Download Macro4 Fed - Lynchland

Macroeconomics 4: The “Fed” and Monetary Policy
Banks cannot lend out all the money
deposited. They must keep some cash in
reserve. Billions of dollars. They have to
keep it in a bank. Our national banking
system where banks keep their reserve
money is called the Federal Reserve System.
The Federal Reserve System of banks is
who controls the total amount of money in
our economy. The “Fed” is 12 large regional
banks spread out across America. The “Fed”
is actually owned by the banks that are
members of it and store their reserves in it. It
is a privately owned company. And yet its
leaders determine how much money there is
in our economy, and their decisions cannot
be vetoed by anyone. The Chairman of the
Fed is therefore very powerful. He or she is
appointed by the President, serves for four
years, and may not be removed by the
President. This is so the Fed Chairman
makes wise decisions not influenced by
politics and keeping a President happy.
The Fed Chairman and his or committee
make decisions about the supply of money
in the US. They are tasked with keeping
unemployment and inflation both low. That
is usually hard to do. They try to do these
things by monetary policy: increasing or
decreasing the total amount of money in the
US economy.
They can do this several ways:
1. The Fed can change the amount of
money banks must keep in reserve.
2. It can change the interest rates it
charges banks to borrow money, and
the rate banks charge each other to
borrow.
3. The Fed can purchase or sell bonds
worth millions or billions of dollars.
Scenario One: GOOD TIMES
If the economy is going too well, that can
lead to inflation. Everyone has lots of money
to spend, companies are making lots of
money. When there’s lots of something, its
value goes down. That’s what inflation is:
the value of money going down, so prices go
up. To cool down the economy and reduce
inflation, the Fed committee will vote to:
1. Make banks keep more money in
reserve and lend less.
2. Raise interest rates, so people are
less likely to borrow money.
3. Sell bonds it owns, to remove cash
out of the economy.
But they have to be careful! Don’t cool off
the economy too much!!
Scenario Two: In a RECESION:
The Fed will vote to:
1. Let banks lend more money and keep
less in reserve.
2. Lower interest rates so its easier
people to borrow money. (The Fed
has done this – interest rates are at an
all-time low. And they say they’re
not going up anytime soon.)
3. Buy up bonds from the government
and from companies, thus putting
cash into the economy. This is
essentially how the Fed “prints more
money.” They just sort of create it
and say it’s there, then buy bonds
with the money. The Fed has done
this twice so far since the Great
Recession and is thinking about
doing another round.
These all serve to get more money into the
economy into the hands of businesses and
people, to spend, spend, spend. But once the
economy gets rolling again, the Fed has to
be careful – we don’t want inflation starting
back up!
Look at your money. Who is it issued by? It
says at the top: a national banking system
owned by banks, but somewhat controlled
by the government. Let’s hope Fed chairman
Bernanke keeps “pulling the right levers.”
 2012 Philip B. Lynch
Practice
Use your brain first; then look back if you must.
Ok – hard stuff. Monetary policy. Solve the word puzzles. GO SLOW.
Times are great. Everybody’s employed, their wallets are full, and they’re spending like sailors.
Inflation is high, though!
_____1. Which is a monetary policy the Fed should employ (use)?
a. raise interest rates
b. let banks lend more of their money
c. raise taxes
_____2. What’s another monetary policy the Fed should implement (use)?
a. lower interest rates
b. make banks keep more money in reserve
c. lower taxes
Times are tough. Unemployment is up, companies are doing poorly and people aren’t spending.
_____3. Which is a monetary policy the Fed should employ (use)?
a. raise interest rates
b. let banks lend more of their money
c. lower taxes
_____4. What’s another monetary policy the Fed should implement (use)?
a. make banks keep more money in reserve and lend less
b. lower interest rates
c. sell bonds so there is less cash in the economy
5. Circle A, B, or C; then explain. (I don’t care one iota which you choose, so be honest.)
A. I like learning about all this economics stuff because it is real life and now I know what is
going on.
B. meh
C. Economics is boring and I dislike it. Boo.
 2012 Philip B. Lynch