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Money_and_the_Fed.pptx
- 1. Money and the Fed Unit 4 Notes
- 2. MONEY • Task! –What is money? –What is the function of money? –What has served as money throughout history?
- 3. Money • Money has Three Basic Functions: – 1. Medium of Exchange- enables us to carry out trade and commerce easily – 2. Standard of Value- allows us to measure and compare value using one scale – 3. Store of Value- it (usually) holds its value over time
- 4. Money • Money also has Six Main Characteristics: – 1. Acceptability- in order for you to buy something, the seller must be willing to accept what you offer as payment – 2. Scarcity- needs to be scarce enough to be valued by buyers and sellers
- 5. – 4. Durability- if money is to serve as a store of value, it must be durable • 3. Portability- in order to be convenient as a medium of exchange it must be portable
- 6. – 5. Divisibility- to be useful as a medium of exchange, money must be easily divided into smaller amounts – 6. Uniformity- a dollar is a dollar is a dollar. We take for granted that each dollar is the same as the next.
- 7. What Serves as Money? – Throughout history, many items such as: salt, shells, cattle, beads, fur, tobacco, gold, and silver have served as money – These are examples of commodity money– form of money that has some intrinsic value or alternate use • Gold and silver have generally been preferred because they hold many of the characteristics of money
- 8. What about today? • However, our money is no longer backed by precious metals such as gold and silver • Fiat money- paper money decreed as legal tender, but not representing anything of intrinsic worth – Rather, money is accepted solely because we believe that it is worth something, and is backed by the “full faith and credit” of the United States government Trust me!
- 9. What is Currency and Money Supply? • Currency- the bills and coins currently in circulation in the economy • However, currency is only a part of the total money supply in the country • Money Supply – total amount of currency, loans/credit, and other liquid instruments available in the economy at a given time
- 10. M1& M2 Money Supply • M1 Money Supply is made up of: – Coins and bills (currency) – Checkable deposits (liquid assets) – Travelers Checks • M2 Money Supply is made up of: – All of M1 – Less liquid assets such as savings deposits, money market accounts, etc. Discussion: Do we want a larger or smaller total money supply?
- 11. • So how is that money (M1 and M2) transferred between people and managed? – By banks!
- 12. The Regional Banks of the Federal Reserve • http://www.youtube.com/watch?v=8Hq5zw4Y aZQ&list=PL2EVBfEJ5a_JPvnd463lXOKmqdzL1 9ygR • http://www.youtube.com/watch?v=M5drSk6E kHk&feature=c4-overview- vl&list=PL2EVBfEJ5a_JPvnd463lXOKmqdzL19y gR
- 13. The Banking System in a Nutshell: • Fractional Reserve Banking- a system whereby banks keep a fraction of deposits in reserves but loan out the rest to businesses and consumers • System allows our MONEY SUPPLY TO EXPAND!
- 14. Federal Reserve Reading • Pg. 282-285 – Read 14.4 “What Tools Does Monetary Policy Use to Stabilize the Economy” • Complete Sections A-D of “The Federal Reserve” Notes
- 15. Follow-Up Questions – Reread Pgs. 282-284 • What is the Federal Reserve System? • What is monetary policy? • Why does the Fed use… – An easy-money policy? – A tight-money policy?
- 16. Catch Me If You Can • http://www.youtube.com/watch?v=DCOm4os fWn8 • http://www.youtube.com/watch?v=dK2LZarp Nek
- 17. Monetary Policy- what is it? • Monetary Policy- central bank policy aimed at regulating interest rates and the amount of money in circulation to influence the health and direction of the economy
- 18. The Federal Reserve (Fed) • The Federal Reserve is America’s central bank, established in 1913 • Congress gave the Fed enough power to act independently in regards to monetary policy
- 19. Structure of the Fed • 1. Board of Governors – 7 member board that oversees the Fed from Washington D.C. – Appointed by the president and confirmed by the Senate for one 14 year term in office – President selects one governor to serve as chairman for 4 years – Responsible for the overall direction of monetary policy
- 20. Structure of the Fed • 2. Regional Federal Reserve Banks – 12 regional banks – Carry out many of the day-to-day duties – Each regional bank overseen by a president
- 21. Structure of the Fed • 3. Federal Open Market Committee (FOMC) – Consists of: • All 7 governors from the Board of Governors • 5 rotating regional fed presidents – **But always New York’s president – FOMC is the policymaking body of the Fed – Study economic information and decide what changes (if any) to make to monetary policy
- 22. Policies followed by Fed • Easy Money Policy (Expansionary) – Fed expands the money supply trying to cause cheaper lending to stimulate economic growth – Interest rates lower but too much easy money policy leads to INFLATION • Tight Money Policy (Contractionary) – Fed shrinks the money supply trying to cause lending to be more expensive to slow the economy – Interest rates rise but too much tight money policy leads to a RECESSION
- 23. Federal Reserve Reading • Pg. 286-288 – Read the rest of14.4 “What Tools Does Monetary Policy Use to Stabilize the Economy” • Complete Section E & F of “The Federal Reserve” Notes
- 24. Follow-Up Questions • What are open-market operations? • What is the reserve requirement? • What is the discount rate? • What is the purpose of these tools?
- 25. 3 Main Tools of the Fed • 1. Open Market Operations- the buying and selling of government securities in the bond market (most used tool) – Easy-Money Policy: • Fed bond traders BUY government securities, which increases the money supply – Tight-Money Policy: • Fed bond traders SELL government securities, which decreases the money supply
- 26. • 2. Reserve requirement- the minimum percentage of deposits that banks must keep in reserve at all times (least used tool) – Easy-Money Policy: • Fed LOWERS REQUIREMENT, which increases the money supply – Tight-Money Policy: • Fed INCREASES REQUIREMENT, which decreases the money supply
- 27. • 3. The Discount Rate- the interest rate the Fed charges on loans to private banks (last tool in their toolbox) – This tool leads to the Fed being known as the “lender of last resort” – Controlled by the Board of Governors – Easy-Money Policy: • Fed LOWERS rate, which increases the money supply – Tight-Money Policy: • Fed RAISES rate, which decreases the money supply
- 28. The Fourth “Tool” • 4. Federal Funds Rate- the interest rate that banks charge one another for quick (overnight) loans • Banks set this rate, so this is NOT a monetary policy tool • HOWEVER, the Fed sets a target rate based on its view of the economy & uses OMO to nudge the rate towards the target! – The Federal Funds Rate affects the interest rate on everything: credit cards, mortgages, savings accounts, bonds, etc.
- 30. Review of Monetary Policy • How does the Fed stimulate the economy?
- 31. UNIT #5 Fed REVIEW: • Define monetary policy in your own words. • If the Fed wanted to increase the money supply using the discount rate, what would they do? Would the Fed be attempting to stimulate or slow down the economy? • If the Fed wanted to decrease the money supply using reserve requirement, what would they do? What would happen to interest rates? • If the Fed wanted to increase the money supply using open market operations, what would they do? Would this be considered easy or tight money policy? • What is the relationship between interest rates and the amount of credit demanded?
- 32. How much do banks need to keep on reserves? Pat’s $1000 Deposited Pat’s $1000 - $200 in reserve LOAN Kim’s $800 for School books Pat’s $1000 – $200 in reserve PSU deposits $800 – $160 in reserve LOAN Dave’s $640 for New TV **In a sense, as banks continuously lend money that is not in reserves, they are “creating money” in the money supply. This lending is increasing the flow of money that ordinarily wouldn’t be able to happen!**
Editor's Notes
- THE BANKS OF BANKS! Why so many banks – no one bank could be all-powerful, regional structure more responsive to local needs 1913: Congress decides that there is a need to create The Fed Lacking the money to create The Fed, Congress asks banks in each district to contribute money to est. the institution (so member banks –banks belonging to the Fed – own it), they get stock in Fed back (Fed pays dividends to member banks) As a result, the private banks own the Fed and elect a board of directors to run in CONGRESS DOES NOT APPROPRIATE FUNDS (Fed is SELF-SUFFICIENT)
- FOMC – 8 meetings a year where they release their feelings/projections about economy & set the target fed funds rate (rate banks charge each other for overnight loans of reserve balances to each other) Prime Rate – set by banks, lowest interest rate charged to best customers Board of Governors – Elects a chairman for 4 years (this person reports to Congress twice a year) The Fed is an independent monetary authority, but it comes under political pressure to raise or lower interest rates. The president and Congress can affect the Board of Governors by appointing new members when governors’ terms expire.
- GOAL IS TO INCREASE MONEY SUPPLY FAST ENOUGH TO KEEP UP WITH GROWTH BUT NO FASTER! Easy money – consumers spend too much, increase in demand causes demand-pull inflation Tight money – deflation results with low levels of investment & spending
- THREE TOOLS ARE USED TO INFLUENCE THE TARGET FEDERAL FUNDS RATE! RR – change requirement for savings & checking accounts, powerful tool but very rarely used to influence monetary policy (CHANGED BY GOVERNORS) DR (rate charged by individual banks for loans obtained from the Fed Central Banks (set by Fed at anytime)– why getting loan from Fed. 1. Reserves could have dropped which shrinks excess reserves = less loans 2. Banks could face seasonal demand for loans (bank in agricultural area might have high loan demand during planting) 3. many withdrawals Banks shy away from borrowing from Fed because usually means they are in trouble, instead they borrow from fellow banks DR has been as high as 7.0% to low of 0.75% from 1990-2008 If lower rate then “opens window” for lending (LOOSE MONETARY POLICY) If high then “closes” window for lending (TIGHT MONETARY POLICY) OMO Want to increase money supply Fed buys gov’t securities from dealer who specializes in large volume transactions Fed writes a check to pay for it Dealer deposits check in his/her bank Bank forwards check to Fed & Fed “pays” check by increasing the bank’s reserves RESULT – Any time the Fed writes a check, reserves are pumped into banks (therefore more loans can be given) Shrink money supply Instructs Fed bond traders to Sell billions of $ of securities to dealers Dealers pay for securities with checks withdrawing from bank Fed processes checks by reducing reserves from bank Fewer reserves = less money to loan = less money supply
- Required to get quick loans if they don’t have enough reserves Why this rate? = easiest rate to change using OMO, affects interest rates for mortgages/credit cards/savings accounts/bonds
- The FOMC Policy Decision "The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability." Again, the FOMC opted for no change in the target federal funds rate, essentially repeating the March policy statement. 'The fed funds rate can't be used effectively to help the member banks, who borrow reserves at the fed funds rate from other member banks. With the target so low, monetary policy, especially open market operations, is not an effective stimulatory tool.
- The demand for money consists of consumers borrowing for such items as cars and homes, firms borrowing for such items as factories and equipment, and the government borrowing to finance the national debt. The supply of money is set by the Federal Reserve Board of Governors, the central banking system for the United States. The supply and demand for money determine the interest rate that must be paid for the use of borrowed money. So if the Federal Reserve increases the money supply, interest rates will fall, making it less expensive to borrow money. In that case, those wishing to borrow money will be more likely to do so-- and be more likely to spend that money on products. If the Federal Reserve reduces the money supply, interest rates will rise, so less will be borrowed and spent (because of the higher cost of borrowing).
- With every deposit, there is an increase in the lending power of the bank Thus, the monetary value of one deposit will have lending power well beyond its value