Monetary Policy

Key Terms monetary policy open-market operations gross domestic product (GDP) fiscal policy Federal Reserve Federal Reserve System discount rate reserve requirement economy interest rate

Key Questions: What is the Federal Reserve? How does the Federal Reserve use the tools of Monetary Policy to influence the economy? How does inflation affect consumers and the economy? Student Objectives describe how the Federal Reserve System uses the three tools of monetary policy, including open market operations, changes in the discount (interest) rate and changes in the reserve requirements to influence the economy (4.1.4f) describe the effectiveness of monetary policy in achieving economic growth, full employment and price stability (4.1.4g) explain how inflation reduces buying power and may contribute to a slow down in the economy (4.1.4j)

Key Terms Key TermDefinition inflationan increase in the overall price level in an economy interest A fixed charge for borrowing money, usually a percentage of the amount borrowed Federal Reserve the nation’s central bank; the Federal Reserve uses the three tools of monetary policy including open market operations, adjustments in reserve requirement and changes in the interest rate to influence the economy monetary policy a course of action that seeks to affect the amount of money and credit available in the economy and the cost of the credit (interest rates) in order to help the economy grow, keep prices stable, and keep employment at a high level

WARM-UP: 4/19/16 & 4/20/16 Take one of each of the handouts from the front desk. If you have a dollar bill, take it out now!

Overview The Federal Reserve is an independent agency of the federal government commonly known as the "Fed." The Federal Reserve regulates how much money there is in the economy and monitors the economy through monetary policy. By the end of this lesson, you will be able to answer these questions: 1. What is the Federal Reserve? 2. Why is the Federal Reserve important? 3. How does monetary policy and the actions of the Federal Reserve affect me?

Money Facts You Can't Count On It To Last! The average life span of a dollar bill in circulation is 5.9 years. Paper Money Isn't Actually Paper! Dollar bills are made of cloth, a combination of linen and cotton. Ripped Bills Are Still Redeemable! For the most part, the U.S. Bureau of Engraving and Printing will redeem mutilated dollar bills as long as you still have more than half of the note. The Secret Service Started Off Protecting The Dollar! Most well-known for its role of guarding the life of the president, the Secret Service was actually started to fight counterfeit money, in a time when around 1/3 of bills were thought to be fake.

Money Facts There's a $100,000 note! The largest bank notes ever printed were issued in 1934 and depicted the face of President Woodrow Wilson. Which bill is most common? The United States $1 bill is the most common denomination of US currency, totaling 45% of all bills ($1, $2, $5, $10, $20, $50 and $100) produced. There are about 2 billion $1 bills in circulation. Why Green? Each color has its own physical characteristics. Green was selected for U.S. dollars because it’s the most resistant to fading, flaking, and discoloration.

Where have you seen the “Federal Reserve”? U.S. money is distributed for circulation by the 12 Federal Reserve Banks. These institutions act as "banks for the banks." Which Federal Reserve Bank seal is on the front of the dollar in your wallet?

Geographic Boundaries of the Federal Reserve Districts Which district are we in?

Where is your money from? A= Boston (1) B= New York City (2) C= Philadelphia (3) D= Cleveland (4) E= Richmond, VA (5) F= Atlanta (6) G= Chicago (7) H= St. Louis (8) I= Minneapolis (9) J= Kansas City (10) K= Dallas (11) L= San Francisco (12)

What is the Federal Reserve? the central bank of the United States an independent agency of the federal government commonly known as the "Fed" regulates how much money there is in the economy Most banks are members of the Federal Reserve system. Why is it important? The Fed uses monetary policy to affect how much money is available to banks. This in turn, affects the amount of money available to people everyday.

What does the Federal Reserve do? The Federal Reserve makes and carries out the monetary policy of the government. Through its regulations, the Fed influences economic conditions to promote high employment, economic growth, and stable prices.

Monetary Policy a course of action that seeks to affect the amount of money and credit available in the economy and the cost of the credit (interest rates) in order to help the economy grow, keep prices stable, and keep employment at a high level the Fed’s actions to manage the money supply to keep inflation low and stable The Fed… processes checks and provides electronic payment services and other financial services to financial instructions and banks supervises and regulates banks and financial instructions to promote the safety of deposits and soundness of the banking system

Fiscal Policy Review! The ways in which the government adjusts its spending levels and tax rates to monitor and influence the nation's economy Fiscal policy: always connected to spending and taxing!!

What does the Federal Reserve do? While the Federal Reserve tries to regulate the economy through the management of the money supply, the Fed can not guarantee that the economy will grow at a healthy pace or that jobs will be available for everyone who wants one. To promote economic growth, the Fed attempts to control inflation so it does not affect business or individual spending.

Rapid Growth & the Effects on the Economy Inflation occurs when the growth of money (deposits in banks and cash in circulation) and credit exceed the supply of goods and services. you have to spend more dollars for goods and the dollars are worth less To keep the economy strong, the growth of money and credit should NOT grow too rapidly or too slowly.

Government Spending The government spends money when it wants to INCREASE the money supply. This is done when a country is in a recession or depression. When the money supply increases… interest rates are lower people spend more unemployment goes down

Government Spending: Actions of the Federal Reserve Too much spending can lead to inflation. Too little spending can cause unemployment and decreases in the production of goods. The job of the Fed is to balance these forces using three major methods or tools, which help the economy grow or slow depending on what the Fed thinks is needed.

HOW THE FED AFFECTS THE MONEY SUPPLY & THE ECONOMY 1. changing the reserve requirement 2. changing the discount rate 3. buying or selling government securities

Actions of the Federal Reserve

1. The Reserve Requirement When money is deposited in a bank, the bank is allowed to lend or invest part of that deposit. But it must keep part of the deposit in "reserve." Definition: the minimum amount of money that local banks must keep at their location at the end of the day. (This is a requirement of the FED.)

Raising the Reserve Requirement Takes place when the nation is experiencing inflation (the Fed wants the economy to slow down). Banks will keep more money in the bank instead of loaning it to you. This decreases the money supply.

Lowering the Reserve Requirement Takes place when the Fed wants to help the economy grow, the reserve requirement is lowered. Banks can loan more money to consumers to buy cars, houses, or other goods. This helps the economy grow by increasing spending and employment. This increases the money supply.

What is an interest rate? A fixed charge for borrowing money, usually a percentage of the amount borrowed Remember! Money is not free to borrow. Think of it this way. Interest rates reflect: the price of money what money costs

Interest Rate Example Alex wants to borrow $1,000. The local bank puts a “10% interest rate” on the loan. To borrow the $1,000 for 1 year will cost: $1,000 × 10% = $100 In this case the “interest” is $100, and the “interest rate” is 10% (people often say “10% interest” without saying “rate”) Of course, Alex will have to pay back the original $1,000 after one year, so this is what happens: Alex borrows $1,000, but has to pay back $1,100.

2. The Discount (Interest) Rate discount rate: interest rate the Federal Reserve charges banks The Fed charges this rate if your bank needs to borrow from the Fed because it doesn't have the amount of reserves it is required to have. The Fed loans money to banks at an interest rate that the Fed chooses.

The Discount Rate (con’t) When it increases: banks have to pay more to borrow money banks pass high rate along to customers so it costs consumers more to borrow money (mortgages, credit cards, car loans, personal loans); the bank isn't as likely to borrow money from them (the bank has less money to lend to you) decreases the money supply When it decreases: banks pay less to borrow money banks pass low rate along to customers so it increases the money supply the bank is more likely to borrow and have more money to lend you money to buy a house, car, etc. increases the money supply

3. Open Market Operations (Buying and Selling Securities) When the federal government borrows money, it does so by selling treasury securities to interested buyers. These buyers may sell the bonds to other buyers. One buyer is the Fed. U.S. Treasury securities: are debt obligations of the U.S. government. When you buy a U.S. Treasury security, you are lending money to the federal government for a specified period of time. Examples: bills, notes, and bonds

Selling Securities To slow growth (decrease the money supply), the Fed will sell some of the government securities it owns. As a result, the money supply decreases. If your bank decides to buy some of the securities the Fed is selling, it has to pay the Fed. This means it has less money to use for other things like lending money to people or businesses.

Buying Securities To make the economy grow, the Fed buys securities and the money supply increases. If the Fed buys securities from your bank, it gives the bank more money to lend to customers. This may lower interest rates. Customers then borrow and buy more goods and services with the money they borrow.

HOW THE FED AFFECTS THE MONEY SUPPLY & THE ECONOMY 1. changing the reserve requirement 2. changing the discount rate 3. buying or selling government securities

The amount of money banks can lend and the amount people want to borrow AFFECTS 1. The money supply AFFECTS 2. How much people want to spend in the economy AFFECTS 3. The health of the economy

Check for Understanding What actions can the Federal Reserve take to slow the economy? What actions can the Federal Reserve take to help the economy grow?