Go Global !Global Economic Environment :The Effect of GovernmentMacroeconomic Policy on Business                          ...
Learning Objectives To identify the fiscal policy instruments of  Government to manage the economy To critically assess ...
Agenda1. Fiscal Policy2. Monetary   Policy
Fiscal Policy Government Policy DilemmaAggregate DemandFiscal PolicyIssues
1. Impact of Government Economic Policy
2. Aggregate Demand
2.1 Movements vs Shifts
2.2 Economic Downturn
2.3 National Income & Consumption
2.4 National Output (GDP)
2.5 GDP=C+I
2.6 Multiplier Model
2.7 Taxes (-T)
2.8 Government Spending (+G)
2.9 GDP=C+I+G
2.9.1 GDP=C+I+G
2.10 Economic Boom & Defence Spending
3. Fiscal Policy     • Council of Economic Advisers       (CEA)     • Discretionary fiscal policy      • Eliminate recessi...
3.1 Fiscal Policy     • Expansionary fiscal policy      • Increased spending and/or        lower taxes      • Budget defic...
3.2 Expansionary Fiscal Policy                                                          Recessions                        ...
3.3 Contractionary Fiscal Policy          Reduce        Demand Pull                      $5 Billion          Inflation    ...
3.4 Built-In Stability     • Automatic stabilizers      • Taxes and transfers     • Economic importance     • Tax progress...
3.5 Built-In Stability                                                                    T     Government Expenses, G    ...
3.6 Evaluating Fiscal Policy • Standardized budget   • Full-employment budget   • Cyclical deficit   • Recent U.S. fiscal ...
3.6.1 Evaluating Fiscal Policy                                                                       T                    ...
3.6.2 Evaluating Fiscal Policy                                       Standardized deficit             T1                  ...
4. Fiscal Policy Issues      Problems, Criticisms, and Complications• Problems of timing   • Recognition lag   • Administr...
4.1 Budget Balances as % of GDP                    (2)                      (3)                 Actual                Stan...
4.2 Standardized Budget Balance     Percentage of Potential GDP, 2007                              Deficits               ...
4.3 Federal Budget Balance     Actual and Projected, Fiscal 1994-2014                                                     ...
4.4 The Public Debt• National or public debt $9.01  trillion• Ownership • U.S. securities • 53% owned by federal   governm...
4.5 The Public Debt     Debt Held Outside       The Federal                                    Debt Held by the           ...
4.6 Debt and GDP     Federal debt held by the public, percentage of GDP                           50                      ...
4.7 Debt and GDP     Publicly Held Debt: International Comparisons                            As a Percentage of GDP, 2007...
4.8 Debt and GDP• Interest charges • Primary burden • 1.7% of GDP 2007• False concerns • Bankruptcy • Refinancing • Taxati...
4.9 Debt and GDP• Substantive issues     • Income distribution     • Incentives     • Foreign-owned public debt• Crowding-...
4.10 Crowding Out     A Large Public Debt to Finance Public Investment Will Cause…                                        ...
4.11 The Leading Indicators     1. Average workweek     2. Initial claims for        unemployment insurance     3. New ord...
Monetary Policy Money The Central Banker : FRS The Banking System Monetary Policy The US Subprime Crisis
1. Functions of Money• Medium of exchange • Used to buy/sell goods• Unit of account • Goods valued in dollars• Store of va...
1.1 Money Defined• M1 • Currency • Checkable deposits• Institutions offering checkable  deposits • Commercial banks • Savi...
1.2 Money Defined• M2 • M1 plus near-monies • Savings deposits including   money market deposit   accounts (MMDA) • Small ...
1.3 Money Defined                                                    M1        M2January 2008                       Curren...
1.4 Money Supply• Are credit cards money?• What “backs” the money  supply? • Nothing!• Why is money valuable? • Acceptabil...
1.5 Money and Prices• Prices affect purchasing power  of money• Hyperinflation renders money  unacceptable• Stabilizing mo...
2. Federal Reserve System• Historical background• Board of Governors• 12 Federal Reserve Banks • Serve as the central bank...
2.1 Federal Reserve System                        Board of GovernorsFederal Open Market Committee                    12 Fe...
2.2 Federal Reserve System The 12 Federal Reserve Banks                    Source: Federal Reserve Bulletin               ...
2.3 Federal Reserve System• Federal Open Market Committee • Aids Board of Governors in setting   monetary policy • Conduct...
2.4 Federal Reserve Functions•   Issue currency•   Set reserve requirements•   Lend money to banks•   Set discount rate•  ...
2.5 Federal Reserve System• Federal Reserve independence• Recent developments   • Relative decline of banks and     thrift...
2.6 Financial Institutions  World’s 12 Largest Financial Institutions, 2007                                   Assets (Bill...
2.7 U.S. Financial Institutions•   Commercial banks•   Thrifts•   Insurance companies•   Mutual fund companies•   Pension ...
2.8 The Global Greenback• U.S. currency circulating abroad  • Russia $80 billion  • Argentina $50 billion  • $450 billion ...
3. Fractional Reserve Banking• The Goldsmiths • Stored gold and gave a receipt • Receipts used as money by public • Made l...
3.1 Fractional Reserve System• Balance sheet • Assets = Liabilities + Net   Worth • Both sides balance• Necessary transact...
3.2 Creating a Bank• Transaction #1• Vault cash: cash held by the  bank                 Creating a Bank            Balance...
3.2.1 Creating a Bank• Transaction #2• Acquiring property & equipment            Acquiring Property and Equipment         ...
3.2.2 Creating a Bank• Transaction #3• Commercial bank  functions • Accepting deposits • Making loans Deposits           A...
3.2.3 Creating a Bank•   Transaction #4•   Depositing reserves in a    Federal Reserve bank    • Required reserves    • Re...
3.2.4 Reserve Requirements                                   Current     Statutory     Type of Deposit             Require...
3.2.5 Creating a Bank• Transaction #4• Assume the bank deposits all  cash on reserve at the Fed             Depositing Res...
3.2.6 Reserve Requirements• Excess reserves • Actual reserves - required  reserves• Required reserves • Checkable deposits...
3.2.7 Creating a Bank• Transaction #5• Clearing a check • $50,000 check reduces reserves   and checkable deposits         ...
3.3 Money Creating Transactions  • Transaction #6a  • Granting a loan   • $50,000 loan deposited to     checking a Loan is...
3.3.1 Money Creating Transactions   • Transaction #6b   • Using the loan     • $50,000 loan cashed           After a Check...
3.3.2 Money Creating Transactions   • Transaction #7   • Bank buys government     securities from dealer    • Deposits pay...
3.4 Commercial Banks•   Conflicting goals•   Earn profit    • Make loans to earn interest    • Buy securities to earn inte...
3.5 The Banking System•   Multiple-deposit expansion•   Assumptions:    • 20% required reserves    • All banks “loaned up”...
3.6 The Banking System              (1)                   (3)          (4)           Acquired        (2)    Excess Amount ...
3.6.1 The Banking System                              (2)                (1)       Required          (3)            (4)   ...
3.7 The Monetary MultiplierMonetary                         1                         1multiplier   =        required rese...
3.7.1 The Monetary Multiplier• Maximum amount of new  money created by single  dollar of excess reserves• Higher R, lower ...
3.8 Bank Panics of 1930-1933• Before deposit insurance• Bank failure led to mass withdrawals• Forced loan reduction• 25-33...
4. Interest Rates• Price paid for the use of  money• Many different interest rates• Speak as if only one interest  rate• D...
4.1 Demand for Money• Why hold money?• Transactions demand, D1 • Determined by nominal GDP • Independent of the interest r...
4.1.1Demand for Money                                                                                                     ...
4.2 Interest Rates• Equilibrium interest rate • Changes with shifts in money   supply and money demand• Interest rates and...
4.3 Federal Reserve Balance Sheet   • Assets     • Securities     • Loans to commercial banks   • Liabilities     • Reserv...
4.3.1 Federal Reserve Balance Sheet                  February 14, 2008 (in Millions)         Assets                       ...
4.4 Central Banks   Selected Nations       Australia:   Reserve Bank of Australia (RBA)        Canada:     Bank of Canada ...
4.5 Tools of Monetary Policy• Open market operations • Buying and selling of government   securities (or bonds) • Commerci...
4.5.1 Open Market OperationsFed buys $1,000 bond from a commercialbank                      New Reserves                  ...
4.5.2 Open Market OperationsFed buys $1,000 bond from the public                      Check is Deposited                  ...
4.6 Tools of Monetary Policy• The reserve ratio • Changes the money multiplier• The discount rate • The Fed as lender of l...
4.6.1 Tools of Monetary Policy• Open market operations most  important• Reserve ratio last changed 1992• Discount rate was...
4.7 The Federal Funds Rate• Rate charged by banks on  overnight loans• Targeted by the Federal Reserve• FOMC conducts open...
4.7.1 The Federal Funds Rate                          Using Open Market Operations   Federal Funds Rate, Percent          ...
4.8 Monetary Policy• Expansionary monetary  policy • Economy faces a recession • Lower target for federal funds rate • Fed...
4.9 Taylor Rule• Rule of thumb for tracking actual  monetary policy• Fed has 2% target inflation rate• If real GDP = poten...
4.10 Monetary Policy• Affect on real GDP and price  level• Cause-effect chain • Market for money • Investment and the inte...
4.11 Monetary Policy and GDP                                                                                              ...
4.12 Expansionary Monetary Policy                   Problem: unemployment and recession                 Fed buys bonds, lo...
4.13 Restrictive Monetary Policy                             Problem: inflation              Fed sells bonds, increases re...
4.14 Monetary Policy• Advantages over fiscal policy • Speed and flexibility • Isolation from political pressure• Recent U....
4.15 The Big Picture   Input                                              ConsumptionResources                            ...
4.16 The Mortgage Debt Crisis•   Home mortgage default 2007•   Banks write off bad loans•   Reserves reduced•   Fed as len...
5.   The US Subprime Crisis Video : Capitalism : A Love Story“Over all history, money has oppressed people in one of two ...
Conclusion“Understanding the forces that affect aggregate     demand,     including government fiscal and monetary policie...
Casestudy : IKEA1. Read    and   prepare   the   Casestudy      on     IKEA   (Johnson, Whittington &   Scholes     (2011)...
Core Reading Juleff, L, Chalmers, A.. and Harte, P. (2008) Business Economics in a Global  Environment, Napier University...
Questions?
Upcoming SlideShare
Loading in...5
×

Enu macroecon policy 040812

356

Published on

Fiscal and Monetary Policies

Published in: Business, Technology
0 Comments
2 Likes
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total Views
356
On Slideshare
0
From Embeds
0
Number of Embeds
0
Actions
Shares
0
Downloads
31
Comments
0
Likes
2
Embeds 0
No embeds

No notes for slide
  • The Learning Objectives for Chapter 1 are To define globalization and international business and show how they affect each other To understand why companies engage in international business and why international business growth has accelerated To discuss globalization’s future and the major criticisms of globalization To become familiar with different ways in which a company can accomplish its global objectives To apply social science disciplines to understanding the differences between international and domestic business
  • Enu macroecon policy 040812

    1. 1. Go Global !Global Economic Environment :The Effect of GovernmentMacroeconomic Policy on Business By Stephen Ong Edinburgh Napier University Business School chong@mail.tarc.edu.my Visiting Professor, College of Management, Shenzhen University 4 August 2012
    2. 2. Learning Objectives To identify the fiscal policy instruments of Government to manage the economy To critically assess the effectiveness of fiscal policy To identify the principal instruments of monetary policy To evaluate the nature and effectiveness of monetary policy
    3. 3. Agenda1. Fiscal Policy2. Monetary Policy
    4. 4. Fiscal Policy Government Policy DilemmaAggregate DemandFiscal PolicyIssues
    5. 5. 1. Impact of Government Economic Policy
    6. 6. 2. Aggregate Demand
    7. 7. 2.1 Movements vs Shifts
    8. 8. 2.2 Economic Downturn
    9. 9. 2.3 National Income & Consumption
    10. 10. 2.4 National Output (GDP)
    11. 11. 2.5 GDP=C+I
    12. 12. 2.6 Multiplier Model
    13. 13. 2.7 Taxes (-T)
    14. 14. 2.8 Government Spending (+G)
    15. 15. 2.9 GDP=C+I+G
    16. 16. 2.9.1 GDP=C+I+G
    17. 17. 2.10 Economic Boom & Defence Spending
    18. 18. 3. Fiscal Policy • Council of Economic Advisers (CEA) • Discretionary fiscal policy • Eliminate recessionary or inflationary gap • Countercyclical • Nondiscretionary fiscal policy18 • Passive or automatic
    19. 19. 3.1 Fiscal Policy • Expansionary fiscal policy • Increased spending and/or lower taxes • Budget deficit • Contractionary fiscal policy • Lower spending and/or higher taxes19 • Budget surplus • Policy options?
    20. 20. 3.2 Expansionary Fiscal Policy Recessions Decrease $5 Billion Aggregate Additional Demand Spending AS Price Level Full $20 Billion P1 Increase in Aggregate Demand AD1 AD220 $490 $510 Real Domestic Output, GDP
    21. 21. 3.3 Contractionary Fiscal Policy Reduce Demand Pull $5 Billion Inflation Initial Decrease In Spending AS Price Level Full $20 Billion P1 Decrease in Aggregate Demand AD4 AD321 $510 $522 Real Domestic Output, GDP
    22. 22. 3.4 Built-In Stability • Automatic stabilizers • Taxes and transfers • Economic importance • Tax progressivity • Progressive tax system • Proportional tax system22 • Regressive tax system
    23. 23. 3.5 Built-In Stability T Government Expenses, G and Tax Revenues, T Surplus G Deficit23 GDP1 GDP2 GDP3 Real Domestic Output, GDP
    24. 24. 3.6 Evaluating Fiscal Policy • Standardized budget • Full-employment budget • Cyclical deficit • Recent U.S. fiscal policy • Budget deficits and projections24 • Social security considerations
    25. 25. 3.6.1 Evaluating Fiscal Policy T Cyclical deficit Fiscal policy Government Expenses, G neutral and Tax Revenues, T b a $500 G $450 c25 GDP2 GDP1 (Year 2) (Year 1) Real Domestic Output, GDP
    26. 26. 3.6.2 Evaluating Fiscal Policy Standardized deficit T1 Expansionary fiscal T2 policy Government Expenses, G and Tax Revenues, T e d $500 G $475 h $450 f $425 g26 GDP4 GDP3 (Year 4) (Year 3) Real Domestic Output, GDP
    27. 27. 4. Fiscal Policy Issues Problems, Criticisms, and Complications• Problems of timing • Recognition lag • Administrative lag • Operational lag• Political considerations• Future policy reversals• Offsetting state and local finance• Crowding-out effect• Current thinking on fiscal policy 27
    28. 28. 4.1 Budget Balances as % of GDP (2) (3) Actual Standardized (1) Deficit (-) or Deficit (-) or Year Surplus (+) Surplus (+) 1992 -4.5% -2.9% 1993 -3.8% -2.9% 1994 -2.9% -2.1% 1995 -2.2% -2.0% 1996 -1.4% -1.2% 1997 -0.3% -1.0% 1998 +0.8% -0.4% 1999 +1.4% +0.1% 2000 +2.5% +1.1% 2001 +1.3% +1.0% 2002 -1.5% -1.2% 2003 -3.4% -2.5% 2004 -3.5% -2.4% 2005 -2.6% -1.9% 2006 -1.9% -1.8%28 2007 -1.3% -1.4% Source: Congressional Budget Office
    29. 29. 4.2 Standardized Budget Balance Percentage of Potential GDP, 2007 Deficits Surpluses -6 -4 -2 0 2 4 6 Denmark New Zealand Ireland Canada Norway France United States United Kingdom29 Japan Source: Organization for Economic Cooperation and Development
    30. 30. 4.3 Federal Budget Balance Actual and Projected, Fiscal 1994-2014 Actual Projected (as of March 2008) $300 Budget Deficit (-) or Surplus, Billions 200 100 0 -100 -200 -300 -400 -50030 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Source: Congressional Budget Office
    31. 31. 4.4 The Public Debt• National or public debt $9.01 trillion• Ownership • U.S. securities • 53% owned by federal government and Federal Reserve • 47% held outside the federal government and Federal Reserve 31
    32. 32. 4.5 The Public Debt Debt Held Outside The Federal Debt Held by the Other, Including Government State and Local Federal Government and Federal Governments and Federal Reserve (47%) Reserve (53%) U.S. Banks And other 8% 7% Financial 9% Institutions Federal 25% Reserve Foreign Ownership 44% 7% U.S. Government U.S.32 Individuals Agencies Source: U.S. Treasury Total Debt: $9.01 trillion
    33. 33. 4.6 Debt and GDP Federal debt held by the public, percentage of GDP 50 45 40 35 Percent of GDP 30 25 20 15 10 5 0 1970 1975 1980 1985 1990 1995 2000 2005 Year33 Source: Economic Report of the President, 2006
    34. 34. 4.7 Debt and GDP Publicly Held Debt: International Comparisons As a Percentage of GDP, 2007 0 20 40 60 80 100 Italy Japan Belgium Hungary Germany United States United Kingdom France Netherlands Canada Spain34 Poland Source: Organization for Economic Cooperation and Development
    35. 35. 4.8 Debt and GDP• Interest charges • Primary burden • 1.7% of GDP 2007• False concerns • Bankruptcy • Refinancing • Taxation •35Burdening future generations
    36. 36. 4.9 Debt and GDP• Substantive issues • Income distribution • Incentives • Foreign-owned public debt• Crowding-out effect revisited • Burden on future generations • Public investment as an offset36 • Graphically
    37. 37. 4.10 Crowding Out A Large Public Debt to Finance Public Investment Will Cause… 16 If Public Spending 14 Spurs More Private Investment Will Real Interest Rate (Percent) 12 Increase to ID2 b c 10 8 a 6 Interest Rate Crowding- 4 Rise Will Out Effect Decrease ID 2 2 Investment a to b ID 1 0 5 10 15 20 25 30 35 4037 Investment (Billions of Dollars)
    38. 38. 4.11 The Leading Indicators 1. Average workweek 2. Initial claims for unemployment insurance 3. New orders for consumer goods 4. Vendor performance 5. New orders for capital goods 6. Building permits for houses 7. Stock prices 8. Money supply38 9. Interest-rate spread 10.Consumer expectations Source: The Conference Board
    39. 39. Monetary Policy Money The Central Banker : FRS The Banking System Monetary Policy The US Subprime Crisis
    40. 40. 1. Functions of Money• Medium of exchange • Used to buy/sell goods• Unit of account • Goods valued in dollars• Store of value • Hold some wealth in money form• Money is liquid 31-40
    41. 41. 1.1 Money Defined• M1 • Currency • Checkable deposits• Institutions offering checkable deposits • Commercial banks • Savings and loan associations • Mutual savings banks • Credit unions 31-41
    42. 42. 1.2 Money Defined• M2 • M1 plus near-monies • Savings deposits including money market deposit accounts (MMDA) • Small time deposits • Money market mutual funds (MMMF) 31-42
    43. 43. 1.3 Money Defined M1 M2January 2008 Currency + 56% M1 Checkable Deposits + 44% 18% Small Time Deposits + 16% Money Market Mutual 14% Funds Held By Individuals + Savings Deposits, 52% Including Money Market + Deposit Accounts Totals $1,365 $7,499Source: Federal Reserve System Billion Billion 31-43
    44. 44. 1.4 Money Supply• Are credit cards money?• What “backs” the money supply? • Nothing!• Why is money valuable? • Acceptability • Legal tender • Relative scarcity 31-44
    45. 45. 1.5 Money and Prices• Prices affect purchasing power of money• Hyperinflation renders money unacceptable• Stabilizing money’s purchasing power • Intelligent management of the money supply – monetary policy • Appropriate fiscal policy 31-45
    46. 46. 2. Federal Reserve System• Historical background• Board of Governors• 12 Federal Reserve Banks • Serve as the central bank • Quasi-public banks • Banker’s bank 31-46
    47. 47. 2.1 Federal Reserve System Board of GovernorsFederal Open Market Committee 12 Federal Reserve Banks Thrift Institutions (Savings and Loan Associations, Commercial Banks Mutual Savings Banks, Credit Unions) The Public (Households and Businesses) 31-47
    48. 48. 2.2 Federal Reserve System The 12 Federal Reserve Banks Source: Federal Reserve Bulletin 31-48
    49. 49. 2.3 Federal Reserve System• Federal Open Market Committee • Aids Board of Governors in setting monetary policy • Conducts open market operations• Commercial banks and thrifts • 7,300 commercial banks • 11,000 thrifts 31-49
    50. 50. 2.4 Federal Reserve Functions• Issue currency• Set reserve requirements• Lend money to banks• Set discount rate• Check collection• Fiscal agent for U.S. government• Supervise banks• Control the money supply 31-50
    51. 51. 2.5 Federal Reserve System• Federal Reserve independence• Recent developments • Relative decline of banks and thrifts • Consolidation • Convergence of services provided by financial institutions • Globalization of financial markets • Electronic payments 31-51
    52. 52. 2.6 Financial Institutions World’s 12 Largest Financial Institutions, 2007 Assets (Billions of U.S. Dollars) 0 1,300,000 1,600,000 1,900,000 Barclays (UK) BNP Paribas (France Citigroup (USA) HSBC Group (UK) UBS (Switzerland)Royal Bank of Scotland (UK) ING Group (Netherlands) Mitsubishi UFJ (Japan) Deutsche Bank Group (Ger) Bank of America (US) Allianz Worldwide (Ger) JPMorgan Chase (USA) Source: Organization for Economic Cooperation and Development 31-52
    53. 53. 2.7 U.S. Financial Institutions• Commercial banks• Thrifts• Insurance companies• Mutual fund companies• Pension funds• Securities firms• Investment banks 31-53
    54. 54. 2.8 The Global Greenback• U.S. currency circulating abroad • Russia $80 billion • Argentina $50 billion • $450 billion total • 60% of total US currency• U.S. profits from dollars leaving• Black markets and illegal activities• Dollar offers stable purchasing power• Exchange rate risk 31-54
    55. 55. 3. Fractional Reserve Banking• The Goldsmiths • Stored gold and gave a receipt • Receipts used as money by public • Made loans by issuing receipts• Characteristics • Banks create money through lending • Banks are subject to “panics” 32-55
    56. 56. 3.1 Fractional Reserve System• Balance sheet • Assets = Liabilities + Net Worth • Both sides balance• Necessary transactions • Create a bank • Accept deposits • Lend excess reserves 32-56
    57. 57. 3.2 Creating a Bank• Transaction #1• Vault cash: cash held by the bank Creating a Bank Balance Sheet 1: Wahoo Bank Assets Liabilities and Net Worth Cash $250,000 Stock Shares $250,000 32-57
    58. 58. 3.2.1 Creating a Bank• Transaction #2• Acquiring property & equipment Acquiring Property and Equipment Balance Sheet 2: Wahoo Bank Assets Liabilities and Net Worth Cash $10,000 Stock Shares $250,000 Property 240,000 32-58
    59. 59. 3.2.2 Creating a Bank• Transaction #3• Commercial bank functions • Accepting deposits • Making loans Deposits Accepting Balance Sheet 3: Wahoo Bank Assets Liabilities and Net Worth Cash $110,000 Checkable Deposits $100,000 Property 240,000 Stock Shares 250,000 32-59
    60. 60. 3.2.3 Creating a Bank• Transaction #4• Depositing reserves in a Federal Reserve bank • Required reserves • Reserve ratio Commercial bank’s Reserve Required reserves ratio = Commercial bank’s Checkable-deposit liabilities 32-60
    61. 61. 3.2.4 Reserve Requirements Current Statutory Type of Deposit Requirement Limits Checkable deposits: $0-$9.8 Million 0% 3% $9.3-$43.9 Million 3 3 Over $43.9 Million 10 8-14 Noncheckable nonpersonal savings and time deposits 0 0-9• Fed can establish and vary reserve ratio within limits set by Congress• Required reserves help Fed control lending abilities of commercial banks 32-61
    62. 62. 3.2.5 Creating a Bank• Transaction #4• Assume the bank deposits all cash on reserve at the Fed Depositing Reserves at the Fed Balance Sheet 4: Wahoo Bank Assets Liabilities and Net Worth Cash $0 Checkable Reserves 110,000 Deposits $100,000 Property 240,000 Stock Shares 250,000 32-62
    63. 63. 3.2.6 Reserve Requirements• Excess reserves • Actual reserves - required reserves• Required reserves • Checkable deposits x reserve ratio• Example: • Checkable deposits $100,000 • Reserve ratio 20% 32-63
    64. 64. 3.2.7 Creating a Bank• Transaction #5• Clearing a check • $50,000 check reduces reserves and checkable deposits Clearing a Check Balance Sheet 5: Wahoo Bank Assets Liabilities and Net Worth Checkable Reserves $60,000 Deposits $50,000 Property 240,000 Stock Shares 250,000 32-64
    65. 65. 3.3 Money Creating Transactions • Transaction #6a • Granting a loan • $50,000 loan deposited to checking a Loan is Negotiated When Balance Sheet 6a: Wahoo Bank Assets Liabilities and Net Worth Reserves $60,000 Checkable Loans 50,000 Deposits $100,000 Property 240,000 Stock Shares 250,000 32-65
    66. 66. 3.3.1 Money Creating Transactions • Transaction #6b • Using the loan • $50,000 loan cashed After a Check is Drawn on the Loan Balance Sheet 6b: Wahoo Bank Assets Liabilities and Net Worth Reserves $10,000 Checkable Loans 50,000 Deposits $50,000 Property 240,000 Stock Shares 250,000 A single bank can only lend an amount equal to their preloan excess reserves 32-66
    67. 67. 3.3.2 Money Creating Transactions • Transaction #7 • Bank buys government securities from dealer • Deposits payment into checking Government Securities Buying Balance Sheet 7: Wahoo Bank Assets Liabilities and Net Worth Reserves $60,000 Checkable Securities 50,000 Deposits $100,000 Property 240,000 Stock Shares 250,000 New money is created 32-67
    68. 68. 3.4 Commercial Banks• Conflicting goals• Earn profit • Make loans to earn interest • Buy securities to earn interest• Maintain liquidity• Alternative? • Overnight bank loans • Federal funds rate 32-68
    69. 69. 3.5 The Banking System• Multiple-deposit expansion• Assumptions: • 20% required reserves • All banks “loaned up” • Banks lend all of excess reserves• A $100 bill is found and deposited• Multiple deposits can be created 32-69
    70. 70. 3.6 The Banking System (1) (3) (4) Acquired (2) Excess Amount Bank Can Reserves Required Reserves Lend; New Money Bank and Deposits Reserves (1)-(2) Created = (3)Bank A $100 $20 $80 $80Bank B $80 $16 $64 $64Bank C $64 $12.80 $51.20 $51.20Bank D $51.20 $10.24 $40.96 $40.96 The process will continue… 32-70
    71. 71. 3.6.1 The Banking System (2) (1) Required (3) (4) Acquired Reserves Excess Amount Bank Can Reserves (Reserve Reserves Lend; New Money Bank and Deposits Ratio = .2) (1)-(2) Created = (3) Bank A $100.00 $20.00 $80.00 $80.00 Bank B 80.00 16.00 64.00 64.00 Bank C 64.00 12.80 51.20 51.20 Bank D 51.20 10.24 40.96 40.96 Bank E 40.96 8.19 32.77 32.77 Bank F 32.77 6.55 26.21 26.21 Bank G 26.21 5.24 20.97 20.97 Bank H 20.97 4.20 16.78 16.78 Bank I 16.78 3.36 13.42 13.42 Bank J 13.42 2.68 10.74 10.74 Bank K 10.74 2.15 8.59 8.59 Bank L 8.59 1.72 6.87 6.87 Bank M 6.87 1.37 5.50 5.50 Bank N 5.50 1.10 4.40 4.40 Other Banks 21.99 4.40 17.59 17.59 $400.00 32-71
    72. 72. 3.7 The Monetary MultiplierMonetary 1 1multiplier = required reserve ratio = R Graphic New Reserves $100 Example $80 $20 Excess Required Reserves Reserves $100 $400 Initial Bank System Lending Deposit Money Created 32-72
    73. 73. 3.7.1 The Monetary Multiplier• Maximum amount of new money created by single dollar of excess reserves• Higher R, lower m• Reversibility • Making loans creates money • Loan repayment destroys money 32-73
    74. 74. 3.8 Bank Panics of 1930-1933• Before deposit insurance• Bank failure led to mass withdrawals• Forced loan reduction• 25-33% decline in money supply• 1933 national bank holiday to evaluate all banks• Contributed to the Great Depression• Regulation protects the system today 32-74
    75. 75. 4. Interest Rates• Price paid for the use of money• Many different interest rates• Speak as if only one interest rate• Determined by money supply and money demand 33-75
    76. 76. 4.1 Demand for Money• Why hold money?• Transactions demand, D1 • Determined by nominal GDP • Independent of the interest rate• Asset demand, D2 • Money as a store of value • Varies inversely with the interest rate• Total money demand, Dm 33-76
    77. 77. 4.1.1Demand for Money (c) (a) (b) Total Transactions Asset demand for demand for demand for money, Dm money, Dt money, Da and supplyRate of interest, i percent 10 Sm 7.5 5 + =5 2.5 0 Dt Da Dm 50 100 150 200 50 100 150 200 50 100 150 200 250 300 Amount of money Amount of money Amount of money demanded demanded demanded and supplied (billions of dollars) (billions of dollars) (billions of dollars) 33-77
    78. 78. 4.2 Interest Rates• Equilibrium interest rate • Changes with shifts in money supply and money demand• Interest rates and bond prices • Inversely related • Bond pays fixed annual interest payment • Lower bond price will raise the interest rate 33-78
    79. 79. 4.3 Federal Reserve Balance Sheet • Assets • Securities • Loans to commercial banks • Liabilities • Reserves of commercial banks • Treasury deposits • Federal Reserve Notes outstanding 33-79
    80. 80. 4.3.1 Federal Reserve Balance Sheet February 14, 2008 (in Millions) Assets Liabilities and Net Worth Securities $713,369 Reserves of Commercial Loans to Commercial Banks $ 11,312 Banks 60,039 Treasury Deposits 4,979 All Other Assets 111,689 Federal Reserve Notes (Outstanding) 778,937 All Other Liabilities and 89,869 Net Worth Total $885,097 Total $885,097 Source: Federal Reserve Statistical Release, H.4.1, February 14, 2008 33-80
    81. 81. 4.4 Central Banks Selected Nations Australia: Reserve Bank of Australia (RBA) Canada: Bank of Canada Euro Zone: European Central Bank (ECB) Japan: Bank of Japan (BOJ) Mexico: Banco de Mexico (Mex Bank) Russia Central Bank of Russia Sweden: Sveriges RiksbankUnited Kingdom: Bank of England United States: Federal Reserve System (the “Fed”) (12 Regional Federal Reserve Banks) Malaysia : Bank Negara Malaysia 33-81
    82. 82. 4.5 Tools of Monetary Policy• Open market operations • Buying and selling of government securities (or bonds) • Commercial banks and the general public • Used to influence the money supply• When the Fed sells securities, commercial bank reserves are reduced 33-82
    83. 83. 4.5.1 Open Market OperationsFed buys $1,000 bond from a commercialbank New Reserves $1000 $1000 Excess Reserves $5000 Bank System Lending Total Increase in the Money Supply, ($5,000) 33-83
    84. 84. 4.5.2 Open Market OperationsFed buys $1,000 bond from the public Check is Deposited New Reserves $1000 $800 $200 Excess Required Reserves Reserves $1000 $4000 Initial Bank System Lending Checkable Deposit Total Increase in the Money Supply, ($5000) 33-84
    85. 85. 4.6 Tools of Monetary Policy• The reserve ratio • Changes the money multiplier• The discount rate • The Fed as lender of last resort • Short term loans• Term auction facility • Introduced December 2007 • Banks bid for the right to borrow reserves 33-85
    86. 86. 4.6.1 Tools of Monetary Policy• Open market operations most important• Reserve ratio last changed 1992• Discount rate was a passive tool• Term auction facility is new • Guaranteed amount lent by the Fed • Anonymous 33-86
    87. 87. 4.7 The Federal Funds Rate• Rate charged by banks on overnight loans• Targeted by the Federal Reserve• FOMC conducts open market operations to achieve the target• Demand curve for Federal funds• Supply curve for Federal funds 33-87
    88. 88. 4.7.1 The Federal Funds Rate Using Open Market Operations Federal Funds Rate, Percent 4.5 Sf3 4.0 Sf1 3.5 Sf2 Df Qf3 Qf1 Qf2 Quantity of Reserves 33-88
    89. 89. 4.8 Monetary Policy• Expansionary monetary policy • Economy faces a recession • Lower target for federal funds rate • Fed buys securities • Expanded money supply • Downward pressure on other interest rates• Contractionary monetary policy 33-89
    90. 90. 4.9 Taylor Rule• Rule of thumb for tracking actual monetary policy• Fed has 2% target inflation rate• If real GDP = potential GDP and inflation is 2% then target federal funds rate is 4%• Target varies as inflation and real GDP vary 33-90
    91. 91. 4.10 Monetary Policy• Affect on real GDP and price level• Cause-effect chain • Market for money • Investment and the interest rate • Investment and aggregate demand • Real GDP and prices• Expansionary monetary policy• Restrictive monetary policy 33-91
    92. 92. 4.11 Monetary Policy and GDP (c) (a) (b) Equilibrium real The market Investment GDP and the for money demand Price level Rate of Interest, i (Percent) Sm1 Sm2 Sm3 AS 10 P3 Price Level AD3 8 P2 I=$25 Dm AD2 6 ID I=$20 AD1 0 I=$15 $125 $150 $175 $15 $20 $25 Q1 Qf Q3 Amount of money Amount of investment Real GDP demanded and (billions of dollars) (billions of dollars) supplied (billions of dollars) 33-92
    93. 93. 4.12 Expansionary Monetary Policy Problem: unemployment and recession Fed buys bonds, lowers reserve ratio, lowers the discount rate, or increases reserve auctions Excess reserves increase Federal funds rate falls Money supply rises Interest rate falls Investment spending increases E E S UA C Aggregate demand increases Real GDP rises 33-93 -
    94. 94. 4.13 Restrictive Monetary Policy Problem: inflation Fed sells bonds, increases reserve ratio, increases the discount rate, or decreases reserve auctions Excess reserves decrease Federal funds rate rises Money supply falls Interest rate rises Investment spending decreases E E S UA C Aggregate demand decreases Inflation declines 33-94 -
    95. 95. 4.14 Monetary Policy• Advantages over fiscal policy • Speed and flexibility • Isolation from political pressure• Recent U.S. monetary policy• Problems and complications • Recognition lag • Operational lag • Cyclical asymmetry 33-95
    96. 96. 4.15 The Big Picture Input ConsumptionResources (C a )With Prices Levels of Investment Aggregate Output, Aggregate (I g ) Employment, Supply DemandProductivity Income, and Prices Sources Net Export Spending (X n ) Legal-InstitutionalEnvironment Government Spending (G) 33-96
    97. 97. 4.16 The Mortgage Debt Crisis• Home mortgage default 2007• Banks write off bad loans• Reserves reduced• Fed as lender of last resort• Term auction facility• Fed lowered federal funds rate• Mortgage backed securities as a new innovation • Bad incentives 33-97
    98. 98. 5. The US Subprime Crisis Video : Capitalism : A Love Story“Over all history, money has oppressed people in one of two ways: either it has been abundant and very unreliable, or reliable and very scarce.”John Kenneth Galbraith, The Age of Uncertainty (1977)
    99. 99. Conclusion“Understanding the forces that affect aggregate demand, including government fiscal and monetary policies, can help economists and policymakers smooth out the cycle of boom and bust.” Paul Samuelson
    100. 100. Casestudy : IKEA1. Read and prepare the Casestudy on IKEA (Johnson, Whittington & Scholes (2011)) for discussion and presentation next week.2. Identify and evaluate the challenges facing IKEA during the global recession, by conducting External Environment, Industry, Competitor analysis and SWOT.
    101. 101. Core Reading Juleff, L, Chalmers, A.. and Harte, P. (2008) Business Economics in a Global Environment, Napier University Edinburgh Daniels, J.D., Radebaugh, L.H. and Sullivan, D.P. (2012) International Business: Environments and Operations. 14th edition, Pearson Samuelson, P.A. and Nordhaus, W. D. (2010)“Economics” Irwin/McGraw-Hill, 19th Edition Porter, Michael E. (2004)“Competitive Strategy – Techniques for Analyzing Industries and Competitors” Free Press
    102. 102. Questions?
    1. A particular slide catching your eye?

      Clipping is a handy way to collect important slides you want to go back to later.

    ×