Download Money And the Federal Reserve

Chapter 5
Money and the
Federal Reserve
These slides supplement the
textbook, but should not
replace reading the textbook
1
What is barter?
The practice of trading one
good or service for another
2
What is a double
coincidence of wants?
A situation in which two
traders are willing to
exchange their
products directly
3
What is money?
Anything that can be
used to signify
someone’s credit and
someone’s debit in a
financial transaction
4
What are the 4 basic
functions of money?
Medium of exchange
Unit of account
Store of value
Standard deferred payment
5
What a
medium of exchange?
Money is accepted
in exchange for a
good or service
6
What a
unit of account?
Money is used to
compare the relative
value of different
goods and services
7
What a
store of value?
Money is used as a
means of saving
8
What a
standard of
deferred payment?
Money is used to keep
track of the method and
the amount of money is to
be paid back in the future
9
What are the
properties of money?
Scarcity
Portability
Divisibility
10
What is
commodity money?
Anything that serves
both as money and
as a commodity
11
What is
token money?
Money that exceeds
the value from which
it was made, for
example, quarters
12
What are examples
of money?
Federal Reserve Notes
Coins
Checks
Travelers checks
13
What does the term
liquidity mean?
The easier something is to
spend the more liquid it is,
the more difficult it is to
spend the less liquid it is
14
Which form of money
is most liquid?
It all depends on the
circumstances
15
What is fiat money?
Money not redeemable for
any commodity; its status
as money is conferred by
the government
16
What is legal tender?
Currency that constitutes
a valid and legal offer of
payment for debts
17
Does gold or silver
back up our money?
No, our money is not
backed up by anything
18
Why does money
have value?
It is useful and
relatively scarce
19
What determines the
value of money?
The general price level
20
Why are banks called
depository institutions?
Because they accept
deposits from the public
21
What are
commercial banks?
Depository institutions
that make loans to
the public
22
What are
demand deposits?
Accounts at financial
institutions that pay no
interest and on which
depositors can write checks
to obtain their deposits
23
How do banks
make profit?
After interest paid or
services rendered minus
costs equals bank’s profit
24
Who were the
first bankers?
Goldsmiths in the middle ages
25
What is the Federal
Reserve System?
The central bank and
monetary authority of
the United States;
known as “the Fed”
26
What is the function
of the Fed?
To ensure the availability
of enough money and
credit in the banking
system to support a
growing economy
27
When was the
federal reserve
system established?
The Federal Reserve
Act of 1913
28
Does the Fed loan
money to private
companies?
No, they only do
business with
financial institutions
29
Why would the Fed
want to decrease the
money supply?
To lower inflation
30
Why would the Fed
want to increase the
money supply?
To stimulate employment
31
How many Federal Reserve
banks are there?
The U. S. is divided into 12
Federal Reserve districts,
each district has a Federal
Reserve Bank
32
Who makes the
decisions for the
Federal Reserve?
The Board of Governors
and the Open Market
Committee
33
How long do most
board members serve?
14 years, after which they
cannot serve again
34
How long does
the chairman of
the board serve?
The Chairman serves
4 years, but can
serve again
35
What is the Federal Open
Market Committee?
Made up of the 7 board
members and 5 presidents
of Federal Reserve Banks
36
What is the role of
the Federal Open
Market Committee?
The FOMC makes
decisions as to the
buying and selling of
government securities
37
Member Banks
 owns stock in Federal
Reserve
 only national banks are
required to be members
38
Why are some banks
not members of
Federal Reserve?
High minimum capital
requirements
Restrictions & regulations
Can use Fed’s major
facilities anyway
39
What do the letters
FDIC stand for?
The Federal Deposit
Insurance Corporation
40
When was the FDIC
established?
1933
41
What is the function
of the FDIC?
To ensure deposits in any
banking institution that
purchases FDIC insurance
42
How much are
deposits insured for?
Each account in a bank is
insured up to $250,000
per depositor per bank
43
What is the Full
Employment and Balanced
Growth Act of 1978?
Among other things the
Federal Reserve was
mandated to do everything in
its authority to achieve full
employment and stable prices
44
What was the
Glass-Steagall Act of 1932?
Separated depository banks
from Wall Street investment
banks, it regulated the
commercial banks but not
the investment banks
45
What was the
Financial Services
Modernization Act of 1999?
Because of lobbying efforts of
Citigroup and other large banks
who wanted to underwrite and
trade financial instruments such
as collateralized debt
obligations the Glass-Steagall
Act was repealed
46
What is a Collateralized
Debt Obligation?
A CDO is an structured asset
backed security whose
value and payments are
derived from a portfolio of
fixed income underlying
assets, such as mortgages
47
How does a CDO work?
A CDO is a promise to pay
cash flows to investors in
a prescribed sequence,
based on how much the
CDO collects from the
pool of assets, the higher
tranches first and the
lower tranches last
48
What is the name of the
market where money is
bought and sold?
The loanable funds market
49
Why would the Fed
want to expand the
money supply?
If we have
unemployment the Fed
wants to increase the
money supply to
stimulate employment
50
Why would the Fed
want to contract the
money supply?
If we have inflation the
Fed wants to decrease
the money supply to
bring down prices
51
What does the term
liquidity mean?
A measure of the ease
with which an asset can
be converted into money
without significant loss in
its value
52
What does liquidity
have to do with the
money supply?
With inflation the Fed
wants banks to be less
liquid
With unemployment the
Fed wants banks to be
more liquid
53
What makes a bank
more or less liquid?
A lot of cash in excess
reserves - very liquid
Little cash in excess
reserves - less liquid
54
What is a
required reserve ratio?
The ratio of reserves to
deposits that banks are
required to hold
55
What are
required reserves?
The dollar amount of
reserves a bank is
legally required to hold
56
Where are bank’s
reserves held?
Deposits with the Fed and
cash in the bank’s vault
57
What are
excess reserves?
Bank reserves in excess
of required reserves
58
What money do
banks lend out?
Excess reserves
59
If a bank has $6,000 in
checkable deposits with a
reserve ratio of .2 how
much can the bank lend?
No more than $4,800
60
How does the Fed
influence the money
supply?
Change reserve
requirements
Change discount rate
Change federal funds rate
Buy/sell govt. securities
61
What are
reserve requirements?
The percentage of a bank’s
assets that must be kept
in cash and therefore
cannot be lent out
62
Who sets
reserve requirements?
Reserves are determined
by the Fed for all
financial institutions
63
If we have inflation
what will the Fed do to
reserve requirements?
Raise reserve requirements
thereby decreasing bank’s
excess reserves
64
If we have unemployment
what will the Fed do to
reserve requirements?
Lower reserve requirements
thereby increasing bank’s
excess reserves
65
What is the
discount rate?
The interest that banks
pay when they borrow
money from the Fed
66
What will the Fed do
to the discount rate
during periods of
inflation?
The Fed will raise the
discount rate to
discourage borrowing
and thus spending
67
What will the Fed do
to the discount rate
during periods of
unemployment?
The Fed will lower the
discount rate to
encourage borrowing
and thus spending
68
What is the
federal funds rate?
The interest rate that
banks pay to borrow
excess reserves from
another bank
69
What will the Fed do to
the federal funds rate
during periods of
inflation?
The Fed will raise the
federal funds rate to
discourage borrowing
and thus spending
70
What will the Fed do to
the federal funds rate
during periods of
unemployment?
The Fed will lower the
federal funds rate to
encourage borrowing
and thus spending
71
What is the
prime interest rate?
The interest rate that big
banks charge their
best and most credit
worthy customers
72
What is a
government security?
A short term bond that the
federal government sells
73
What is the
open market?
A place where bonds
are bought and sold
74
What are
open market operations?
The act of the Fed
buying or selling
government securities
at the open market
75
Why does the
government sell
securities?
This is its way of
borrowing money
76
What will the Fed do if
we have unemployment?
The Fed will buy
government securities
making banks more
liquid so they can lend
out more money
77
What will the Fed do
if we have inflation?
The Fed will sell
securities making banks
less liquid so they will
have less money to lend
78
Which monetary tool
is most often used?
Open-market operations
79
What is
moral suasion?
A host of different
measures that the
Fed uses to influence
the activities of banks
in one way or another
80
What is the largest
component of
assets of the Fed?
U.S. government securities
81
What is the largest
component of the
Fed’s liabilities?
Federal Reserve notes
82
Why is the Fed so
profitable?
Because it pays no interest
on its liabilities but earns
interest on its assets
83
If the Fed wants to
increase the money
supply by $1,000 million,
what should it do?
With a reserve requirement
of 10% it should increase
the money supply by
$100 million
84
What is the money
multiplier with a
reserve requirement
of 1/10?
10
85
What is the Money
Multiplier formula?
1/Required reserve ratio
86
If the required reserve
ratio is 1/10 and all
banks are exactly
meeting their reserve
requirement - how do
we calculate the
money multiplier?
87
One divided by one
tenth equals 10
.
1 .
1
X
1
10
10 =
1
Multiplier
=
10
88
$100
$90
$81
original deposit
$74
$63 total money
...
$1,000
89
If the Fed wants to
decrease the money
supply by $1,000 million,
what should it do?
With a reserve
requirement of 10% it
should decrease the
money supply by
$100 million
90
Why is the Fed better
at fighting inflation
than unemployment?
The Fed can’t force people
to borrow more money
91
What things will cause
interest rates to rise?
 Demand for money increases
 The Fed raises the Discount
or Federal Funds Rate
 The Fed sells government
securities
92
What things will cause
interest rates to fall?
 Demand for money decreases
 The Fed lowers the Discount
or Federal Funds Rate
 The Fed buys government
securities
93
What is
Quantitative Easing?
A politically polite term
for monetizing the
debt, the Fed creates
money to buy bonds
94
END
95