy is called "expansionary".

  • Restrictive policy is intended to prevent or curb inflation by taking excess money out of the economy. Just as too many shares of stock dilutes a company's equity and makes each share worth a little less, every Federal Reserve note backed by the full faith and credit of the United States makes all greenbacks worth a little less.

  • A restrictive policy will also have the effect of raising interest rates because while demand for money is constant, supply is being trimmed and the law of supply and demand holds. Prices go up under such circumstances, and interest is nothing more or less than the price of money.

  • Conversely, expansionary policies will tend to drive down interest rates.
International Economic Factors
Related Articles
  1. Professionals

    5 Reasons Financial Advisors Still Choose Mutual Funds

    Take a look at five primary reasons why financial advisors still choose to recommend mutual funds over other types of investment vehicles.
  2. Brokers

    Broker-Dealer Industry 101: The Landscape

    Independent broker-dealers are a great choice for experienced, self-starter planners who have established practices.
  3. Personal Finance

    RIAs and Brokers: What's the Difference?

    RIAs and brokers are held to different standards when providing investment advice. Here's how they differ.
  4. Trading Systems & Software

    Steps to Starting Up an Independent Broker Dealer

    Launching your own broker-dealer is a lot of work, but the potential payoff is great, both personally and financially.
  5. Professionals

    How To Answer Option Questions On The Series 7 Exam

    Learn how to answer option questions on the Series 7 exam. Pass your Series 7 exam with the help of these tips.
  6. Professionals

    Series 55

    FINRA Series 55 Exam Guide
  7. Professionals

    Series 62

    FINRA Series 62 Exam Guide
  8. Professionals

    Series 99

    FINRA/NASAA Series 99 Exam Guide
  9. Professionals

    Series 65

    FINRA/NASAA Series 65 Exam Guide
  10. Professionals

    Series 6

    FINRA Series 6 Exam Guide
  1. No results found.
  1. Do financial advisors need to pass the Series 7 exam?

    The exact nature of a financial advisor's job responsibilities determines whether he must have a Series 7 license. If a financial ... Read Full Answer >>
  2. Do financial advisors have to be licensed?

    Financial advisors must possess various securities licenses in order to sell investment products. The specific products an ... Read Full Answer >>
  3. What are the differences between the Series 6 exam and the Series 7 exam?

    The Financial Industry Regulatory Authority (FINRA) offers a variety of licenses that must be obtained before conducting ... Read Full Answer >>
Hot Definitions
  1. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  2. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  3. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  4. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  5. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  6. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
Trading Center