Transcript Money and Monetary Policy

Money and Monetary Policy
Objectives
• Examine the characteristics and functions of
money
• Identify three tools used to control with value
of a given currency
• Explain how monetary policy tools are used to
control the macroeconomic environment
• C3 Po5&6
Before money we had Barter
• Barter is a
voluntary
exchange of
items which are
not alike or set
in value
• Barter is alive
and well, but has
drawbacks
Drawbacks of Barter
• Uncertain connection of
producers & consumers
• Uncertain valuation of
barter goods
• Indivisibility of some
barter goods
• Storage of excess
Money is…
• 6 characteristics (U.P.A.D.D.L)
– Uniform
– Portable
– Acceptability
– Durable
– Divisible
– Limited Supply
U.P.
Uniform
• Looks the same over time
• Changes well publicized
Portable
• Light and Flexible
• Metals, Cotton, Plastic
• Yap Islander Coins
A.D.
Acceptability
• US Dollar is int’l reserve
currency (used by smaller
countries to store value)
• Accepted worldwide except
(officially) by Cuba and N.
Korea
Durable
• Average life of a $1 bill
• 6 months
• Average life of a $1 coin
• 13 years!
• Made of metals, cotton,
plastic, shell,
D.L.
Divisible
• Available in various
denominations
•
•
•
•
•
Mexico= Pesos & Centavos
Russia= Rubles & Kopeks
UK=
Pounds & Pence
India= Rupees & Paistres
China= Yuan & Jiao
Limited Supply
• Small supply= High Value
• Old bills shredded
• Counterfeits increase Q
Supply
• http://www.newmoney.gov
/newmoney/flash/interactiv
e100/index.html
Who’s on the Money Matching
US Historical Figure
Denomination
•
•
•
•
•
•
•
•
•
•
•
•
•
•
A. Jackson
B. Lincoln
C. Jefferson
D. Washington
E. Grant
F. Franklin
G. Hamilton
$1
$2
$5
$10
$20
$50
$100
Three Functions of Money
• Money Does…
– Medium of exchange
• I trade 1 hour labor for $31.25/hr
+ benefits
– Unit of account
• I check prices at several stores
– Store of Value
• I have $2000 in my savings
Monetary Policy (Simplified)
Monetary Policy
• Monetary policy manipulates the Q Supply of
money in circulation to lessen bad effects of
business cycles
• M Policy is controlled through
– Interest Rates
– Reserve Ratios
– Bond Sales
Interest
• Interest is a % fee paid to borrow money
• The Federal Reserve set the Prime Interest
Rate,
– PIR= the interest Federal Reserve charge large
banks for large loans via the “Discount Window”
• The Federal Reserve can speed up borrowing
by lowering the Prime Interest Rate
• The Federal Reserve can slow borrowing by
raising the Prime Interest Rate
US Federal Reserve
• The Federal Reserve is
the Central Banking
System of the United
States
– Run by Board of
Governors
– Divided into 12 regions
($1 letters A-L)
– Made up of member
banks
• Bank of America, Chase
From Interest to Demand
Prime Interest Rate Practice
Up Or Down?
• The US economy is going to
fast and prices are feeling
inflationary pressures (going
up) hurting consumers. The
Fed should…
Up or Down
• The US economy is falling
fast into recession. Prices
are deflating (dropping),
hurting businesses. The Fed
should….
• Raise Interest Rates to
increase borrowing costs
• Lower Interest Rates to
increase borrowing costs
• Raise Interest Rates to
decrease borrowing costs
• Lower Interest Rates to
decrease borrowing costs
Reserve Ratio
• Banks work by loaning out depositors money
and collecting interest
– Assuming few depositors will need money daily
– Assuming loans will be repaid on time with interest
• Reserve Ratio is the amount of money banks
must keep on hand to cover withdrawals.
• Set by Federal Reserve
• Lower reserves=Faster economy
• Higher reserves=Slower economy
Money Multiplier Effect
• Formally called
fractional
reserve banking
• Money
Multiplier is the
effect of a cycle
of deposits and
loans in money
creation
Reserve Ratio Practice
Increase or Decrease?
• Banks are making riskier
and riskier loans, and home
prices are spiking higher.
The Fed should…
Increase or Decrease?
• Despite Record Low Interest
rates, Home prices continue
to drop. The Fed should…
• Increase the Reserve Ratio
to cover possible losses
• Decrease the Reserve Ratio
to cover possible losses
• Increase the reserve ratio to
stimulate demand
• Decrease the reserve ratio
to stimulate demand
Bond Sales
• Bond Sales- Also Called Open Market
Operations, this is the most used monetary
policy tool
• US Bonds borrow money from public for US
gov. use.
• Federal Reserve Eases Monetary Policy though
buying US Treasury bonds from investors
• Federal Reserve Tightens Monetary Policy
through selling US Treasury bonds to investors.
• The Fed Can fight inflation by Selling Bonds
Easing and Tightening Example
Easing
• I spend $50,000 to buy a
$100,000 US Treasury Bond,
due in 2030.
• Fed Reserve wants me to
spend more money right
now-speed up economy
• Fed offers to buy the bond
from me today for $75,000.
• I accept, and can now spend
principle (50k) + profit (25k)
tomorrow on a Corvette.
• Fed can cash in bond in 20
yrs for a $25,000 profit
Tightening
• Fed owns $100,000 US
Treasury Bond, due in 2020
yrs. Purchase price was $75k
• Fed wants me to stop
spending-slow economy
• Fed offers to sell me bond
today for $80,000. Profit?
• I accept and tie up my money
for 10 years. Economy slows.
• I cash in bond in 2020. Profit?
Easing/Tightening Practice
E or T?
• Economy is going too fast
and inflation is starting to
drive up prices. Should the
Fed…
E or T?
• Economy is slowing and
unemployment is starting to
rise. Should the Fed…
• BUY Bonds to take money
out of circulation
• SELL Bonds to take money
out of circulation
• BUY Bonds to put money
back into circulation
• SELL Bonds to put money
back into circulation
Fed Reserve Chairman Game
• http://www.frbsf.or
g/education/activiti
es/chairman/index.
html
• So where is the
most money in the
banking system?
– M1
• Cash and Cash
instruments
– M2
• Small Value, Short
Time Deposits
– M3
• Large Value,
Longer Time
Deposits (best
rates of interest
M1-M3
Summary
• Money is a tool
• The Federal Reserve Controls Money Supply in
the USA
• Interest Rates, Reserve Ratios and Bond Sales
are the three main monetary Tools
• Most of the money in the economy is in
investments, land and other long term assets