Transcript Federal Reserve - LegagneursLearningLounge

Macroeconomics:
Understanding the Difference
between Fiscal Policy and
Monetary Policy
SSEMA2
Students will explain the role and function of
the Federal Reserve System
Fiscal Policy
 Fiscal Policy- refers to governments taxing and spending
policy, and how it affects the economy.
1. Expansionary Fiscal Policy (BAD TIMES)- government
spends more money on goods and services- hopefully
leads to more jobs
a. Cut Taxes- lower taxes puts more money in
consumers hands to spend and invest.
b. Disposable Income- the income earned minus
taxes can only spend what’s available
c. Savings- unspent money
2. Contractionary Policy (GOOD TIMES)- government
spends less, leads to slower GDP growth.
a. Raise Taxes- raising taxes reduces income
for businesses and consumers, slows GDP.
How Taxes Work
 Taxes- used by the federal government to pay for services
and goods for Americans
1. Tax base- is the income, property, good, or service
that is subject to a tax.
 Three Types of Taxes
1. Proportional tax- is a tax for which the percentage of
income paid in taxes remains the same for all income
levels. (SALES TAX)
2. Progressive tax- is a tax for which the percent of
income paid in taxes increases as income increases.
(INCOME TAX)
3. Regressive tax- is a tax for which the percentage of
income paid in taxes decreases as income increases.
(SOCIAL SECURITY/MEDICARE)
Impact of Fiscal Policies
 Limits to Fiscal Policy1. Difficulty of Changing Spending- small part of the
budget
2. Predicting the Future- nobody understands the
economy and its hard to react at the right time
3. Delayed Results- takes time for change to be felt
4. Political Pressure- Voters put pressure on
representatives to reduce taxes and cut spending
5. Government Coordination- the different branches and
services need to work together to implement good fiscal
policies (IMPOSSIBLE)
The Federal Budget
 Budget Surplus- when the government taxes exceed
government expenditures (costs).
 Balanced Budget- when taxes collected equal to government
expenditures.
 Budget Deficit- When the government collects less taxes than
its spends.
National Debt
 How does a government pay for Budget Deficits?
1. Borrow- government borrows money to pay for the
deficit.
2. Sells: Government Securities known as: Treasury
Bonds, Savings Bonds, etc…
 National Debt- is the total money owed by the government to
anyone who owns a Treasury Bond or Savings Bonds.
1. Payback- We owe 11 trillion dollars and the interest
we owe must be paid first and cuts out on the goods or
services the government can provide. (education,
defense, health care, etc…)
 Difference between National Debt and Budget Deficit- a
deficit is one year, and the national debt is the total amount
owed by the country.
Federal Reserve System
 Chaos- Before 1913 every bank could print its own money,
which meant at anytime there could be lots of money or very
little money available for businesses and people.
 Federal Reserve- established in 1913 to regulate the amount
of money available in the economy.
 The Federal Reserve System Organization
1. Board of Governors- 7 member group that oversees
the Federal Reserve and set monetary policy in the
FMOC
a. Chairman of the Federal ReserveBen Bernanke
Federal Reserve System
2. Federal Reserve Districts- 12 Federal Banks throughout the
country that monitor and report on economic activity
3. Member Banks- all nationally chartered banks join the
Federal Reserve and are partners allowing it to operate
independently of the government.
4. FOMC- Federal Open Market Committee is composed of the
Board of Governors and 12 District Banks
4,000 member banks and 25,000
other depository institutions
Board of Governors
Federal Open Market Committee
12 District Reserve
Banks
Structure of the Federal Reserve System
The Federal Reserve as a server
 Federal Reserve serving the Government
1. Bonds- The Fed sells all U.S. bonds
2. Currency- The Fed prints all paper money
 Federal Reserve serving Banks
1. Checks- all checks are cleared through the Fed
2. Bank reserves- ensures that banks maintain 10% of all
deposits to cover their customers.
3. Lender of Last Resort- in case of emergency (2008)
the Fed will lend money to commercial banks to keep
them afloat.
4. Problems- the Fed can force banks to sell risky
investments if they are too exposed to too much liability
The Fed regulates the money
supply
 MONETARY POLICY- changes in the supply of money and
credit offered by the Federal Reserve.
 What affects the money supply?
1. Money- allows for easier transactions
2. Higher prices- as prices rise so does the demand for
cash
3. Interest Rates- The price charged to borrow money,
High Interest=decrease demand for cash.
Low Interest=increase demand for cash
4. Home Income- as income rises so does the demand
for more cash
5. Watching- The Fed watches the supply of money and
the demand for money to keep inflation low.
First tool of the Federal Reserve
 The First Tool- Required Reserve Ratio
1. Required Reserve Ratio- the amount of money a bank
must keep on hand and not loan out, set by the FED.
2. Reducing the RRR- lowering it allows banks to lend
out more money. (MONEY SUPPLY INCREASES)
3. Increasing the RRR- raising it causes banks to keep
more money on hand. (MONEY SUPPLY DECREASES)
Second Tool of the Federal Reserve
 The Second Tool- Discount Rate
1. Discount Rate- the interest rate banks pay to borrow
money from The Fed.
2. Reducing the Discount Rate- makes it easier for banks
to loan out money by making it cheaper for banks to
borrow. (MONEY SUPPLY INCREASES)
3. Increasing the Discount Rate- makes it harder for
banks to borrow money by making it more expensive to
borrow money. (MONEY SUPPLY DECREASES)
Third Tool of the Federal Reserve
 The Third Tool- Open Market Operations
1. Open Market Operations- the buying and selling of
government securities to alter the money supply.
2. Bond Purchaser- the Fed buys securities.
(MONEY SUPPLY INCREASES)
3. Bond Seller- the Fed sells securities.
(MONEY SUPPLY DECREASES)
Why does the Federal Reserve
watch money?
 Money and Business Cycles1. EASY MONEY POLICY- During a bad economy The
Fed will relax interest rates to increase spending, this
EXPANDS the ECONOMY
2. TIGHT MONEY POLICY- The Fed will raise interest
rates, to decrease spending and lower the money
supply. This is to CUT OFF INFLATION
3. Timinga. Right- the economy will go through peaks and
contractions quickly and easily.
b. Bad- The economy will go through extreme
cycles of Expansions and Contractions
American Banking System
 Financial System- this is a system that transfers money
between savers and borrowers
 Financial Middlemen
1. Banks- Take in deposits from savers and then lend
some of these funds to various businesses.
2. Finance Company- Make loans to consumers and
small businesses, but charge borrowers higher fees and
interest rates to cover possible losses.
3. Mutual Funds- Pool the savings of many individuals
and invest this money in a variety of stocks and bonds.
4. Life Insurance Companies- Provide financial protection
for Life, Auto, Home, Disability.
5. Pension Funds- Are set up by employers to collect
deposits and distribute payments to retirees
Financial Intermediaries
Savers make deposits to…
Financial Institutions that make loans to…
Commercial banks
Savings & loan associations
Savings banks
Mutual savings banks
Credit unions
Life insurance companies
Mutual funds
Pension funds
Finance companies
Investors
Services offered by Financial
Institutions
 Savings- placed directly in an account with a bank it earns a
little interest.
1. Safe- very safe since banks must keep a certain
amount of RRR to pay on savings accounts.
2. Federal Deposit Insurance Company (FDIC)government agency that insures up to 250k on all
savings accounts.
 Interest- money banks pay on your savings accounts.
1. Interest Earned- amount paid on a bond, savings
account, CD or stocks.
2. Interest Charged- amount you are charged by a bank
when you borrow money for a car, house, student loan.
THIS IS HOW BANKS MAKE MONEY.
Services cont’d…
 Certificate of Deposit (CD)- you deposit a fixed amount for a
certain period of time, in exchange for a higher interest rate.
1. Safe- very safe no risks
 Bonds- are IOU’s that you buy from a corporation,
organization or government.
1. Payment- the borrower pays you periodically interest
on the loan and then repays you the entire loan on the
due date, usually years later.
2. How are Bonds used? - Government uses them to pay
other debts or public good projects. Corporations use
them for capital investments.
3. Safe- very safe no risks
Services cont’d…
Stocks- offer the biggest payouts but the highest risks
1. Safe- Very Risky can lose all your money
2. Capital Gains- if you sell your stocks at a profit you
pay these taxes on the stocks sold.
Mutual Funds- pools of money from many different investors to
buy a large variety of stocks in a PORTFOLIO.
1. Safe- a combination of both High Risk and Low Risk
stocks- Makes this safe
2. Why Buy- because of the mix investors almost never
lose all their money
Becoming Creditworthy
 Are you creditworthy?
1. Work
2. Income
3. Savings
4. Current Expenses
5. How many people depend on you for their needs
6. Debt
7. Collateral- something the bank can take from you if
you fail to repay your loan
8. Credit History- shows if you pay your bills
9. Credit Score- Higher it is the more likely a bank will
lend you money and vice versa
Interest Rates
 Annual Percentage Rate- the amount charged annually
 Fixed Interest Rates- never changes
 Variable Interest Rates- can go up at any time
 Simple Interest Rates- you are charged interest only on the
original amount of the loan.
$1,000 loan with 10% interest rate for a year=
1,000 + (.10 x 1000)= $1,000 + 100= $1,100
 Let’s try another: $1,000 @ 10% interest for 2 years,
remember to add a (.10 x 1000 for each year).
Interest Rates
Compound Interest Rates: interests is charged not only on the
original amount you borrowed, but also on the amount you
still owe.
$1,000 loan with 10% interest rate for 2 years=
1st year: $1,000+ (.10 x 1,000)= $1,000 + 100= $1,100
2nd year: $1,000+ (.10 x 1,100)= $1,100 + $110= $1,210
 Credit cards: use compounded interest rates but monthly,
which causes people to owe more and more each month.