Download Chap. 15 - Angelfire

Monetary
Policy
Standards
• Standard 10 – Students will understand that:
institutions evolve in market economies to
help individuals and groups accomplish
their goals. Banks, labor unions,
corporations, legal systems, and not-forprofit organizations are examples of
important institutions. A different kind of
institution, clearly defined and well enforced
property rights, is essential to a market
economy
Standards
• Standard 11 – Students will understand that:
money makes it easier to trade, borrow,
save, invest, and compare the value of
goods and services
Monetary Policy
Is regulated by the Federal Reserve Board (FED), the
central bank
Monetary policy monitors the money supply by
moving interest rates and regulating the banks
The Chairman of the Fed is Janet Yellan – nominated
by the President and confirmed by the Senate
The FED is controlled by a Board of Governors
Is not supposed to be political!
Monetary Policy Strategies
Goals of Monetary Policy- the Fed wants to control
inflation and try to achieve low unemployment
• Monetary Policy- a government’s plan for regulating
a nation’s money supply and availability of credit in
order to accomplish certain economic goals.
• Easy-money policy- expands the supply of money
and increases aggregate demand creating jobs
and reducing unemployment to promote economic
growth.
• Tight money policy- used to contract or restrict the
money supply and limit credit. Interest rates are
increased and the money supply would contract
causing a reduction in aggregate demand.
– The Fed is the central bank because it is the chief
monetary authority in the country
– The Fed is responsible for supervising banks and
controlling the money supply
– The Fed conducts open market operations by
buying or selling securities – to a) change the
money supply, b) affect the economy
– Open market purchases increase the money
supply
– The Fed DOES NOT print Federal Reserve notes
Structure of the Federal Reserve
• The Board of Governors
– The Federal Reserve System is overseen by the seven-member Board
of Governors of the Federal Reserve. Actions taken by the Federal
Reserve are called monetary policy.
• Federal Reserve Districts
– The Federal Reserve System consists of 12 Federal Reserve Districts,
with one Federal Reserve Bank per district. The Federal Reserve Banks
monitor and report on economic activity in their districts.
• Member Banks
– All nationally chartered banks are required to join the Fed. Member
banks contribute funds to join the system, and receive stock in and
dividends from the system in return. This ownership of the system by
banks, not government, gives the Fed a high degree of political
independence.
• The Federal Open Market Committee (FOMC)
– The FOMC, which consists of The Board of Governors and 5 of the 12
district bank presidents, makes key decisions about interest rates and
the growth of the United States money supply.
Responsibilities of the Fed
– The Fed has six major responsibilities:
1. Control the money supply.
2. Supply the economy with paper
money, or Federal Reserve notes.
Federal Reserve notes are printed
at the Bureau of Engraving and
Printing in Washington, D.C.
3. Hold bank reserves. Each bank that
is a member of the Federal Reserve
System is required to keep a
reserve account with its district
bank. Reserve accounts are similar
to checking accounts.
4. Provide check-clearing services.
Suppose that Harry writes a $1,000 check
and sends it to Julie.
Julie receives the check, takes it to her local
bank, deposits it in her checking account.
Balance in her account rises by $1,000.
Julie’s bank sends the check to its Federal
Reserve district bank. The reserve bank
increases the reserve account of Julies’s
bank by $1,000 and decreases the reserve
account of Harry’s bank by $1,000.
The reserve bank sends the check to
Harry’s bank, which then reduces the
balance in Harry’s checking account by
$1,000.
5. Supervise member banks. If the Fed
finds that a bank has not followed
established banking standards, it can
pressure the bank to do so.
6. Serve as the lender of last resort for
banks suffering cash management
problems.
Changing the Money Supply
– The Fed has three tools that it can use to
raise or lower the money supply.
1. the reserve requirement
2. open market operations
3. the discount rate
Increasing the Money Supply
– Banks are not allowed to print currency. However,
banks can create checking account deposits.
– When a customer deposits money in a checking
account, that deposit increases the amount of
money that the bank has on hand in its vault.
– If the bank pays out less in withdrawals than it
accepts in deposits during the day, the bank will
have excess reserves at the end of the day. These
excess reserves can then be lent out in the form of
loans.
Creation of Money
1. Changing the Reserve Requirements
Different Types of Reserves
– Banks have three types of reserves: total,
required, and excess.
– total reserves are the sum of the bank’s deposits
in its reserve account at the Fed plus its vault
cash. Eg. if a bank has $10 million in its reserve
account and $5 million cash in its vault, its total
reserves are $15 million.
– Required reserves are the minimum amount of
reserves a bank must hold against its deposits as
mandated by the Fed.
– A reserve requirement is a Fed regulation,
requiring a bank to keep a certain percentage of its
deposits in its reserve account with the Fed or in its
vault as vault cash. For example, if the Fed requires
a bank to hold 20 percent of its deposits in reserve,
and the bank has $50 million in deposits, the
required reserves are $10 million.
– Excess reserves are any reserves held beyond the
required amount. For example, if a bank has $15
million in total reserves and the Fed requires that it
keep $10 million in required reserves, the bank has
$5 million in excess reserves.
2. The Federal Open Market Committee (FOMC)
– The FOMC conducts open market operations by
buying and selling government securities.
– When the FOMC makes an open market purchase,
it increases the money supply. When an open
market sale is made, the money supply falls.
– If the Fed purchases bonds (quantitative easing) it
would lower the interest rate for long-term loans
and could lead to inflation
3. Changing the Discount Rate
– Federal funds rate is the interest rate one bank
charges another for a loan.
– Discount rate is the interest rate the Fed charges a
bank for a loan.
– When the discount rate is decreased, the money
supply rises. When the discount rate is increased,
the money supply falls.
Is a Savings Account Money?
– A savings account is an interest-earning
account. A savings account that allows for
check-writing privileges is considered a
checking account.
– A nonchecking savings account is not
considered money because it is not widely
accepted for purposes of exchange.
Are Credit Cards Money?
– A credit card is not considered money.
Money must be acceptable as a form of
payment and repayment.
A credit card cannot be used to repay debt
but to incur debt. The use of a credit card
places a person in debt, which he or she then
has to repay with often with interest, which
makes them a liability
– Gold is not considered money because it
is not liquid
The Problem of Timing
Bad Timing
• Properly timed economic
• If stabilization policy is
policy will minimize
not timed properly, it
inflation at the peak of the
business cycle and the
can actually make the
effects of recessions in the
business cycle worse.
troughs.
Good Timing
Policy Lags
Policy lags are problems experienced in the timing of
macroeconomic policy. There are two types:
Inside Lags
• An inside lag is a delay
in implementing
monetary policy.
• Inside lags are caused
by the time it actually
takes to identify a shift in
the business cycle.
Outside Lags
• Outside lags are the
time it takes for
monetary policy to
take affect once
enacted.
Anticipating the Business Cycle
The Federal Reserve must not only react to current trends, but
also must anticipate changes in the economy.
Monetary Policy and Inflation How Quickly Does the
Economy Self-Correct?
• Expansionary policies
enacted at the wrong time
• Economists disagree
about how quickly an
can push inflation even
economy can self-correct.
higher.
Estimates range from two
• If the current phase of the
to six years.
business cycle is anticipated
• Since the economy may
to be short, policymakers
take quite a long time to
may choose to let the cycle
recover on its own, there is
fix itself. If a recession is
time for policymakers to
expected to last for years,
guide the economy back to
most economists will favor a
stable levels of output and
more active monetary policy.
prices.
Theorists
Keynesians Economists
• The economy will fix itself – • Named after John
Maynard Keynes
if you simply give it time.
• Proved a flawed assumption • Only massive spending by
the government can end a
because of the Great
recession
Depression.
Classical Economists