Don't Worry,The G-Men are on the Case....

 How The Fed Fights Inflation

As we learned in our last post, inflation is bad for the real estate industry. In order to ensure that the economy remains healthy, the Federal Reserve ( the nation’s centralized bank) regulates the nation’s money supply.  The Board of Governors, the twelve high ranking officials of The Fed, congregate to decide what actions are needed to keep the nation's economy strong.

Here is a bit of trivia. Who is the current Chairman of the Board of Governors?

The answer is Ben Bernanke.

How does The Fed fight inflation you might ask?

The Fed fights inflation by decreasing the money supply. They achieve this with three  tools.

 Increasing the reserve requirements of banks.

If you do not know, all banks are required to keep a certain percentage of deposits in reserves.  This percentage is called the reserve requirement.  The percentage is established by the Board of Governors and all banks must comply.  The reserve requirement is adjusted by The Fed as they see fit to help the economy.  In times of inflation, The Fed will raise the reserve requirements.  As a consequence of this, banks will reduce their volume of  loans, ultimately reducing the money supply and decreasing consumer demand to the point of equilibrium.

The second tool is open market operations

The Fed is authorized to buy and sell US government securities (long-term bonds, U.S. Treasury Notes) as they see fit to help the economy.  In times of inflation, The Fed will sell these securities in order to decrease the money supply.  How does this work?  An individual purchases a US government security via a check from their local banking account.  When The Fed receives the check, they subtract the check amount from the local bank's reserve account.  In an attempt to regain the percentage of deposits required, local banks will begin to constrict the volume of loans  in order to comply with the reserve amount.

The third tool is increasing the discount rate

The discount rate is the interest rate that The Feb charges banks to borrow from The Fed.  When the discount rate is increased, this discourages banks from borrowing from The Fed.  As result, banks will constrict the the volume of loans that they make to the public effectively reducing the money supply.

Hopefully this post will help you understand how the actions of The Fed effect the nation’s money supply.  Understanding this can make you a shrewd real estate investor.  When the money supply decreases, it will  make securing a loan harder and vice versa.