Macroeconomics The study of behavior and decision making of entire economies

The goal of any stabilization policy is to smooth out fluctuations in the business cycle

Business cycle - A period of macroeconomic expansion followed by a period of contraction

MONETARY POLICY AND THE FEDERAL RESERVE

The Federal Reserve System is the nation’s central bank

The Department of Treasury is responsible for manufacturing (printing) money

The Federal Reserve (aka The FED) controls the MONEY SUPPLY

The Federal Reserve is responsible for putting and taking dollars dollars into or out of circulation

STRUCTURE OF THE FEDERAL RESERVE

Board of Governors - The seven- member board that oversees the Federal Reserve System

Appointed by President Confirmed by the Senate I APPOINT THE BOARD OF GOVERNORS

1 Board of Governors = Federal 12 District Banks = Regional 10,000 National Banks = Local

Monetary policy Influencing the economy by controlling the nation’s money supply

What are goals of fiscal policy? The same as macroeconomic goals…remember them? 1.Economic growth 2.Full employment 3.Low inflation

Monetarism Belief that the money supply is the most important factor in macroeconomic performance

The cost of borrowing money is the interest rate

Monetary policy alters the supply of money

The supply of money affects interest rates

Interest rates affect the level of investment and spending in the economy

The money supply affects interest rates Too much money rates are low…Too little and rates are high Remember supply and demand?

HIGH $ SUPPLY = LOW INTEREST RATES

People and Businesses  borrow more money  …because money is cheap!!!!

People may buy a new house or car Businesses may expand

Creates jobs Encourages consumer spending Helps the economy grow C + I + G + (X-M)

The FED can influence the economy by controlling the nation’s money supply MONETARY POLICY

Influence the economy

Is the problem unemployment, or is the problem inflation???

Expand?Contract?

Easy Money Policy Purpose is to Speed up the economy Used in periods of contraction and recession

Easy money policy Monetary policy that increases the money supply

The Fed may follow an easy money policy when the macroeconomy is experiencing a contraction

SMALL $ SUPPLY = HIGH INTEREST RATES, PEOPLE & BUSINESSES BORROW LESS

Tight Money Policy purpose is to slow the economy Used in period of expansion and inflation

Tight money policy Monetary policy that reduces the money supply

The Fed may follow a tight money policy when the macroeconomy is experiencing TOO rapid rate of growth

Three tools the Fed uses to adjust the money supply

1.Reserve requirement

2. Discount rate

3. Open market operations

Increase the money supply: Decrease the Required Reserve Ratio (RRR) 2.Decrease the Discount Rate 3.Buy Back Federal Securities on the Open Market

Decrease the money supply: Increase the Required Reserve Ratio – RRR 2.Increase the Discount Rate 3.Sell federal Securities on the Open Market

Reserve requirements

Reserve Requirement Banks must keep a certain percentage of their deposits on “reserve” That money cannot be loaned out “Required reserve”

Reserve requirement Formula used to compute the amount of reserves an institution must have Set by the Fed To ensure that banks have enough funds to meet customers’ withdrawal needs

Legal reserves Coins, currency, and deposits used to fulfill the Fed’s reserve requirement Vault cash

Excess reserves Bank money available for loans Lending ability depends on excess reserves

The more money in excess reserves… …the more banks can loan out.

If the Fed lowers the rewerve requirement…banks have more excess reserves and can loan more out.

When a bank loans more out…

…the money supply increases.

MONEY SUPPLY RESERVE REQUIREMENT

HIGH $ SUPPLY = LOW INTEREST RATES

People Businesses Borrow more money Money is cheap

People may buy a new house or car Businesses may expand

Creates jobs Encourages consumer spending Helps the economy to grow C+I+G+(X-M)

Easy Money Policy SPEED UP THE ECONOMY!!!! Unemployment!!!

If the Fed increases the reserve requirement…

…banks have less excess reserves and can loan less out.

When a bank loans less out…

…the money supply decreases.

RESERVE REQUIREMENT MONEY SUPPLY

SMALL $ SUPPLY = HIGH INTEREST RATES

Tight Money Policy SLOW DOWN THE ECONOMY !!!! INFLATION

Tight Money Policy = SLOW DOWN THE ECONOMY !!!!

Changing the reserve requirement is Simplest way to adjust money supply BUT ………………….

The Fed rarely changes the reserve requirement It can be disruptive to the whole banking system

Reserve requirements,the discount rate,and open market operations 3 TOOLS

The discount rate

The interest rate that the Fed charges on loans to banks

Discount Rate If the Fed lowers the discount rate…

…it will cost less for banks to borrow money.

Therefore, banks are more willing to borrow money from the Fed.

Discount Rate Banks can loan out more of their EXCESS RESERVES.

When banks loan more out, the money supply goes up.

MONEY SUPPLY DISCOUNT RATE

Easy Money Policy

Discount Rate If the Fed raises the discount rate…

…it will cost more for banks to borrow money.

Therefore, banks are less willing to borrow money from the Fed.

Discount Rate Since banks must meet the RESERVE REQUIREMENT, they will loan less out to customers

When banks loan less out, the money supply goes down

DISCOUNT RATE MONEY SUPPLY

Tight Money Policy

Reserve requirements,the discount rate, and open market operations 3 TOOLS

Open market operations

Refers to the buying and selling of government securities by the Fed

Open market operations It is the monetary policy tool used most often by the Fed

The Federal Open Market Committee (FOMC) Looks at the state of the economy Decides what to do with the money supply

Federal Advisory Council (FAC) The research arm of the FED = number crunchers GDP CPI UNEMPLO. Etc…

Government securities Savings bonds Treasury bonds Treasury notes Treasury bills

If the Fed PURCHASES securities, it is giving people money…

Which goes into circulation, increasing the money supply.

What effect does the Fed’s purchase of government bonds have on the money supply? It increases the money supply

MONEY SUPPLY BUYS GOVERNMENT SECURITIES

Easy Money Policy

If the Fed SELLS securities, it is taking money from people…

Which take money out of circulation, decreasing the money supply.

How does the Fed’s sale of bonds reduce the money supply? When people buy bonds, their money is going out of circulation

MONEY SUPPLY SELLS GOVERNMENT SECURITIES