317

Imagine that you wanted to borrow $2 trillion. Whom would you ask? In 2008, the worldwide financial system was in a crisis and banks and other financial institutions wanted to borrow more than $2 trillion—they turned to the only person in the world capable of lending that kind of money, a mild-mannered, former professor of economics named Ben Bernanke. As chairman of the Federal Reserve System (the Fed), Bernanke was sometimes said to be the second most powerful person in the world, after the president of the United States. Bernanke was able to make the loans because he could draw on the awesome power of the Federal Reserve Bank to create money.

What is the Federal Reserve? How does it create money? What does it use its power for?

If you read this chapter, you’ll come away with an understanding of the Federal Reserve and its powers. The quick and dirty answer is that through its influence over the money supply, the Federal Reserve usually has more influence over aggregate demand than any other institution and shifts in aggregate demand can greatly influence the economy in the short run (as we first showed in Chapter 32). So, let’s take a look at the Federal Reserve System first, then examine what is meant by the money supply, and finally focus on the tools that the Fed uses to influence the money supply, aggregate demand, and the economy.