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and its Macroeconomics – Unit 4 WARNING WARNING You’ll work an open-book free response AP question at the end of class tonight with an “earned partner.” AP question will be based on lecture notes & reading assignments WARNING WARNING Since the 1930’s our Government has been required to carry out policies to [1] growth / GDP maximize ___________ unemployment [2] minimize ___________ inflation [3] minimize ___________ Let’s say the economy is having a problem. What’s the problem illustrated here? PL SRAS LRAS economy in recession PL 1 AD Y1 YP Q=realGDP=Y We have 2 kinds of policy that we can pursue to ameliorate the problem... Fiscal policy has 2 possibilities: (1) ________ G which will shift ____ AD a. change ____ DY b. change ___ T which will ____ C & ___I which will which will ___ AD shift ___ Fiscal Policy is carried out by .... The President Congress (a) __________ & (b) _________ (2) _________ Monetary policy Monetary Policy is carried out by our Central Bank – in the US called ... The Fed = The Federal Reserve System The Fed was established in 1913 & restructured in 1935 to ... [1] aide expansion of US businesses by supplying more cash, and [2] be a source of emergency cash in case of a panic 6 of 37 Structure of the Federal Reserve System 7-member Board of Governors (including Chair of Board) 12 District Reserve Banks 4000 private bank members who benefit from membership The Federal Reserve System is comprised of 12 regional banks with 25 branches. This man served as Chair of the Board for 18 years. Alan Greenspan _______________ This man was sworn in as our new Chair on Jan 31, 2006. Ben Bernanke _______________ The Fed is constantly monitoring the health of the USA economy. The Fed is owned by its 12-member government banks, NOT the USA ____________ high degree of independence. B/c Fed officials aren’t elected, the Fed most often acts with the best interests of the country in mind, unlike politicians who have to worry re-elected about being __________. Functions of the Fed: [1] to serve as the bank of the US Gov’t [2] to regulate its member banks [3] to serve as a lender of last resort for member banks 11 of 37 Functions of the Fed: [4] to issue new currency coins are minted at the US Mint part of the Dept of Treasury (gov’t) new paper currency is printed by the Fed and first issued by the Fed Reserve Banks Once the Fed designs its “Federal Reserve Note” it is signed by the Treasurer of the U.S. Anna Escobedo Cabral – 42nd Treasurer of the USA Summer, 2007 Newly-designed “5” had not been released and she told us that it would be the color ________. Functions of the Fed: [5] to clear checks Functions of the Fed: [6] to set the supply of money in the economy [7] to set a key interest rate – the discount rate These decisions are made by the 14 members of the Federal Open Market Committee (FOMC). The FOMC meets 8 times per year at the Washington DC Fed. The Fed has 3 tools to carry out Monetary Policy to help control the economy reserve requirement set the _______ at private banks discount set the ________ rate – the [2] interest rate at which the Fed loans money to banks [1] [3] open market operations 17 of 37 # 1 Reserve Requirement If the Fed increases the reserve requirement money supply ____ If the Fed decreases the reserve requirement money supply ____ __1__ simple money multiplier = r # 2 Discount Rate The discount rate is the rate of interest the Fed charges for loans it makes to banks. If the Fed decreases the discount rate encouragedto borrow banks are ____________ more _________ money supply ____ changes in reserve requirement & discount rate are not used on a day-to-day basis by the Fed...more frequently used is tool # 3 Banks we use are private businesses ... they set their own rates Our new car loan rates range from 6.74% to 13.74% APR. To obtain the lowest annual percentage rate, you must have excellent credit history, .... (Dec. 2008) Annual Percentage Rates (APR) As Low As .... New car 5.30% Used car (franchise dealer) 5.85% 20 of 37 but ... Used car (private party) 8.34% but ... the rate at which banks loan money to us is strongly impacted by the discount rate – the rate at which the Fed loans to private banks. $ discount rate – the rate at which the Fed loans to banks $ $ $ $ Fed Reserve Bank of New York $ $ federal funds rate – the rate at which banks loan to each other over night commercial paper – overnight loans between banks The Fed uses its open market operations to target the federal funds rate. the federal funds rate – the interest rate at which banks lend to each other. Fed funds rate determined by supply & demand, but thru its operations the FED “targets” this rate. This rate has a direct impact then on the interest rate at which banks are willing to loan money to consumers investors ___________ & ___________. # 3 Open Market Operations Open Market Operations = the Fed’s buying and selling of government securities. A security is either a stock or a bond. US Dept of Treasury issues US Gov’t securities which are called Treasury Bills Treasury Bonds Treasury Notes 23 of 37 A bond is an _____ IOU in which the issuer of the bond agrees to pay the owner of the face _______ value bond the amount of the _____ (“par value”)of the bond on a future date. Bonds -- a way for the government (or borrow corporations) to _______ money to finance new projects or expansions. Bond buyers are essentially loaning __________ money to the bond issuers. Treasury Bills T-Bills mature in less than 1 year Treasury Notes mature in 1 year – 10 years T-Notes mature in 10 years or Treasury Bonds more from their issue T-Bonds date Open-Market Operations – buying and selling of gov’t securities (bonds). Southwest Airlines owns bonds. The Fed goes to the bond market and buys a $50,000 worth of bonds from Southwest The Fed pays Southwest $50,000 which it deposits into its account with Wells Fargo bank The Fed takes the $50,000 worth of bonds and puts them in the Fed’s vault (which is NOT circulated in the economy) and The Fed takes $50,000 out of its vault to pay Southwest by depositing it into SW’s account with Wells Fargo bank The supply of money circulating in the economy has ____ This is an example of a(n)...... expansionary / contractionary monetary policy If the Fed has expanded the money supply interest rates will ____ because there will be ______ money more out there to lend out lower interest rates lead individuals & firms PL SRAS to __________ more borrow which will in LRAS P2 turn increase AD2 ______________ P1 &consumption ___________ investment shifts _____ to AD AD the right. Y1 Y2 YP Q=realGDP=Y 29 of 37 How about the Fed goes out and sells $50,000 worth of T-Bonds to Southwest ... which way do arrows go? So has the Fed increased the supply of money circulating in the economy or decreased it? AP workbook p. 203, Act 38 do charts on overhead with class Money Market The demand for money is based on whether to hold your wealth as ... interest rate money market i2 (1) interest-bearing assets such as savings acct or _________ stocks _________, ......or...... (2) interest as money which doesn’t earn ________. MD i1 Q Q1 So what’s the shape of the demand curve for money....what if interest rates are high...will Q be high or low? quantity of money Money Market money market interest rate i2 The opportunity cost of holding money interest rate is the ________________. The demand for money depends on the PL and on Y right As PL MD shifts ______ left As Y MD shifts ______ MD1 i1 MD0 MD2 Q Q1 quantity of money 33 of 37 Money Market interest rate MS2 MS The supply of money is presumed set by the Fed. What do you think it looks like? MS3 i2 If the Fed contracts the MS Q ____ & i _____ If the Fed expands the MS Q ____ & i _____ i1 i3 MD Q Q1 Q quantity of money money market interest rate MS MS2 investment price level interest rate i1 i1 i2 i2 MD Q1 Q2 quantity of money AD AD ID Q1 Q2 Q of I Y1 Y2 Q = Real GDP = Y On the AP/IB exams you’ll be expected to explain step-by-step how an action by the Fed affects the economy. money market interest rate MS MS2 investment price level interest rate i1 i1 i2 i2 MD Q1 Q2 quantity of money AD2 AD ID Q1 Q2 Q of I Y1 Y2 Q = Real GDP = Y The Fed purchases gov’t securities Fed issues IOU’s for the purchase causing MS ____ interest I ____ & C ____ rate ____ AD ____ AP workbook p. 206-207, Act 39 20 min interest rate MS money market i1 MD Q1 37 of 37 quantity of money