The Federal Reserve

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The Federal Reserve

  1. 1. Monetary Policy Alan Greenspan: Was The 2 nd most powerful Person in the US. the “ Fed ”
  2. 2. GOALS OF MONETARY POLICY … to assist the economy in achieving a full employment , noninflationary level of output Ben Bernanke : The New Man in charge at the Fed: Took over January 2006. Scored 1590 on SAT
  3. 3. The Federal Reserve - 1913
  4. 4. The FOMC Meeting Room in Washington DC The FOMC meets around a 27-foot oval mahogany table in a room with a 23-foot ceiling with a 1,000-pound chandelier .
  5. 5. New reserves $800 Excess Reserves $ 4000 Money created thru Bank Lending Mischa Barton Deposits $1,000 In Her Bank [ RR is 20 % ] $ 200 RR $ 1000 Initial Deposit TMS is $ 5,000 Mischa from the O.C. [member of the public] Mischa Barton’s
  6. 6. New reserves $1,000 Excess Reserves $ 5,000 New money Created thru lending Fed buys a $ 1,000 Bond from Mischa’s Bank TMS is $5000 20% RR Fed Mischa Barton’s
  7. 7. The Fed’s 25 Branches
  8. 8. Functions of the Fed Refund Check Destroy/Issue paper notes
  9. 9. 4. Several Thousand Member Banks
  10. 10. Recent GDP
  11. 11. “ When the party gets too good, it’s the job of the Fed to take away the punch bowl.” The Fed’s policy is “If you see inflation, its too late. Whip it before it gets out of the box.” During a recession, the Fed is happy to “spike the punch.”
  12. 12. If The Economy Is Exceeding The FE GDP Speed Limit Of 4% -
  13. 13. Beating the Inflation Dragon
  14. 14. See if you can understand some “GREEN-SPEAK”
  15. 15. “ For Richer or For Poorer ” For Andrea, it took 12 years to get a marriage proposal she could understand. [She got 3, but didn’t understand what he was saying]
  16. 16. G reenspan S worn in for a 5 th 4 -year T erm
  17. 17. Last P aragraph of Mr. Greenspan’s Marriage Proposal <ul><li>“ Despite these concerns, and in the final analysis, </li></ul><ul><li>the more preponderous weight of evidence considered in these deliberations falls on the side of a matrimonial rapproachement. I am prepared to act on these conclusions where warranted, with your consent, in a way that is consistent with my role as chairman of the Federal Reserve.” </li></ul>This was Greenspeak for , “Will You Marry Me?”
  18. 18. Y R Real GDP D M Investment Demand Reall Interest Rate 10 8 6 0 Money Market QID1 “ Easy Money” During Recessions MS 1 AS AD 1 P 1 10 8 6 0 MS 2 P 2 Price level Buy If there is RECESSION MS will be increased. QID2 D I Y* “ Easy Money” – (Buy/Sell) bonds, which (increase/decrease) MS, which (increase/decrease) interest rates, which (appreciate/depreciate) the dollar, which (increase/decrease) C, Ig, & Xn, which (increase/decrease ) AD & therefore, PL, GDP, & emp. E 1 E 2 AD 2 “ Students, should the Fed increase or decrease the money supply?” Jobs are tough to get. LRAS
  19. 19. D I AD 1 Y I D m Investment Demand Reall Interest Rate 10 8 6 0 Money Market QID 2 AS 10 8 6 0 P 2 MS 1 P 1 MS 2 If there is INFLATION , MS will be decreased. Sell QID 1 Y * “ Tight Money” during Inflation “ Tight Money” – (Buy/Sell) bonds, which (incr/decr) the MS, which (incr/decr) in. rates, which (apprec/deprec) the dollar, which (incr/decr) C, Ig, & Xn, which (incr/decr) AD, PL, & GDP. E 1 E 2 AD 2 “ Now, should I buy or sell ?” “ I’ll get rid of some money.” LRAS
  20. 20. Y R Y * Investment Demand 9 % 6% 3 % 0 Money Market $50 $60 AS AD 1 PL 1 9 % 6 % 3 % 0 MS 2 AD 2 PL 2 $70 Y I AD 3 D I D m PL 3 MS 1 MS 3 $100 120 140 Q I D I =$50] I =$60 I =$70 RDO The ideal economy is AD 2 , with I.R. at 6% & Ig at $60 billion .
  21. 21. Fed Review <ul><li>What is the banking multiplier formula? </li></ul><ul><li>When would the Fed want to increase the money supply? </li></ul><ul><li>When would the Fed want to decrease the money supply? </li></ul><ul><li>How many Fed districts are there? </li></ul>
  22. 22. First Board of Governors, 1914
  23. 23. Scored 1590 on SAT VP
  24. 24. <ul><li>Open Market Operations: Buying or </li></ul><ul><ul><li>Selling bonds. </li></ul></ul><ul><li>- “nuts and bolts” of M onetary P olicy [main tool] </li></ul><ul><li>- $60-$70 billion every day </li></ul>Three Tools Of Monetary Policy
  25. 25. 2. Reserve Requirement - most powerful (seldom used) - affects money creation by changing ER and the multiplier - an increase of ½ of 1 % would increase bank reserves by over $5 billion - RR was 20% from 1937-1958 Sledgehammer of M onetary P olicy RR - Atomic Bomb of Monetary Policy
  26. 26. $10,000 [$9,000+$1,000] [In 1980, the RR was set at 12%; stayed there until 1992; went to 10%] “ E asy M oney ” AS AD 1 AD 2 Y R Y * PL $1,000 Initial deposit $900 [$900x10] $1,000 $810 $729 Monetary Expansion [10% RR] [1/.10=10] “ Easy Money” The Reserve Requirement “ Easy Money” – increase the money supply
  27. 27. $5,000 [$4,000+$1,000] “ Tight Money” - decrease the money suply RR at 20% - Tight Money Monetary Expansion (20% RR) [1/.20=M D of 5] “ Tight Money” $1,000 Initial deposit $800 $640 $512
  28. 28. 3. Discount Rate Fed loans to banks Hurricane EarthQuake FL borrowed $99 million In 1991
  29. 29. Part of Uncle Sam’s Menu
  30. 31. Strengths of Monetary Policy <ul><li>Speed and flexibility </li></ul><ul><li>Isolation from political pressure </li></ul><ul><li>Successes in the 1980s & 1990s </li></ul>Shortcomings and problems [better at fighting inflation than fighting depressions ] Fiscal Policy better Monetary Policy better
  31. 32. Only “fiscal or monetary policy” can get me back on my feet and allow “Sam” to get back up. “ Help”
  32. 33. Presidents try to put a positive spin on a struggling economy
  33. 34. TOOLS OF MONETARY POLICY Discount Rate The Reserve Ratio Open Market Operations <ul><li>Easy Money Policy </li></ul><ul><ul><li>Lower Discount Rate </li></ul></ul><ul><ul><li>Lower Reserve Ratio </li></ul></ul><ul><ul><li>Buy Bonds </li></ul></ul>“ Easy Money” Fed
  34. 35. TOOLS OF MONETARY POLICY Discount Rate The Reserve Ratio Open Market Operations <ul><li>Tight Money Policy </li></ul><ul><ul><li>Raise Discount Rate </li></ul></ul><ul><ul><li>Raise Reserve Ratio </li></ul></ul><ul><ul><li>Sell Bonds </li></ul></ul>“ Got to decrease the MS.” Fed
  35. 36. The End

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