Government & the U. S. Economy What does the government do to keep the U.S. economy from acting like a roller coaster: INFLATION rising prices & increasing consumer spending RECESSION A loss of GDP for at least 6 months. (Less individual spending & higher unemployment)

The government tries to control the economy with two different types of policies 1. Fiscal policy 1. Fiscal policy - decisions made by the federal government (Congress & President) regarding how much money to spend and how much to collect in taxes 2. Monetary policy - 2. Monetary policy - decisions made by a central bank (Federal Reserve) about the amount of money in circulation and interest rates

Imagine that the U.S. economy is like a campfire.

If the campfire gets too small, the fire goes out and that’s bad!

If the U.S. economy slows down and shrinks, we have a recession that could lead to an economic depression.

So what does the government do to try to keep the economy stable?

If the economy slows too much, the government would increase the amount of money in circulation to stimulate economic growth. If the fire is low, you would add sticks and logs to make the fire grow larger. This is called Expansionary Policy. Government is trying to expand the economy.

The government tries to stimulate the economy with fiscal policy: 1.Congress can lower taxes so that business and individuals have more money to spend. 2.The government can increase the amount of money it spends.

The Fed tries to stimulate the economy with monetary policy: 1.They can buy securities to increase the amount of money banks have on hand. 2.The Fed can lower interest rates to make it easier for individuals and business to borrow money. 3.The Fed can lower the reserve requirement to allow banks to lend out more money.

If the campfire gets too big, that’s bad! Back to the campfire…

If the economy grows too large, we have high prices and inflation.

If the economy grows too rapidly, the government would decrease the amount of money in circulation to slow economic growth. If the fire became too big, you could remove some sticks and logs to make the fire slow down. This is called Contractionary Policy. Government is trying to slow the economy.

The government tries to slow down inflation with fiscal policy: 1.Congress can raise taxes so that businesses and individuals have less money to spend. 2.The government can decrease the amount of money it spends in the economy.

The Fed tries to slow down inflation with monetary policy: 1.They can sell securities to decrease the amount of money banks have on hand. 2.The Fed can raise the discount rate to make it cost more for individuals and business to borrow money. 3.The Fed can raise the reserve requirement to force banks to keep more money and lend less.

The Federal Reserve Started in 1913 is response to yet another financial crisis Is Quasi-public Serves three purposes Regulates the payment system Supervises banks Conducts monetary policy Washington D.C.

Federal Reserve Functions Issue currency Set reserve requirements Lend money to banks Collect checks Act as a fiscal agent for U.S. government Supervise banks Control the money supply LO

12 REGIONAL FEDERAL RESERVE BANKS 25 BRANCH BANKS FOR THE 12 REGIONS FINANCIAL INSTITUTIONS Janet Yellen

LO3 The 12 Federal Reserve Banks 14-19

More than one-third of U.S. commercial banks are members of the Federal Reserve System. National banks chartered by the federal government are, by law, members of the Federal Reserve System.

State-chartered banks may choose to become members of the Federal Reserve System if they meet the standards set by the Board of Governors.

10 Fun Facts About the Fed

Monetary Policy and the Federal Reserve Monetary policy involves decisions the Fed makes to affect the nation’s money supply and credit. Goals * Economic growth * Full employment * Stable prices Federal Reserve Bank of Richmond

Open Market Operations Think back to our inflation activity where you bought candy. The process of buying and selling Treasury securities is called open market operations. This is done by the Federal Open Market Committee (FOMC) The Federal Reserve doesn’t keep a stockpile of candy. The candy represents Treasury securities – US Govt. treasury bills & bonds.

How else does the Fed keep prices stable and maintain economic growth? Discount Rate – (Interest rates) The Fed does not “set” the interest rate that most people pay. It sets a discount rate that it charges to banks for short-term loans, which then contributes to the rate that the banks charge customers on their loans. – Lower interest rates = more banks making loans which creates money. – Higher interest rates = less loans, less money

How else does the Fed keep prices stable and maintain economic growth? Reserve Requirements Reserve requirements are the amount of funds that a depository institution (bank, credit union,…) must hold in reserve against specified deposit liabilities. Within limits specified by law, the Board of Governors has sole authority over changes in reserve requirements. Depository institutions must hold reserves in the form of vault cash or deposits with Federal Reserve Banks.

Your Turn!!! If the country is in a recession, the government might _______ taxes so that there is ______ money available for businesses and individuals. lower more

Your Turn!!! If the country is experiencing high inflation, the Federal Reserve might _____ interest rates causing banks to lend __________ which leaves less money available for ______________________________. raise less money businesses & individuals to borrow

Your Turn!!! The country is in a bad recession and many people are out of work. The government might _________ its spending so that there is ______ money in the economy. increase more How would this help create new jobs?

Your Turn!!! The government recognizes a problem with the economy and decides to start selling more bonds to the public. Will this action increase or decrease the amount of money in the economy? Why? Does this show the country experiencing inflation or a recession? How do you know?

Your Turn!!! What message is the cartoonist is trying to convey?

Memorandum from the Chairman of the Board of Governors To: Federal Reserve Board of Governors Re: Current Economic Problems I have received the following economic data and would appreciate your recommendations for policy regarding monetary policy. Unemployment Rate Inflation Rate Last Year 6.2% 2.6% This Year 8.5% 2.5% Forecast for Next Year 9.6% 2.3% 1. Given the information in the table, what is the major economic problem confronting the U.S. economy? 2. Please summarize your suggested changes for monetary policy.