1. ~How did the panic of 1907 affect US banking? ~What are the purposes and characteristics of the Federal Reserve system?

2. ► Panic of 1907  Causes:  1. Nation’s monetary system at the time had no mechanism for expanding the amount of money in circulation ► C and B unable to borrow money, so started to use their savings = Bankrupt Banks in 1907  2. Systems of Pyramided Reserves failed ► Pyramided Reserves (virtually all smaller, local banks deposit some of their reserves at lager city banks deposit into larger commercial banks)

3.  Effect: ► Federal Reserve Act in 1913 ► Created the Central Bank called the Federal Reserve ► Role Of the Fed  Goals: Furnish an elastic currency and more effective supervision of banking in the US  1. Supervises member banks  2. Holds cash reserves (funds available for short term borrowing for COM. Banks and GOV.)  3. Moves money into out of circulation (stabilize monetary and banking system)

4. ► Characteristics of the Fed  Lack of a single central bank  Ownership and control by member banks ► US Government does not own stock in the fed  Optional membership in the fed for some banks ► National Charter banks have to join Fed, but State Charter banks don’t (less than 40% of commercial banks are apart of the fed)

6. ► Organizations of the Fed  National Level ► Makes key decisions ► Board of Governors (7 members 14 yr terms)  Federal Open Market Committee  regulates supply of money  District level (12 District Reserves) ► 25 offices located throughout the nation

7. REVIEW QUESTIONS ► List the major caused of the Panic of 1907, and explain how the government worked to resolve the panic. ► Explain the role of the Fed. How does the Fed differ from central banks in other countries? ► Why is the Federal Reserve system organized on national and district levels?

8. ► What services does the Fed provide to banks? ► How does the Fed serve the federal government?

10. ► Services to Government  As a Government Bank ► Provides services similar to what is provides to individuals ► 1. Federal Depository of federal revenues ► 2. Holds Treasury Checking Account (Social Security checks, Tax Refund) ► 3. Advise the Legislative and Executive Branches on their economic programs

11. ► Supervising Member Banks  “watchdog” for member banks  Monitor loans and investments and conduct ► Regulating the money Supply  Reserve prints money and distribute currency ► How does the Fed increase or decrease the US money supply?  The Fed in NYC buys and sells securities on the open market.  Tells Fed when to (I) or (D) money supply

12. ► M1  Simplest measure of the money supply  Consist of only funds that are easily accessible ► All Currency in Circular Flow ► All Checks and Account Deposits ► M2  Broader measure of the money supply ► More accurate b/c includes markets accounts, mutual fund share, and savings deposit ► M3  Broadest Measurement ► All large Time Deposits over $100,000

14. Review Questions ► What services does the FED provide to banks? ► How does the Fed serve the government? ► What are the four different measurements of the US money supply? Which funds are included in each measurement?

15. ~Why does the Fed rely either an easy-money policy or a tight-money policy?

16. ► Monetary Policy and Aggregated Demand  Monetary Policy- plan or Contract the money supply in order to influence the cost and availability  1. Easy-Money Policy ~ expands the money supply, increase aggregated demand, create jobs and (D) unemployment, (I) economic growth ► Lower Interest Rate  2. Tight-money policy~ higher interest rates and a contraction of the money supply, Reduce Agg. Demand ► Raise Interest Rate

20. Three major instruments of monetary policy ► Open Market Operations  This is the buying and selling of securities. This is the most important control of the Fed.  When the Fed buys securities it increases the reserves of the commercial banks ► The Reserve Requirement  The Fed influences the banks ability to lend through the reserve ratio.  If the fed increases the reserve requirement they take away part of the banks excess reserves. This takes away the banks ability to create money.

21. Three major instruments of monetary policy ► The Discount Rate  The Fed loans money to banks if they are in need of money. The rate of interest that they charge is the discount rate. ► Strengths of the Monetary Policy  1) Speed and flexibility over the fiscal policy. It could be done on a daily basis if need be.  2) Isolation from political pressure

22. ► Strengths of the Monetary Policy  1) Speed and flexibility over the fiscal policy. It could be done on a daily basis if need be.  2) Isolation from political pressure ► Shortcomings and problems  1) Cyclical Asymmetry: ► EZ money does not mean that banks will loan or that people will borrow. ► People may use the excess money to pay off loans.  2) Changes in V. ► Velocity can sometimes go the opposite direction. If m increases, V may actually decrease. This will of course affect total spending. ► If i decreases people will hold m for asset demand. This affects V.  3) Money demand is interest elastic. (It depends on the elasticity of the Dm curve)  4) Investment is interest elastic. (It depends on the elasticity of the I curve)  5) Inflow of international capital from the increase in interest rates leads to an expansion of AD.

23. DISCRETIONARY FISCAL POLICY  the deliberate manipulation of taxes and government spending by Congress to alter real output and employment, control inflation, and stimulate economic growth. ► BUILT IN STABILIZER  anything which increases the government's deficit (or reduces its surplus) during a recession and increases its surplus (or reduces its deficit) during inflation without requiring explicit action by policy makers.

24. Ways to help ► RECESSION:  cut taxes and increase government spending. ► INFLATION:  raise taxes and decrease government spending. ► Keynesian approach assumed that a tradeoff between unemployment and inflation is possible.  When unemployment is too high, the goal is to increase AD (without causing or aggravating inflation.)  When there is little unemployment and inflation prevails, the goal is to decrease AD and increase unemployment levels to eliminate inflation. ► The problem is this has not worked since the 1970's.

25. STAGFLATION ► Inflation during periods of unemployment ► macroeconomics used to describe a period characteristic of high price inflation combined with economic stagnation, unemployment, or economic recession. macroeconomicsinflation economic stagnation unemploymentrecession macroeconomicsinflation economic stagnation unemploymentrecession

27. RATIONAL EXPECTATIONS  argues that people expect changes in economic policy and act to offset the intended results of such changes. They claim that recession and booms are exaggerated as a result of government policy rather than smoothed out. ► Keynesians  believe that the free-market has problems and it is up to the government to react and control these problems.  believe that the free-market has problems and it is up to the government to react and control these problems.  They believe the markets are not totally competitive so the prices and wages can not be driven down. This means that both fiscal and monetary policies are needed.  GDP = C + I + G + Xn

28. MONETARISM ► argue that steady economic growth and price stability can be achieved with a steady increase in the money supply (at about the same rate as Real GNP growth).  the supply should just increase at a pre announced steady 3-5 percent.

29. SUPPLY-SIDE ECONOMICS  believe fiscal policy should be designed to provide incentives to increase aggregate supply (lowering taxes). ► supply creates its own demand," the idea that one must sell before one can afford to buy. Therefore good economic policy encourages increased production, vice attempts to stimulate demand

30. ► Automatic Stabilizers:  our tax system is such that net tax revenues (net taxes minus transfers and subsidies) vary directly with GDP. Almost all taxes yield more revenue when GDP increase. (Income, payroll, sales...) ► Loanable funds market  www.econ.ilstu.edu/ntskaggs/ECO105/Lectures/ student_notes/oh_3-09.ppt