Transcript Document

Bellringer—
Money Supply Activity
Money Supply Activity Write-up
• What happened to the price of the item auctioned b/t the 1st and 3rd
auctions?
• What happened to the amount of “money” in the classroom b/t the
1st & 3rd auction?
• What gave the seeds and beans their value?
• When students had more money to spend, what happened in the
successive auctions?
• What do you think would have happened to the price if the number
of items offered for sale in the 3rd auction would have increased
from 1 to 100?
• Under what conditions is increasing the supply of money
inflationary?
• Under what conditions is increasing the money supply not
inflationary?
Monetary
Policy
The Power of the Fed…
10:23 a.m. MT, Monday, February 26, 2007
youtube.com
HONG KONG - Former U.S. Federal
Reserve Chairman Alan Greenspan
warned Monday that the American
economy might slip into recession
by year's end.
He said the U.S. economy has been
expanding since 2001 and that
there are signs the current
economic cycle is coming to an end.
6:57 PM EST, Tuesday, February 27, 2007
Brutal day on Wall Street (Tuesday,
Dow tumbles 416, biggest one-day point loss since 2001,
as investors eye China.
By Alexandra Twin,
CNNMoney.com senior writer
NEW YORK (CNNMoney.com) -- Stocks slumped Tuesday on
worries about economic growth at home and abroad, sending the
Dow industrials to their biggest point drop since the day the
market reopened after the Sept. 11 attacks.
A big decline in Chinese stocks, weakness in some key readings
on the U.S. economy and news that Vice President Dick Cheney
was the apparent target in a Taliban suicide bombing attack in
Afghanistan all fueled the selling on Wall Street.
The Federal Reserve uses three tools to
control monetary policy:
1. Reserve Requirement
2. Discount Rate
3. Open-market Operations
But, before we look at the individual
tools, let’s review by looking at a graph
of the macroeconomy.
On your white board, graph me a
graph of the macroeconomy in
recession.
The percentage of the dollar-amount of
deposits that banks are required to keep in
their own vaults or on reserve with the
Federal Reserve.
Reserve Requirement
• By changing how much member banks
must keep on reserve, the Fed again can
control the money supply and how much is
available for banks to loan out, interest
rates, and spending.
• When the Fed lowers the percentage, the
banks can release more of their reserves in
the form of loans.
• When the percentage is raised, this
essentially restricts the money supply.
The Discount Rate is the rate at which the
Federal Reserve charges member banks
for borrowing money. Banks do this
through what is called, the discount window.
Discount Rate
• By changing what it costs member banks to
borrow money from the Fed, the Fed can
encourage/discourage borrowing by banks,
which affects the availability of loans for
people and businesses.
• This rate determines the prime rate
(interest rate for bank’s best commercial
customers) on which many other interest
rates are founded.
• It also affects the Federal Funds Rate
The Federal Funds Rate is the rate that banks
charge other banks for borrowing money
overnight. These are called, overnight drafts.
The Federal Funds Rate
• On any given day, banks with insufficient reserves
can borrow from banks with excess reserves.
• The interest rate on these loans is the federal funds
rate.
• The FOMC uses OMOs to target the fed funds rate
we’ll look at this graphically later).
• Changes in the fed funds rate cause changes in other
rates and have a big impact on the economy.
The Fed Funds rate and other rates, 1970–2011
Fed Funds
20
Prime
3 Month T-Bill
15
(%)
Mortgage
10
5
0
1970
1975
1980
1985
1990
1995
2000
2005
2010
Open-market Operations (OMO) is the
buying and selling of government securities.
Maturity--less than a year
Maturity--one to ten years
Maturity--more than ten years
Open Market Operations
• This is the most used tool of monetary policy.
• Conducted by the Federal Open Market
Committee (FOMC).
• The buying and selling of government securities
affects the expansion and contraction of the
money supply, which affects interest rates and
therefore the overall spending in the economy.
Open-Market Operations (OMO)
Fed buys bonds…
• Money into economy, Fed
gets bond
• Expands money supply
• Thus, this is called
Expansionary/Loose/Easy
Monetary Policy
Fed sells bonds…
• Money to Fed, Individuals
get bonds
• Contracts money supply
• Thus, this is called
Contractionary/Tight
Monetary Policy
REVIEW
• When the Fed conducts open market
purchases,
• A) it buys Treasury securities, which
increases the money supply.
• B) it buys Treasury securities, which
decreases the money supply.
• C) it sells Treasury securities, which
increases the money supply.
• D) it sells Treasury securities, which
decreases the money supply.
REVIEW
• Which list contains only actions that
increase the money supply?
• A) make open market purchases, raise the
reserve requirement ratio
• B) make open market purchases, lower the
reserve requirement ratio
• C) make open market sales, raise the
reserve requirement ratio
• D) make open market sales, lower the
reserve requirement ratio
New Graph Time!!!
Money Supply. Is there a graph?
Of course there is! This is
an economics class isn’t it?
It is called--MONEY MARKET
Nominal
Interest
Rate
MS
i
Q
MD
Q$
MONEY MARKET
Nominal
Interest
Rate
MS MS1
i
i1
MD
Q
Q$
MONEY MARKET
An increase in the money supply (MS) is
a shift to the right.
MS
What entity can change
the money supply?
Banks
i
Md
Q
Money Market
Indirectly, though,
the Federal Reserve
can help in what
three ways:
1. Reserve Requirement
2. Discount Rate
3. Open-market
Operations (Federal
Funds Rate)
If the FED lowers the RR, what happens to the
money supply? MS INCREASES
Nominal
Interest
Rate
This causes i
Nominal
i1
interest
rates to
go DOWN.
MS
Q
MS1 An increase
is always a
shift to the
RIGHT!!
MD
Q$
MONEY MARKET
As interest rates go down, this causes Consumption
and Investment to go
UP
WHY?
Nominal
Interest
Rate
MS
This causes i
Nominal
i1
interest
rates to
Q
go DOWN.
MONEY MARKET
MS1 An increase
is always a
shift to the
RIGHT!!
MD
Q$
Open Market Operations
Graphic Organizers
Insert Money Mrkt. Graph
Graph of Macroeconomy here
Insert Money Mrkt. Graph
Graph of Macroeconomy here
Now, I’m going to show you
how to answer a FRQ by
using just a flowchart and a
graph and NO
SENTENCES!
To speed up the economy, The FED can:
RR
MS
Nominal
Interest
Rate
MS MS1
i
i
i1
Md
AD
C
I
Q$
Money Market
Graph of Macro
Now, show me on your white board what the Fed does to the RR to
lower inflation
To speed up the economy, The FED can:
DR
MS
Nominal
Interest
Rate
MS MS1
i
i
i1
Md
AD
C
I
Q$
Money Market
Graph of Macro
Now, show me on your white board what the Fed does to the DR to
lower inflation
To speed up the economy, The FED can:
Buy
Bonds
MS
Nominal
Interest
Rate
MS MS1
i
i
i1
Md
AD
C
I
Q$
Money Market
Graph of Macro
Now, show me on your white board what the Fed does to the OMO
to lower inflation
But it’s not all about Monetary
Policy…
And who oversees
Fiscal Policy
Fiscal Policy?
I know your head is probably
swimming now, but this is why it
is important to study and do well
in economics…
Average LSAT Scores for 10 majors
with more than 2,000 students taking the exam
1. Economics
2. History
3. English
4. Engineering
5. Journalism/Foreign Language
6. Finance
7. Psychology
8. Accounting
9. Political Science
10. Communication/Arts
155.3
154.0
153.7
152.7
152.5
152.2
151.9
151.8
151.6
150.7
TICKET OUT THE DOOR
Problem:
Following an income tax increase, the Federal
Reserve announces a goal of significantly
increased growth rates in the money supply.
If the Federal Reserve achieves its goal, explain
in detail the short-run effects of the Fed’s
actions on each of the following. Show on a graph.
A) Interest rates
B) Output and employment
C) Prices
ANSWER: