Economics 11/14/11 OBJECTIVE: Examine the Role of the Federal Reserve. MCSS E I. Journal #37 pt.A -Read “The Global Economy” p.420 -Answer questions (1-3) p.420 II. Quiz#20 III. Journal #37 pt.B -questions on Fed Film: What should the Fed do? NOTICE: Chapter#13&14 Test Tomorrow!

The Role of the Fed Main goal of the Fed Open Market Committee…control inflation How can the Fed control inflation? 1.) Change the interest rate 2.) Change the reserve requirement 3.) Open Market Operations - Buy or Sell securities (bonds) *buy – increases the money supply *sell – decreases the money supply

Fed Video 1.) What is the role of the Fed? 2.) What causes inflation? 3.) What happened to the cost of a bagel when the money supply was increased? 4.) How does the Fed determine the money supply? 5.) Why do people spend money when inflation hits? 6.) What were fears of the Fed if inflation continued to rise? 7.) What portion of the money supply is in the form of cash and coins?

8.) What was the prime rate in 1980? 9.) What did this rate do to the housing and auto industry? 10.) What happened to the unemployment rate when the money supply shrank? 11.) What happened to the inflation rate? 12.) What happened to the unemployment rate in 1984? 13.) What role does the Federal Reserve District President play? 14.) How has the Globalization of the economy effected the role of the Fed?

Economics 11/15/11 OBJECTIVE: Demonstration of Chapters#13&14 and begin examination of Monetary Policy. MCSS E I. Administrative Stuff -attendance & distribution of test II. Chapter#13&14 Test III. Journal #38 pt.A -Read “Profiles in Economics” p.414 -Answer questions (1-2) p.414 IV. Journal #38 pt.B -notes on monetary policy

Monetary Policy Monetary policy – the expansion or contraction of the money supply in order to influence the cost and the availability of credit. In English, when the Fed raises interest rates the amount of money in the economy gets smaller. When the Fed lowers interest rates, the amount of money in the economy gets bigger. Higher interest rates encourage people to save money. Lower interest rates encourage people to spend and borrow money.

Structure of the Fed

How does the Fed influence interest rates? Fractional reserve system – requires banks and other depository institutions to keep a certain percentage of their deposits on hand as legal reserves. Legal reserves – consists of coins and currency held in the bank’s vault and the currency it has on deposit with the Federal Reserve. The Fed requires that banks keep a reserve of 12% against demand deposit accounts.

How Banks Operate You deposit $100 in your savings account. The bank MUST keep 12% of that $100 on reserve. (They must keep $12) The bank loans out the other $88. If the person who borrows the money puts it in a checking account, the $88 is treated as a new deposit and 12% or $10.56 of it must be set aside as a reserve. The other $77.44 can now be loaned out. This is the multiplication of the money supply.

Example of Fractional Reserve at 20% Ch#15 sec#2 p.419

Tools of Monetary Policy If the Fed wants the money supply to grow they can do the following: 1.) Lower the interest rate 2.) Lower the reserve requirement 3.) Buy securities (buy bonds) This is known as easy money policy.

Tight money policy If the Fed wants the money supply to contract, or slow they can do the following: 1.) Increase the interest rate 2.) Increase the reserve requirement 3.) Sell securities (sell bonds) This is known as tight money policy.

Tight money policy

The Role of the Fed Main goal of the Fed Open Market Committee…control inflation How can the Fed control inflation? 1.) Change the interest rate 2.) Change the reserve requirement 3.) Open Market Operations - Buy or Sell securities (bonds) *buy – increases the money supply *sell – decreases the money supply

M1 v. M2 The main difference is function! M1, represents the transactional components of the money supply, or the components of the money supply that most closely match money’s role as a medium of exchange M2 is a measure of money that includes those components most closely conforming to money’s role as a store of value M2 includes M1, small denomination time deposits, savings deposits, and money market funds

M1 & M2 Figure 15.9

Economics 11/16/11 OBJECTIVE: Examine the role of Banks. MCSS E I. Administrative Stuff -Attendance II. Film: Modern Marvels Banks -questions on film about Banks

Economics 11/17/11 OBJECTIVE: Examine the Role of the Federal Reserve. MCSS E I. Journal #39 pt.A -Read “The Global Economy” p.420 -Answer questions (1-3) p.420 II. Return of Chapter#13&14 Test III. Quiz#21 IV. Journal #39 pt.B -questions on Fed Film: What should the Fed do?

Easy v. Tight Money Figure 15.6

Open Market Operations Open market operations–the buying and selling of government securities in financial markets Open market operations are one of the methods the Federal Reserve can use to influence short- term interest rates Open market operations involve the purchase or sale of government securities by the Federal Reserve

Government Securities When the Fed purchases gov’t securities, it increases the supply of money, putting downward pressure on interest rates (EASY MONEY) When the Fed sells gov’t securities, it decreases the supply of money, putting upward pressure on interest rates (TIGHT MONEY) Open market operations affect the amount of excess reserves in banks to support new loans

FOMC The Federal Open Market Committee (FOMC) conducts open-market operations The FOMC decides interest rates and monetary growth As a central bank, the Fed makes loans to other depository institutions discount rate–the interest the Fed charges on loans to financial institutions If the discount rate goes up, fewer banks will want to borrow from the Fed, reducing the amount of money these banks have available to loan to their customers and forcing interest rates up & vice versa

Moral Suasion Moral suasion - the use of persuasion such as announcements, press releases, articles in newspapers and magazines, and testimony before congress to control the money supply selective credit controls - credit rules pertaining to loans for specific commodities or purposes

Short-Run Monetary Policy In the short run, an increase or a decrease in the money supply affects the interest rate, which is the price of credit When the Fed expands the money supply, the cost of credit goes down. When the Fed contracts the money supply, the cost of credit goes up

Short Run Contraction Although the Fed tries to do what it thinks is best for the economy, people do not always agree with its decisions In 1981, for example, the Fed was criticized for allowing interest rates to get too high

Monetizing the Debt To keep the rates from going up too high, the Fed decided to monetize the debt– create enough extra money to offset the deficit spending in order to keep interest rates from changing The process of monetizing the debt is illustrated where DD and SS represent the initial demand and supply of money

Economics 11/18/11 OBJECTIVE: Examine the Federal Reserve & Politics. MCSS E I. Journal #40 pt.A -Read “Critical Thinking Skill” p.432 -Answer questions (1-4) p.432 II. Quiz#22 III. Journal#40 pt.B -notes on the Fed & Politics IV. Mindjogger -video quiz on Chapter#15

Board of Governors Because the Fed is privately owned by its member banks, and because the members of the Board of Governors have 14-year terms of office, the Fed is widely regarded as being an independent monetary authority Even so, the Fed often comes under political pressure because it has the ability to move interest rates one way or the other The President or members of Congress up for reelection may call for low interest rates to stimulate the economy Incumbent politicians know that their reelection chances are better if voters are happy–and voters normally prefer lower interest rates to higher ones The President and Congress can gain some influence over monetary policy by appointing new members to the Board of Governors as existing terms expire

The Fed & Politicians The Fed is usually reluctant to accommodate demands for lower interest rates in the short term because of the long- run fear of inflation Unlike many politicians, who frequently focus on interest rates and thereby take a short-term view of monetary policy, the Fed is more concerned about the long-run health of the economy People tend to use the interest rate, like the unemployment rate, as a measure of the overall health of the economy In particular, they think the economy is healthy when interest rates are low, and unhealthy when rates are high This makes it more difficult for the Fed to raise interest rates, especially during election years when incumbents want voters to think that they are doing a good job with the economy