Download unit 6 economics

Unit 6: Federal Reserve System
and Monetary Policy
Topic 1:
Money
Functions of Money
1. Medium of Exchange
It is accepted as a form of payment
2. Unit of accounting
• helps to determine the value of an item
and allows comparison
3. Store of value
• Money can be saved for use in future
Characteristics of money ?
1. Durable
2. Divisible
3. Scarce
4. Portable .
7
Money Systems:
1. Barter system
• People trade one object for another
2. Commodity money system
• An item with intrinsic value is used as
money
Examples:
Cigarettes used in prison
Animal furs used in colonial times
3. Representative Money
System
Money “backed” by something
Example: The Gold standard; people didn’t
carry around the gold, they had a gold
certificate that represented the gold
*4. Fiat money system
• Money that is declared so by the
government
• It is not “backed” by anything
Topic 2: The Federal Reserve and
the Banking System
The Federal Reserve System
(the FED)
- The FED is the central bank of the U.S.
- Created in 1913
Jobs of the FED
•
•
•
•
•
Print money
Clear checks
Supervise banks
Act as a bank to banks
Manage money supply
Organization of the FED
Member banks
Board of Governors
• - Head of the Federal Reserve System
• Chairman of the Board of Governors???
Federal Reserve System
• 12 Districts
Federal Reserve Banks:
12 Districts
Member Banks
FDIC insured (Federal Deposit Insurance
Corporation)
Insures money in banks up to $250,000
• FDIC
– Bank run “It’s a Wonderful Life”
– 60 minutes video: FDIC
Topic 3: Banks and the
Money supply
Fractional Reserve Banking
If you have a bank account, where is your
money?
Only a small percent of your money is in the
safe. The rest of your money has been loaned
out.
This is called “Fractional Reserve Banking”
The FED sets the amount that banks must hold
23
Demand DEPOSIT
• Money placed in banks by customers
• Banks take these deposits and loan
them out to people who want to borrow
money
Reserve Requirement
• Amount of money a bank is required to
hold of a person’s deposit
EXCESS RESERVE
• Deposit that is not part of the required
reserve
Practice:
• If a $100 deposit is placed in a bank
and the reserve requirement is 20%,
how much money does the bank have
to hold?
• How much can they loan out?
Practice
• If $50 is deposited into a bank and the
reserve requirement is $10%, how
much is the bank required to hold?
• How much can they loan out?
• If $10 is deposited into a bank and the
reserve requirement is 10%, how much
money must the bank hold?
• How much money can they loan out?
The process of how banks
“create” money
Banks only influence the amount of $ in the economy if they make loans.
When a loan is taken out, it is spent and ends back up in the banking
System
Example: complete the chart assuming the reserve requirement is 10%
Bank
Deposit
Reserve
requirement
Loan
A
$1000
$100
$900
B
C
The process of how banks
“create” money
Bank
Deposit
Reserve
requirement
Loan
A
$1000
$100
$900.00
B
$900
$90
$810.00
C
$810
$81.10
$728.90
The Money Multiplier
• Used to determine how much a loan
can impact the overall economy
Money
Multiplier
1
= Reserve Requirement (ratio)
33
What is the Money multiplier
on the following reserves?
• 10%
• 20%
• 5%
Maximum change in the money supply =
Money multiplier X Deposit = total - deposit
Example: Billy deposits $400 in his bank and the
reserve requirement is 10%.
What is the money multiplier?
What is the maximum change in the money
supply?
THE MULTIPLE EXPANSION
of money will be less if:
• 1. Banks DO NOT loan out all of their excess
• 2. People DO NOT spend all the money that they
borrow
• 3. When money is spent, it is NOT placed back
into a bank
Practice:
1. $50 is deposited into a bank and the
reserve requirement is 10%. What is
the total expansion of the money
supply
Money multiplier = ?
Money multiplier X deposit (-deposit) = ?
2. $20 is place as a deposit into a bank
and the reserve requirement is 25%.
What is the total expansion of the
money supply?
Money multiplier = ?
Money multiplier X deposit (-deposit) =?
• 3. $100 is deposited into a bank and
the reserve requirement is 5%, what is
the multiple expansion of money?
Money multiplier = ?
Money multiplier X deposit (-deposit) = ?
• Video: Inside the Fed
Topic 4: Monetary Policy
• What the FED does to regulate the
money supply
• The FED controls the money supply by
adjusting Nominal interest rates
Expansionary monetary policy
Implemented during Recession
Goal is to speed up the economy; they
want people to get out and spend $ in
economy
Contractionary Monetary
Policy
• Implemented during INFLATION
• Goal = slow down the economy; want
less spending to occur in the economy
Video:
Monetary policy: Part Art, Part Science
Tools of monetary policy
The FED adjusts the money supply by
changing any one of the following:
1. Change the reserve requirement
2. Changing the Discount rate
Discount Rate- Interest rate the FED
charges banks to borrow money
**3. Open Market Operations
•Buying and selling Bonds
(securities)
Expansionary monetary policy
• Implemented during RECESSION
• Goal is to SPEED UP
How can the Fed speed up
the economy?
• 1. BUY BONDS using open market
operations (BUY = BIG)
• 2. LOWER the reserve requirement
• 3. LOWER the discount rate of interest
Impact of expansionary
monetary policy
1. Banks have more money to lend
2. Interest rates go down
3. People borrow more money due to low interest rates
4. People save less money due to low interest rates
5. People spend more money
Contractionary Monetary
Policy
• Implemented during INFLATION
• Goal is to SLOW DOWN economy
How can the Fed slow down
the economy???
• 1. SELL BONDS using open market
operations (SELL = SMALL)
• 2. RAISE the reserve requirement
• 3. RAISE the discount rate of interest
Impact of Contractionary
Policy
1. Banks have less money to lend
2. Interest rates go up
3. People borrow less money due to high interest rates
4. People save more money due to high interest
rates
5. People spend less money