Transcript Chapters 16 and 17 Fixing an Economy Monetary Policy and

Fixing an Economy:
Monetary Policy
Federal Reserve, Money
Supply, and Banking
CHAPTERS 16 & 17
WHAT MAKES
MONEY, MONEY?
Since we are talking about Monetary policy,
we should make sure we understand why
money is important.
SWS 2009
WHAT MAKES MONEY, MONEY?
History of US currency
For centuries currency has been in the form of
precious metals (gold, silver, copper)
US currency was based on gold until 1973
President Nixon abolished the gold standard
since no additional currency could be printed for
a growing economy if that currency is based on
a fixed commodity (product).
So what backs the value of the
currency in this country…
SWS 2009
Faith!
WHAT MAKES MONEY, MONEY?
The 2 Categories of Money
 Fiat
Money (representative money) is
used as money because of
government decree.
 It
does not have intrinsic value.
 Examples: Present day coins, paper
currency, check deposits, credit cards.
SWS 2009
WHAT MAKES MONEY, MONEY?
The 2 Categories of Money
 Commodity
Money takes the form of
a product with intrinsic value.


The material ITSELF has value!
Examples: Gold, silver, cigarettes.
SWS 2009
WHAT MAKES MONEY, MONEY?
Money has to have three functions
in the economy:
1) Medium of Exchange
2) Unit of Account
3) Store of Value
SWS 2009
3 FUNCTIONS OF MONEY
1.) Medium of Exchange
A medium of exchange is
anything that is acceptable as
payment for goods and services.
OR
IN
EXCHANGE
FOR
SWS 2009
A GOOD OR
SERVICE
3 FUNCTIONS OF MONEY
2.) Unit of Account
A unit of account is the yardstick people
use to post prices, record debts, and
compare values.
We use it to COMPARE the value of two or more goods
EXAMPLE: Measuring the WORTH of your chores
DUTY
$ WORTH
TRADE VALUE
CUT THE YARD
$40.00
Video Game
CUT THE YARD + WASH &
WAX THE CAR
$100.00
Video Game + Clothes
CUT THE YARD, WASH & WAX
THE CAR, & CLEAN THE
WHOLE HOUSE
$300.00
XBOX 360
SWS 2009
3 FUNCTIONS OF MONEY
3.) Store of Value
A store of value is an item that
people can use to transfer
purchasing power from the present
to the future.
IT WILL HOLD
VALUE. SO THAT
IT CAN BE USED
SOMETIME LATER.
SWS 2009
The Federal Reserve
The Federal Reserve (Fed)
serves as the nation’s central
bank.
1) Regulates Banks Practices to ensure they
follow federal laws intended to promote safe
and sound banking practices.
2) Acts as a Banker’s Bank, making loans to banks
and as a lender of last resort.
3) Conducts Monetary policy by controlling the
money supplied to the public.
$
SWS 2009
$
$
$
$
$
The Federal Reserve and
some clarification!
Monetary Policy:
 IS NOT PRINTING MONEY
 The Federal Reserve is NOT
responsible for printing money!
Federal Reserve
SWS 2009
The Fed’s
Organization
 The Fed is run by a
Board of Governors,
which has seven members appointed by
the President and confirmed by the Senate.
 Among the seven members, the most
important is the chairman (Ben Bernanke)
 The chairman directs the Fed staff, presides
over board meetings, and testifies about Fed
policy in front of Congressional Committees.
SWS 2009
The Federal
Reserve System

The Structure of the Federal Reserve
System:
 The
primary elements in the Federal
Reserve System are:
1) The Board of Governors (7 members)
2) The 12 Regional Federal Reserve Banks
3) The Federal Open-Market Committee
SWS 2009
The 12 Federal Reserve Banks
Since each district has
different money needs the
various branches deal with
each region independently.
What is Monetary Policy?
Monetary Policy:
 Controlling the economy through
increasing or decreasing the money
supply.
 Two Types of Monetary strategy:
1) Tight Money: taking money out of the
economy (decrease money supply)
2) Easy Money: putting more money in the
economy (increase money supply)
SWS 2009
Fed’s Tools of
Monetary Control
The Fed has 3 “tools” in its monetary toolbox:
1) Open-Market Operations (buying & selling
government securities)
2) Changing the Reserve Requirement
3) Changing the Discount Rate
SWS 2009
Monetary Policy Tools
REGULATING THE MONEY SUPPLY THROUGH BUYING/SELLING BONDS
1. OPEN-MARKET OPERATIONS
The money supply is the quantity of
money available in the economy.
 The primary way in which the Fed
changes the money supply is through
open-market operations.

 The
Fed BUYS and SELLS U.S. Government
Bonds and/or other U.S. Securities
Let’s look at a graphic example…
SWS 2009
Monetary Policy Tools
REGULATING THE MONEY SUPPLY THROUGH BUYING/SELLING US SECURITIES
1. OPEN-MARKET OPERATIONS
MONEY SUPPLY =
INCOME, INFLATION & GDP =
Federal Reserve
INTEREST RATES =
SELLS
GOVERNMENT
SECURITIES
SWS © 2009
Consumers, Banks,
Businesses & Countries
Monetary Policy Tools
REGULATING THE MONEY SUPPLY THROUGH BUYING/SELLING US SECURITIES
1. OPEN-MARKET OPERATIONS
MONEY SUPPLY =
INCOME, INFLATION & GDP =
Federal Reserve
INTEREST RATES =
BUYS
(back)
GOVERNMENT
SECURITIES
SWS © 2009
Consumers, Banks,
Businesses & Countries
Monetary Policy Tools
CONTROLLING THE MONEY SUPPLY THROUGH BANKS
2. THE RESERVE REQUIREMENT
Reserves are deposits that banks
have received but have not loaned
out.
 In the U.S. we have a fractional
reserve banking system:

 banks
hold a fraction of the money
deposited as reserves and lend out the
rest.
SWS 2009
Monetary Policy Tools
CONTROLLING THE MONEY SUPPLY THROUGH BANKS
2. THE RESERVE REQUIREMENT
The money supply in America is affected
by the amount deposited in banks and
the amount that banks loan out.
 The fraction of total deposits that a bank
has to keep as reserves is called the
reserve requirement ratio.
 Put another way, the reserve requirement
is the amount (%) of a bank’s total reserves
that may not be loaned out.
SWS 2009
• Peak: increase the reserve
requirement in order to stop
banks from lending so much.
This stops $ entering economy.
• Trough: decrease reserve
requirement in order to have
banks lend more to stimulate
economy. This allows $ to enter
economy.
Monetary Policy Tools
CONTROLLING MONEY SUPPLY THROUGH THE INTEREST RATE
3. THE DISCOUNT RATE
Changing the Discount Rate
The Discount Rate is the interest rate the Fed
charges banks for loans.
 Increasing the discount rate decreases the
money supply (peak).
 Decreasing the discount rate increases the
money supply (trough).
 Basically, if the Federal Reserve charges
banks more interest to borrow money then
the banks have to charge higher interest on
all loans.

Monetary Policy Tools
REVIEW: TOOLS OF MONETARY POLICY
Open-Market Operations
The Reserve Ratio
The Discount Rate
What will happen to the money
supply in the following situations?
Examples:
•Buy securities
MONEY INCREASES
•Increase Reserve Ratio
MONEY DECREASES
•Raise Discount Rate
MONEY DECREASES
•Sell Securities
MONEY DECREASES
•Decrease Reserve Ratio
MONEY INCREASES
•Lower Discount Rate
MONEY INCREASES
Monetary Policy Tools
Open-Market Operations
The Reserve Requirement
The Discount Rate
SWS 2009
Fiscal Policy Tools
Taxes
Government Spending
Transfer Payments
SWS 2009
END CHAPTERS 16 & 17
MONETARY POLICY, FEDERAL
RESERVE & MONEY
SWS 2009