1. List the three creators of money in the U.S.
Pump Primer
List the three creators of money in the U.S.

2. Unit IV: Economics of the Financial Market
“ECONOMICS for Christian Schools”
By Alan J. Carper
Bob Jones University Press. 1998
Unit IV: Economics of the Financial Market

3. “Central Banking”
Chpt. 11

4. Objectives: List the three creators of money in the U.S.
Explain why the Federal Reserve System was organized
Describe the supervisory bodies of the Federal Reserve
Explain the necessity of the Federal Reserve
List and describe the functions of the Federal Reserve
Describe the effects that change the discount rate
Describe the effects of the open market operations has upon the money supply
Identify two reasons that the Fed attempts to control the supply of money
Explain the dangers of the Fed's actions to control the money supply

5. BIBLICAL INTEGRATION
Wisdom and understanding are to be more valuable than money.
"How much better is it to get wisdom than gold! and to get understanding rather to be chosen than silver!“ Prov. 16:16

6. “Financial Intermediaries” Activity 37by
Advanced Placement Economics Teacher Resource Manual. National Council on Economic Education, New York, N.Y

7. Objectives Explain the economic function of financial intermediaries.
Explain the fractional reserve system.
Explain the process by which banks create or destroy money and the factors that affect the increase or decrease in the money supply.
Define the required reserve ratio, required reserves, excess reserves and deposit expansions multiplier.

8. Introduction
Financial intermediaries at as the go-between borrowers and lenders.
They take deposits from households and business and make loans to other households and businesses.
Financial intermediaries include commercial banks, savings and loan associations, savings banks, credit unions and money market mutual fund companies.

9. Functions of financial intermediaries:
The role of financial intermediaries - bringing people who want to borrow funds together with people who want to lend funds.
Functions of financial intermediaries:
Liquidity creation
Minimization of the cost of borrowing
Minimization of the cost of monitoring borrowers
Risk reduction through pooling.

10. Central Banking What is a central bank?
A public authority that provides banking services to banks and regulates financial institutions and markets.
(“Who Is the FDIC?”)

11. Central Banking Why should you keep your money in a bank? Safety
Convenience
Cost
Security
Financial Future
(“Who Is the FDIC?”)

12. Central Banking Choosing An Account
Decide what type of account suits your needs the best.
Checking
Student/College
Interest baring
Savings
Money Market
(“Who Is the FDIC?”)

13. Central Banking Choosing A Bank? Services Fees Convenient
Insured (FDIC)
(“Who Is the FDIC?”)

14. Banks
The term banks is used to mean any depository institution whose deposits are a part of M1.
Banks must hold a specific percentage of the deposit as reserves; this percentage is called the required reserve ratio.
The deposit that is not part of required reserves is called excess reserves.
The bank may loan excess reserves or buy government securities.
A bank makes a loan by creating a checkable deposit for the borrower; this results in an increase in the money supply.
The money supply, or M1, equals currency, checkable deposits and traveler’s checks.

15. The total increase in the money supply may be less than predicted by the money expansion multiplier if
Borrowers do not spend all of the money they borrow,
Banks do not lend out all their excess reserves, and
People hold part of their money as cash.

16. Preserves and Promotes Public Confidence
Independent Agency
Created: 1933
Started: January 1, 1934
Main Office: Washington, D.C.
Preserves and Promotes Public Confidence
Insuring accounts up to $250,000
(thru 12/31/2013; 1/1/2014 returns to $100,000)
Banks
Thrift Institutions
(“Who Is the FDIC?”)

17. Does not insure: Securities Mutual funds
Stocks, or any other types of investments that the bank or thrift institutions may offer.
(“Who Is the FDIC?”)

18. Banks are chartered by:
States (and/or)
Federal Government
State chartered banks still have the choice of joining the Federal Reserve System.
(“Who Is the FDIC?”)

19. Managed by a five member Board of Directors
Appointed by the President
Confirmed by the Senate
No more than three from the same political party
(“Who Is the FDIC?”)

20. THE FEDERAL RESERVE SYSTEM
The Fed’s Policy Tools
The Fed uses three main policy tools:
Required reserve ratios
Banks and thrifts are required to hold a minimum percentage of deposits as reserves, a required reserve ratio.
Discount rate
Open market operations
(Bade 665) 20

21. Required Reserves
“The Federal Reserve requires most banks to hold a portion, up to 10 percent, of their deposits in reserve. These are called required reserves.”
Present rates:
$0 to $10.7 million = 0%
More than $10.7 million to $55.2 million = 3%
More than $55.2 million = 10%
(Hill)

22. Discount Rate
“The discount rate is the interest rate at which the Fed stands ready to lend reserves to commercial banks.”
“A change in the discount rate begins with a proposal to the FOMC by at least one of the 12 Federal Reserve banks.”
“If the FOMC agrees that a change is required, it proposes the change to Board of Governors for its approval.”
(Bade 665) 22

23. Open Market Operations
“An open market operation is the purchase or sale of government securities—U.S. Treasury bills and bonds—by the New York Fed in the open market.
When the New York Fed conducts an open market operation, the New York Fed does not transact with the federal government.”
(Bade 666) 23

24. The Multiple Expansion of Checkable Deposits
Part A
Assumes that
The required reserve ration is 10 percent of checkable deposits and banks lend out the other 90 percent of their deposits (banks wish to hold no excess reserves) and
All money lent out by one bank is redeposited in another bank.

25. Under these assumptions, if a new checkable deposit of $1,000 is made in Bank 1.
How much will Bank 1 keep as required reserves? _______
How much will Bank 1 lend out? _______
How much will be redeposited in Bank 2? ________
How much will Bank 2 keep as required reserves? _______
How much will Bank 2 lend out? _______
How much will be redeposited in Bank 3? ______
$100
$900
$900
$90
$810
$810

26. Use your answers to Question 1 to help you complete the table in Fig, Fill in the blanks in the table, rounding numbers to the second decimal (for example, $ = $59.05). After you have completed the table, answer the questions that follow by filling in the blanks or underlining the correct answer in parentheses so each statement is true.

27. Figure 37.1 Checkable Deposits, Reserves and Loans in Seven Banks
$1,000.00
$100.00
$900.00 2
$810.00 3
$81.00 4
$656.10 5 6
$59.05 7
$531.44
$478.30
All other banks combined
Total for all banks
$10,000.00
$9,000.00
$90.00
$810.00
$729.00
$729.00
$72.90
$656.10
$65.61
$590.49
$590.49
$531.44
$53.14
$4,782.98
$478.29
$4,304.67
$1,000.00

28. 3. In this example:
The original deposit of $1,000 increased total bank reserves by _______. Eventually, this led to a total of $10,000 expansion of bank deposits, ________ of which was because of the original deposit, while ________ was because of bank lending activities.
Therefore, if the fractional reserve had been 15% instead of 10%, the amount of deposit expansion would have been (more / less) than in this example.
Therefore, if the fractional reserve had been 5% instead of 10%, the amount of deposit expansion would have been (more / less) than in this example.
$1,000.00
$1,000.00
$9,000.00

29. If banks had not loaned out all of their excess reserves, the amount of deposit expansion would have been (more / less) than in this example.
If all loans had not been redeposited in the banking system, the amount of deposit expansion would have been (more / less) than in this example.

30. Another way to represent the multiple expansion of deposits is through T-accounts.
In short, a T-account is an accounting relationship that looks at changes in balance sheet items. Since balance sheets must balance, so, too, must T-accounts.
T-account entries on the asset side must be balanced by an offsetting asset or an offsetting liability.
For the bank, assets include accounts at the federal Reserve District Bank, Treasury securities and loans; liabilities are deposits and net worth is assets minus liabilities. Show how the $1,000 checkable deposit described in Question 1 would be listed in a T-account.
Assets
Liabilities
Loans $900
Deposits $1,000
Reserves $100

31. Part B
The Federal Reserve sets the reserve requirements: the percentages of the bank’s deposits that the bank must hold as reserves.
Banks may not loan out these required reserves. As we said in Part A, this fractional reserve system actually allows banks to create money.
The amount of reserves a bank holds is known as its total reserves.
Total reserves are composed of required reserves, which the bank must keep, and excess reserves, which the bank can loan to other customers.
The reserves held by the bank beyond those required by the /fed are excess reserves.

32. To find out, we must calculate the deposit expansion multiplier.
How much money would be created if the bank continued to loan out its excess reserves to the last penny?
To find out, we must calculate the deposit expansion multiplier.
The deposit expansion multiplier determines how much money can be created in the economy from an initial deposit. The formula for the deposit expansion multiplier is 1
Deposit expansion multiplier =
reserve requirement

33. In the example in Part A, the Federal Reserve set the reserve requirement at 10%. So, the deposit expansion multiplier would be:
To find the maximum amount of money that could be created, the formula is: 1
Deposit expansion multiplier = = 10
0.10
Expansion of the money supply = deposit expansion multiplier x excess reserves

34. The multiplier is 10, and excess reserves from the initial bank deposit are $900. So the potential expansion of money (M1) would be:
Expansion of the money supply = 10 x $900 = $9,000
M1 now consists of the original $1,000 deposit plus the $9,000 created.

35. Part B
Assume that $1,000 is deposited in the bank, and that each bank loans out all of its excess reserves. For each of the following required reserve ratios, calculate the amount that the bank must hold in required reserves, the amount that will be excess reserves, the deposit expansion multiplier and the maximum amount that the money supply could increase.

36. Deposit expansion multiplier Maximum increase in the money supply
Required Reserve Ratio 1% 5%
10%
12.5%
15%
25%
Required reserves
Excess reserves
Deposit expansion multiplier
Maximum increase in the money supply
$10
$50
$100
$125
$150
$250
$990
$950
$900
$875
$850
$750
100 20 10 8
6.67 4
$99,000
$19,000
$9,000
$7,000
$5,669.50
$3,000

37. If the required reserve ratio were 0 percent, then money supply expansion would be infinite. Why don’t we want an infinite growth of the money supply?
We would have hyperinflation.

38. If the Federal Reserve wants to increase the money supply, should it raise or lower the reserve requirement? Why?
The Federal Reserve should lower the required reserve ratio. Banks would have more excess reserves to lend out and, thus, the money supply could increase.

39. What would happen if the Federal Reserve increases the reserve requirement?
If the Federal Reserve increase reserve requirements, the money supply will decrease.

40. What economic goal might the Federal Reserve try to meet by reducing the money supply?
Price Stability

41. Why might the money supply not expand by the amount predicted by the deposit expansion multiplier?
Several reasons:
All money may not be deposited into the banking system
The banks may not be able to lend out all excess reserves because people do not want to borrow
Banks may want to keep excess reserves as a precaution.

42. Three Creators of Money
1. United States Treasury
2. Financial Institutions
3. Federal Reserve System
(Carper 141)

43. Located in Washington, D.C.
Federal Reserve Bank
Under Supervision of the seven member Board of Governors
Located in Washington, D.C.
Appointed by the president and confirmed by the Senate
Serve 14 yrs. terms (

44. “The Board of Governors meets regularly, typically every other Monday
“The Board of Governors meets regularly, typically every other Monday. The public is invited to attend meetings that are open under the Government in the Sunshine Act.”
(Meet twice a month pursuant to title 5, section 552b,of the U.S. Code)
(“Federal Reserve Board”)

45. There are 12 Federal Reserve banks, one for each of 12 Federal Reserve districts.
Each Federal Reserve Bank has nine board of directors, three of whom are appointed by the Board of Governors and six of whom are elected by the commercial banks in the Federal Reserve district.
The Federal Reserve Bank of New York implements some of the Fed’s most important policy decisions
(Bade 664)

46. Reserve district has its own Federal Reserve Bank.
Each Federal
Reserve district has its own
Federal Reserve Bank.
The Board of Governors of the Federal Reserve System is
located in Washington, D.C.
(Bade 664) 46

47. 47

48. Income Interest earned on gov. securities
Federal Reserve Bank
Income
Interest earned on gov. securities
Priced services to depository institutions
NOT OPERATED FOR PROFIT!
End of fiscal year money is turned over
to the U.S. Treasury Department.
(“Federal Reserve Board”)

49. The Federal Reserve System and Its Tools
Unit 4 Lesson 4
Activity 38
Graboyes, Rover. University of Richmond.
Advanced Placement Economics Teacher Resource Manual. National Council on Economic Education, New York, N.Y

50. Objectives Describe the structure of the Federal Reserve System
Identify each of the tolls of the Fed and explain
Explain basic balance sheets

51. Introduction
The focus of this lesson is the Federal Reserve System; how its actions relate to the money creation process and how its tools affect the money supply.
The Federal Reserve System is the central bank for the United States created in 1913.
It has regulatory authority for many financial institutions that hold checkable deposits.
It has the responsibility to control the money supply to promote the economic goals of full employment, price stability and stable economic growth.

52. The Federal Open Market Committee [FOMC]
“The Fed’s chief body for monetary policymaking.
The FOMC’s decisions ultimately affect interest rates.
The FOMC meets in Washington, usually eight times a year.”
(Emery)

53. “Changes in the federal funds rate trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output, and prices of goods and services.”
(“Federal Reserve Board”)

54. Primary Responsibility:
“Among the Fed's duties are managing the growth of the money supply, providing liquidity in times of crisis, and ensuring the integrity of the financial system.
The FOMC's decisions to change the growth of the nation's money supply affect the availability of credit and the level of interest rates that businesses and consumers pay.
Those changes in money supply and interest rates, in turn, influence the nation's economic growth and employment in the short run and the general level of prices in the long run.”
(“Federal Reserve Board”)

55. The Mechanics of Monetary Policy
To manage the money supply, the Federal Reserve uses the tools of monetary policy to influence the quantity of reserves in the banking system.
Increasing (decreasing) reserves tend to expand (contract) a bank’s ability to make loans.
Thus, reserve management gives the Fed powerful influences over the money supply and, in turn, over the general price level.

56. Balance Sheets
“The Federal Reserve operates with a sizable balance sheet that includes a large number of distinct assets and liabilities. Left side of a balance sheet shows the assets, and the right side shows the liabilities.”
Net worth = assets - liabilities
Liabilities:
Treasury Securities
Federal Reserve notes (U.S. paper currency) and the deposits that thousands of depository institutions, the U.S. Treasury, and others hold in accounts at the Federal Reserve Banks.
Assets:
holdings of Treasury, agency, mortgage-backed securities; discount window lending; lending to other institutions;  foreign currency
(“Federal Reserve Board”)

57. Activity 38
For Questions 1 thru 4 start with the baseline case in Fig The Fed wishes to decrease the money supply from $353 to $303 by market operations. The reserve requirement is 10%.
Will the Fed want to buy or sell existing Treasury securities? _____________
What is the money multiplier? ______
What is the value of Treasury securities that need to be bought or sold? _____________
Sell 10
(1/0.10 = 10)
(50/10 = 5)

58. What is the deposit expansion multiplier? _____________
For Q 5 thru 7, suppose banks keep zero excess reserve and the reserve requirement is 15%.
What is the deposit expansion multiplier? _____________
A customer deposits $100,000 in his checking account.
How much of this can the bank lend to new customers? ___________________
How much must the bank add to its reserves? ___________________
In what two forms can a bank hold the new required reserves?
(1/0.15 = 6.67)
85% of 100,000 = $85,000
15% of 100,000 = $15,000
Vault cash or in the reserve account (Fed Res.)

59. Suppose that the $100,000 had previously been held in Federal Reserve notes under the customer’s mattress and that banks continue to hold no excess reserves. By how much will the customer’s deposit cause the money supply to grow? ______________________
A very low discount rate may (encourage / discourage banks from borrowing) from the federal Reserve. Underline the correct answer and explain why.
$85,000 x 6.67 = $566,950
Banks borrow at a low interest rate, this will create more of a profit

60. The federal funds rate is the interest rate at which financial institutions can borrow from other financial institutions. Suppose the federal funds rate is 5% and the discount rate is 4.5 percent. Why is it that a bank might choose to borrow in the federal funds market, rather than getting the lower interest rate available through the discount window?
Fewer transaction costs and less scrutiny from the Federal Reserve will generate.

61. In a foreign country, the reserve requirement is 100%
In a foreign country, the reserve requirement is 100%. What will be the deposit expansion multiplier? ___________
If the fed decided to implement a policy action designed to increase the money supply in which direction would bank reserves and the federal funds rate change and why?
(1/1 = 1)
Institute a policy to increase reserves (giving banks an increased ability to make loans). Banks have more money to loan to other banks, businesses and consumers, so the federal funds rate is likely to decrease.

62. Circle the correct symbol (↑ for increase, ↓ for decrease)
Fed Actions and Their Effects
Federal Reserve action
Bank Reserves
Money Supply
Fed Funds Rate
A. Sold Treasury securities on the open market
B. Bought Treasury securities on the open market
C. Raised the discount rate
D Lowered the discount rate
E. Raised the reserve requirement
F. Lowered the reserve requirement

63. Contractionary Policy
Indicate in the table in Fig how the Federal Reserve could use each of the three monetary policy tolls to pursue an expansionary policy and a contractionary policy.
Fig Tools of Monetary Policy
Monetary Policy
Expansionary Policy
Contractionary Policy
A. Open market operations
B. Discount rate
C. Reserve requirements
Buy Treasury securities
Sell Treasury securities
Lower discount rate
Raise discount rate
Lower required reserve ratio
Raiser required reserve ratio

64. Recap! FDIC: Five member – Board of Directors Federal Reserve Bank:
Seven member – Board of Governors
Twelve Districts: (each)
Nine member Board of Directors
FOMC:
Twelve member committee:
Fed Board of Governors (seven members)
President of the Federal Reserve Bank of N.Y.
Four other Federal Reserve Presidents (serving a one-year term)