Economic Instability & the Federal Reserve

A Bank Run

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

But WAIT… We’ve already talked about how economics is about survival of the fittest—”Creative Destruction” So why should we care if a bank fails?

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

Fed Geography

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

The Fed Today Twin targets: low unemployment and stable price levels Most powerful central bank in the world Chairman of the Fed: Jerome Powell

Fiscal v. Monetary Fiscal Policy Monetary Policy Controlled by the federal government (usually) and sometimes states Idea is to increase government spending or cut taxes to stimulate economy Controlled by the Federal Reserve Three tools of the Federal Reserve

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.

Which Direction? Contractionary Expansionary Means “shrinking the money supply” Used to rein in inflation Selling bonds, raising the discount rate, or increasing the reserve requirement Means “growing the money supply Used to reduce unemployment Buying bonds, lowering discount rate, decreasing reserve requirement

Quantity of Money (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