Transcript Monetary Policy

5-3-06: Nebraska’s
Unemployment Rate
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3.2%
– Down .2%
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IS THIS
NECESSARILY A
‘GOOD’ NUMBER?
Summarize your investment
strategy
Read Bob Bennie’s letter on growth
and value investing.
WHICH STRATEGY ARE YOU
USING?
Monetary Policy
Chapter 14
How to “fix” a broken economy
Who is Ben Bernanke?
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1953 –
Bachelor’s Degree
Harvard / PhD from MIT
Taught econ at Princeton
Wrote textbooks, articles
on econ issues
Headed National Bureau
of Econ Research.
– Collected data for
government, industry and
the Federal Reserve
How did Bernanke become the
Fed Chairman?
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Short list for the
President.
Nominated,
interviewed by the
Senate and voted on.
7 year term
– TRIVIA: Ben
Bernanke’s title is:
– Chairman of the Board
of Governors of the
Federal Reserve
Federal Reserve Transition
Problems?
Will there be transition problems
for Bernanke?
Something to Remember!
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There are only TWO
ways that government
can influence the
economy:
– FISCAL POLICY
» What Congress /
President can do
– MONETARY POLICY
» What Alan Greenspan
did and now Ben
Bernanke can do
Monetary Policy = The “Fed”
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Federal Reserve Bank
– The government’s bank
– Regulates all FDIC
banks in the country
– Controls the money
supply for the country.
» Watches for inflation
» Keeps money available
but valuable to people.
Federal Reserve Districts
Monetary Policy – 1 More and
Controversial “Duty”
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ADVISE
– Presidents
– Congress
– The Stock Market
– Advice is not always
welcomed!
How does the Fed control the
economy?
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Controls the money
supply for the banks.
 INTEREST
RATES
REVIEW:
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What are “INTEREST
RATES”?
– How much money
COSTS to get.
» $3000 loan from a bank
might have 10%
interest.
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You pay $3,300 back
to the bank.
Profit for banks
So how did Ben Bernanke cause
your stocks to go down?
Situation from April 28, 2006
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Ben Bernanke had
recently been reported
saying:
– “The Fed is finished
raising interest rates for
the time being.”
» 15 increases since
Spring 2004 were
“enough.”
But on April 29, 2006
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Speaking to a CNBC
reporter, he said:
– “I think that the
reporters
misunderstood my
position on interest
rates for the
foreseeable future.”
Result? May 1 and May 3
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Bernacke’s comments
were reported at 2:45
PM. By 3:15 the
DOW fell 70 points.
Wednesday’s down
markets were
supposed to be
investor “jitters about
the Fed.”
Why would investors care what
interest rates are going to be?
Why would the Fed keep
increasing interest rates?
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Fears about inflation?
– Demand-pull inflation?
– Wage inflation?
– Fears that there is too
much velocity to the
dollar?
Cramer’s Question:
“Does the Fed want to create a
RECESSION???”
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IF there is inflation in
the economy –
YES! The Fed could
want to create a
recession.
REVIEW:
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What is a RECESSION?
– People HAVE money, but
don’t feel “safe” about
spending it.
» Creates unemployment
» Bad econ data
» Creates MORE
unemployment.
– 2 or more business
quarters where economic
activity decreases.
» OFFICIAL definition
How could raising interest rates
cause a recession?
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If interest rates go UP
– People spend less
– People don’t take out
loans
– People SAVE their
money
– Money increases in
value
» PURCHASING
POWER GOES UP!
» Inflation “deflates”
Opportunity Costs of a
Recession?
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Unemployment goes
up.
Wages go down.
– More supply than
demand for workers.
– Less frictional
unemployment.
– Government collects
less taxes and people
want more aid.
So what does that mean for your
stock portfolios?
DO NOT PANIC!
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The Fed has been
gently “tapping the
brakes” on the
economy since Spring
2004 to slow us down
enough that a
recession may not
happen.
– OR be very short and
mild.
History of Recessions in the US
Description for 2006’s Economy?
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Strong
Outperforming
BUT
– Soft patches
– Inflationary pressures
and expectations
So, what can the Fed do to keep the
economy going, but not have inflation?
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Keep interest rates the
same?
Raise interest rates
another .25%?
– 6%
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Raise interest rates
.5%?
– 6.25%
» MOAIRH!
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Mother Of All
Interest Rate Hikes
The Goals of the Federal Reserve
Regulating the money supply
 Serving as the government’s bank
 Bank for banks
 Supervising FDIC banks.
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– Clearing checks
– loans
The Money Supply: Types of
Money
M1: Money that is
readily made into cash
or is cash.
M2: M1 + savings CDs,
money markets,
savings deposits.
M3 and L: M1 + M2 +
large CDs, short term
treasury bonds and
other
“near money.”
10
0
0
1st 4th
The Federal Reserve tries to affect
DEMAND for money, goods, and
services
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Specifically –
AGGREGATE
demand
– Aggregate Demand =
TOTAL demand
» EVERYTHING that is
consumed in the
economy.
How does the Fed affect
aggregate demand?
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IF things cost more,
does that affect how
much we DEMAND?
If things cost less – do
we tend to demand
more?
It all demands on the
COST, or the
purchasing power of
our dollar.
How does the Fed affect
aggregate demand?
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The Fed changes the
price of money to
affect:
– Consumer demand
– Investor demand
– How much money
government will want /
get
– The value of American
exports compared to
imports
IF the Fed wants to help
unemployment or a slow economy:
Recession
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EASY MONEY
POLICY: (Loose
Money Policy)
– Interest rates go
DOWN – money is
CHEAP!
– Consumers spend!
– Investors spend!
– American exports are
cheaper than imports!
Easy Money Policy
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Employment goes up!
GDP goes UP!
Economic Recovery or
Peak in the business
cycle.
BUT: If the economic engine is
running “too hot” and inflation is
happening?
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TIGHT MONEY
POLICY:
– SLOW the economy
down.
– RAISE the interest
rates so money costs
MORE
If Interest Rates Go UP?
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Consumer goods cost
MORE
Loans cost MORE
– People don’t buy on
credit
– People don’t take out
loans
– Businesses don’t take
out loans
– Imports cost less than
American made goods
Tight Money Policy
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Unemployment goes
up.
People save more.
Wages go down
Prices go down.
2006: The Fed is engaged in
Tight Money Policy - kinda
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Have 15 “tiny”
increases in the price
of money been enough
to affect behavior?
What does the Fed
want out of us?
So, what can the Fed do to keep the
economy going, but not have inflation?
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Keep interest rates the
same?
Raise interest rates
another .25%?
– 6%
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Raise interest rates
.5%?
– 6.25%
» MOAIRH!
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Mother Of All
Interest Rate Hikes
Concerns about the future:
Inversion of the Yield Curve
Yield Curve Inversion: A signal
of recession?
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USUALLY: The
longer you put money
into a CD / Bond – the
more money you
should get more
interest. Right?
With the present curve
the answer is
WRONG!
– What does this mean??
» WE DON”T KNOW!
Ben Bernanke’s Tools for the
Economy
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Open Market
Operations.
Discount Rate
Prime rate
Reserve Requirements
Open Market Operations
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If Bernanke wants to get more money into the
economy he BUYS government bonds from
banks.
– Banks have more money to loan to customers.
– People then have more money to consume and
invest.
– A way to quickly “inject” money or take it out of
the economy.
Reserve Requirement
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Money that must be held by banks in their
vaults or at the Fed.
-Raise the reserve requirements on a bank. They
have LESS money to loan to customers.
Less money is available – it makes the price of
money (the interest rate) go up. SCARCITY.
Makes C and I go down.
FOMC Meetings: Where the Fed
gives people a “peek” at what they
are doing
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KEY INTEREST RATES
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DISCOUNT RATE:
– What it costs for banks to
borrow from the Fed.
» 5.75%
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PRIME RATE:
– Rate for best customers!
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FED FUNDS RATE:
– What it costs for banks to
loan money to each other.
» Currently: 4.75%
Problems with Monetary Policy?
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Economic forecasting
might not be quite
correct.
Greenspan’s priorities
might not be the
publics.
Lack of coordination
with fiscal policies.
Remember: The FED is not
YOUR bank
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It is the government’s
bank
It is the bank for banks
They won’t open an
account for you!