AA-ch 13_MACRO_FA2010_

AA-ch 13_MACRO_FA2010_ - • There are two ways government...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: • There are two ways government can implement policy. Ch. 13 Ch. Money & Banking – FISCAL Policy — changes in government spending and tax rates (and by implication, borrowing) – MONETARY Policy — changes in the money supply • Who Controls our MS? – The Federal Reserve Why do we study money? • Because money is SO important to the • functioning of any developed society. Also, because money makes us do such WEIRD stuff…. stuff… What is money? • Money is anything that can be used in the purchase of a good or service or in repayment of a debt; coins, cash, checking account funds, travelers checks Are credit cards money? • No, credit is not money. Credit is CREATION of a debt Are debit cards money? • No more than your wallet is money… money… Where did money come from? 1. Who invented money? 2. No one….money is the result of one… human action, not of human design. 3. Friedrich Hayek Functions of Money Functions 1. Medium of Exchange – – eliminates need for barter – Facilitates trade by eliminating need for coincidence of desires • Commodity Money – money whose value comes from a commodity out of which it is made. • Fiat money – little or no intrinsic value, value by Gov’t decree Gov’ – Liquidity – must protect market value Functions of Money 1. Medium of Exchange 2. Store of Value 2. 3. Standard of Value (unit of account) 1. We need this to be able to compare goods and services to see which is a better deal in terms of the other 2. Allows cost / benefit analysis Functions of Money 1. Medium of Exchange – 2. Store of Value – – allows us to transfer purchasing power from one period to another 3. Standard of Value – What determines the value of money? • What determines the value of ANYTHING? – Supply and demand for that THING Value S V1 D MONEY Q of $ What is money demand? What is money supply? • The amount of money you are willing and • M1 — coins, currency, demand deposits, able to hold in your pocket (or in checking account….as highly liquid asset). account… – Money you hold for Liquidity – Money you hold to BUY things • Opportunity Cost of Money Demand (or the opportunity cost of holding money) – Interest foregone (money in your pocket is NOT earning interest) other checkable deposits (interest earning), & traveler’s checks – Most highly traveler’ liquid measurement of Money • M2 – broader measure. M1 + savings deposits + time deposits <$100,000 + MMMF (not generally used as a means of payment but so highly liquid that they can be converted to cash with great ease and quickness.) Who controls our money supply? Who • The FED— FED— – was established • to be the lender of last resort • To restore credibility to the US Banking system. • To eliminate bank runs – What was wrong with the US Banking system? • Wild cat banking • Competing currencies After the FED was established, the US suffered no more major series of bank failures. 1. I agree with that statement. 2. I disagree with that statement. • Did it work? Runs on Banks Runs on Banks • Since the establishment of the FED was • Since the establishment of the FED was How do we create money? How do we create money? • Money is created through the loan • Money is created through the loan not enough to keep runs on banks from happening, what was our next solution? process – Two stories • Fractional reserve banking not enough to keep runs on banks from happening, what was our next solution? • FDIC – Federal Deposit Insurance Corporation • Insures individual accounts up to $250,000 process – Two stories • Fractional reserve banking • The money fairy • How Banks Create Money • Required Reserve Ratio • Excess Reserves • Deposit Expansion Multiplier (leakages) If the Required Reserve Ratio is If 15% and banks hold excess reserves of 5%, what will the deposit expansion multiplier be? If the Deposit Expansion Multiplier is 5, how many bonds (in dollar terms) would the Fed need to buy to increase the money supply by $1,000? This is short answer. Do the calculation and enter your answer. Who controls the U.S. Money Supply? (MA) The FED was formed for which of the following reasons: The FED 1. To put confidence back into the US Independence of the FED • Do we want the FED to be independent? Independence of the FED • Do we want the FED to be independent? Independent of what or whom? banking system 2. To be the lender of last resort 3. To effectively eliminate bank runs 4. To loan money to private businesses Independent of what or whom? – Independence reduces the likelihood of political influences Independence of the FED Independence • Do we want the FED to be independent? Independent of what or whom? – Independence reduces the likelihood of political influences – Countries with central banks that ARE politically dependent have much higher inflation rates Independence of the FED • Do we want the FED to be independent? Independent of what or whom? • ARE THEY independent? Independence of the FED • Do we want the FED to be independent? Independent of what or whom? – Independence reduces the likelihood of political influences – Countries with central banks that ARE politically dependent have much higher inflation rates • Inflation rate of Zimbabwe--231,000,000% / year Zimbabwe--231,000,000% • Inflation rate of Germany 1923—41% per day 1923— Independence of the FED • Do we want the FED to be independent? Independent of what or whom? • ARE THEY independent? – Length of terms – 14 years Independence of the FED • Do we want the FED to be independent? Independent of what or whom? • ARE THEY independent? – Length of terms – Staggered term of Chrm. Of BOG Chrm. Independence of the FED • Do we want the FED to be independent? Independent of what or whom? • ARE THEY independent? – Length of terms – Staggered term of Chrm. Of BOG Chrm. – Staggered terms of the general membership of the BOG (one term pres, at most gets to appoint 2 members; 2 terms expire during 4 years, at most) Independence of the FED Independence • Do we want the FED to be independent? How does the FED control our money supply? Independent of what or whom? • ARE THEY independent? – Length of terms – Staggered term of Chrm. Of BOG Chrm. – Staggered terms of the general membership of the BOG (one term pres, at most gets to appoint 2 members; 2 terms expire during 4 years, at most) – Financial independence Major Monetary Tools of the FED 1. Reserve Requirement – – Increase RR = banks hold MORE money; can loan less money… Thus, MS is tightened money… tightened Decrease RR = banks hold LESS money; can loan MORE money…Thus, MS is eased money… 2. Discount Rate/Federal Funds Rate – – To meet reserve requirements, banks may sometimes need short term loans. They can either: • Borrow from a correspondent bank (FFR) • Borrow from the FED (DR) Major Monetary Tools… Tools… 4. Interest on RESERVES (Reserves that belong to commercial banks, but held at the FED) 1. Increase int. on reserves, opportunity cost of holding money on reserve decreases and banks lend LESS (decrease in MS) 2. Decrease int. on reserves, opportunity cost of holding money on reserve increases and banks want to lend MORE (increase in MS) Major Monetary Tools… Tools… 3. Open Market Operations – buying and selling government bonds on the open market 1. Only GOV’T bonds (although effect GOV’ would be no different)* 2. Second hand sales (primary are issued by Treasury)… Treasury)… *USED to be only Gov’t bonds…now commercial paper, other financial Gov’ bonds… instruments (Mortgage backed securities, etc.) How the Fed controls the growth rate of the money supply • To pursue expansionary monetary policy – – – – ↓RR ↓DR Buy more bonds ↓Int. on reserves • To pursue contractionary monetary policy – ↑ RR – ↑ DR – Sell more bonds (or buy fewer bonds) – ↑ Int. on reserves What has that done to the money supply? Recent Changes in Monetary Policy Recent • Changes in Open Market Operations • • – Previously only bought and sold U.S. Treasury Bonds – Now buy and sell broad range of assets • Mortgage-backed securities, commercial paper, Mortgagecorporate bonds • Has same effect on money supply Extension of Loans – Fed previously gave loans only to member banks for a short periods of time. – Fed now gives loans to non-bank financial institutions for nonlong time periods. Payment of Interest on Reserves – Fed now pays interest on reserves – Can change money supply by changing interest rate paid Excess Reserves • Previously, Fed paid no interest on excess reserves so bank held little in excess reserves • Now Fed pays interest on excess reserves and interest rates are low, bank hold excess reserves Excess Reserves of Depository Institutions, 1980 to the present The intention of recent changes in Fed The changes policy was to: 1. introduce uncertainty into the economic 800 700 2. Billions of Dollars 600 500 400 300 200 100 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 process causing households and businesses to refrain from investing, negating the intention of the policy. create more stability in the economic process causing households and businesses to invest more heavily into the economy, reducing unemployment and stimulating aggregate demand. 2008 Source: Board of Governors of the Federal Reserve System rev20090317 Fed Operations and Monetary Policy Slide 39 of 6 The actual result of recent changes in changes Fed policy was to: Minor Monetary Tool of the FED 1. introduce uncertainty into the economic • Margin Requirement – If you are 2. process causing households and businesses to refrain from investing, negating the intention of the policy. create more stability in the economic process causing households and businesses to invest more heavily into the economy, reducing unemployment and stimulating aggregate demand. borrowing money to buy stock, the MR is the % of your own money you must put down to buy the stock Video – History of US Banking Video VISA was formerly known as: 1. 2. 3. 4. Charge It Pac-man – Pan-American Credit Manager PacanVista Bank Americard PRS The first electronic recording method of accounting (or check clearing machine) was known as: 1. IRMA 2. EMMA 3. ERMA 4. ANNA If we are no longer on the GOLD standard, what is our money supply based on? Monetary Base = Monetary Currency + Reserves • reflects the stock of Gov’t Securities held by the Gov’ FED • analogous to gold stock when we were on the gold standard M1 Money Supply & Monetary Base Figures, year end 2003 a = traveler’s checks included in currency figure traveler’ If the FED increases the discount rate and the reserve requirement and sells bonds, this will Monetary Base • Monetary Base expanded gradually until mid 2008 • Monetary Base nearly doubled between July 2008 and early 2009 • Announced last week the Fed will buy up to $1.15 trillion more 1. Increase the money supply 2. Decrease the money supply 3. Send mixed signals and we don’t don’ assets over the next few months U.S. Monetary Base, 2000 to the present 1,800 Billions of Dollars 1,600 1,400 know WHAT will happen to the money supply 4. Will not change the money supply. 1,200 1,000 800 600 400 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: Board of Governors of the Federal Reserve System Fed Operations and Monetary Policy If the FED increases the discount rate and the reserve requirement and buys bonds, this will 1. Increase the money supply 2. Decrease the money supply 3. Send mixed signals and we don’t don’ know WHAT will happen to the money supply 4. Will not change the money supply. The monetary base: 1. Is currency in circulation + bank reserves at the bank 2. Is the basis of our money supply 3. Also includes travelers checks 4. All of the above (PMA) If the FED buys bonds of (PMA) $10,000, this will: 1. Increase bank reserves 2. Increase the money supply 3. Decrease bank reserves 4. Decrease the money supply 5. Have no impact on the money As we said…money makes us do said… strange things…. things… supply Bonus – Personal Finance Interviewer: Professor Einstein, what is the most powerful force on the face of the earth? Interviewer: Professor Einstein, what is the most powerful force on the face of the earth? Einstein: compound interest The miracle of compound The interest End of Ch. 13 ...
View Full Document

This note was uploaded on 04/02/2012 for the course ECO 2013 taught by Professor Slate during the Fall '10 term at Florida State College.

Ask a homework question - tutors are online