Economic Instability & the Federal Reserve

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The Fed Short for “The Federal Reserve” Created in 1913 by an Act of Congress Two goals: Prevent panic withdrawals Make cross-country payments (especially checks) easier and more efficient Centralized in Washington, DC

Banking History Banks failed a lot People panicked and pulled their money out If the bank had enough money to pay off their deposits, it was okay If not, the bank paid back what it could, and closed its doors when it ran out of money This is a bank failure

GDP Per Capita

Good Economics Generally speaking, good economies have: Positive GDP Growth Low unemployment Relatively low inflation (~2%) Increasing GDP per capita Stable economic institutions

Fed Geography

MATH!!! (M) * (V) = (P) * (Y) where: M = Amount of Money in Supply V = Velocity (how fast is the money being spent) P = Price Level Y = Real GDP

Fed Targets Using this formula, the Fed can use the tools available to them to try to make the economy better In general, it is assumed that an economy needs to have more money to keep it working Think of it as “greasing the gears” of the economy When the Fed gets more money into the economy, it (theoretically) grows the economy This makes everything better (hopefully)

Three Tools of the Fed Open Market Operations Discount Rate This is the process of buying and selling US Government Debt (government bonds) on the open market Discount Rate This is the interest rate that banks are charged when borrowing from the Federal Reserve Reserve Requirement This is the percentage of its liabilities (deposits) that a bank must hold on to and cannot loan out.

More Tools All of these tools have the power to increase (or decrease) the money supply Countercyclical monetary policy In theory, this should make the economy more stable, which is good

Criticism

Fiscal v. Monetary Fiscal Policy Monetary Policy Controlled by the federal government (usually) and sometimes states Idea is to increase government spending, cut taxes, etc., to stimulate economy Controlled by the Federal Reserve Focus is on making money “loose” Three tools of the Federal Reserve