and its Macroeconomics – Unit 4

You’ll work an open-book free response AP question at the end of class tonight with an “earned partner.” WARNING AP question will be based on lecture notes & reading assignments

Since the 1930’s our Government has been required to carry out policies to [1] [2] [3]minimize ___________ maximize ___________ growth / GDP unemployment inflation

PL Q=realGDP=Y LRAS YPYP AD SRAS Y1Y1 PL 1 Let’s say the economy is having a problem. economy in recession What’s the problem illustrated here?

We have 2 kinds of policy that we can pursue to ameliorate the problem... (1) ________ policy (2) _________ policy has 2 possibilities: Fiscal Monetary DY G T a. change ____ which will shift ____ b. change ___ which will  ____ which will  ___ & ___ which will shift ___ AD CI Fiscal Policy is carried out by.... (a) __________ & (b) _________ The PresidentCongress

Monetary Policy is carried out by our Central Bank – in the US called... [1] aide expansion of US businesses by supplying more cash, and The Fed was established in 1913 & restructured in 1935 to... The Fed = The Federal Reserve System [2] be a source of emergency cash in case of a panic 6 of 37

12 District Reserve Banks 7-member Board of Governors (including Chair of Board) 4000 private bank members who benefit from membership Structure of the Federal Reserve System

The Federal Reserve System is comprised of 12 regional banks with 25 branches.

This man served as Chair of the Board for 18 years. This man was sworn in as our new Chair on Jan 31, _______________ Alan Greenspan _______________ Ben Bernanke

The Fed is constantly monitoring the health of the USA economy. B/c Fed officials aren’t elected, the Fed most often acts with the best interests of the country in mind, unlike politicians who have to worry about being __________. The Fed is owned by its 12-member banks, NOT the USA ____________  high degree of independence. government re-elected

Functions of the Fed: [1] [2] [3]to serve as a lender of last resort for member banks to regulate its member banks to serve as the bank of the US Gov’t 11 of 37

Functions of the Fed: [4]to issue new currency coins are minted at the US Mint part of the Dept of Treasury (gov’t) new paper currency is printed by the Fed and first issued by the Fed Reserve Banks

Once the Fed designs its “Federal Reserve Note” it is signed by the Treasurer of the U.S. Anna Escobedo Cabral – 42 nd Treasurer of the USA Summer, 2007 Newly-designed “5” had not been released and she told us that it would be the color ________.

Functions of the Fed: [5]to clear checks

Functions of the Fed: [6] [7] to set a key interest rate – the discount rate to set the supply of money in the economy

These decisions are made by the 14 members of the Federal Open Market Committee (FOMC). The FOMC meets 8 times per year at the Washington DC Fed.

set the ________ rate – the interest rate at which the Fed loans money to banks The Fed has 3 tools to carry out Monetary Policy to help control the economy [1] [3]open market operations set the _______ requirement at private banks reserve 17 of 37 [2] discount

# 1 Reserve Requirement  If the Fed decreases the reserve requirement  money supply ____  If the Fed increases the reserve requirement  money supply ____ simple money multiplier = __1__ r

changes in reserve requirement & discount rate are not used on a day-to-day basis by the Fed...more frequently used is tool # 3 # 2 Discount Rate encouraged If the Fed decreases the discount rate  banks are ____________ to borrow _________  money supply ____ more The discount rate is the rate of interest the Fed charges for loans it makes to banks. 

Our new car loan rates range from 6.74% to 13.74% APR. To obtain the lowest annual percentage rate, you must have excellent credit history,.... (Dec. 2008) Annual Percentage Rates (APR) - As Low As.... New car 5.30% Used car (franchise dealer) 5.85% Used car (private party) 8.34% (Dec. 2008) Banks we use are private businesses... they set their own rates but of 37

but... the rate at which banks loan money to us is strongly impacted by the discount rate – the rate at which the Fed loans to private banks. Fed Reserve Bank of New York $ commercial paper – overnight loans between banks $ $ federal funds rate – the rate at which banks loan to each other over night discount rate – the rate at which the Fed loans to banks $ $ $ $

The Fed uses its open market operations to target the federal funds rate. the federal funds rate – the interest rate at which banks lend to each other. Fed funds rate determined by supply & demand, but thru its operations the FED “targets” this rate. This rate has a direct impact then on the interest rate at which banks are willing to loan money to ___________ & ___________. consumers investors

A security is either a stock or a bond. US Dept of Treasury issues US Gov’t securities which are called Treasury BillsTreasury Notes Treasury Bonds # 3 Open Market Operations Open Market Operations = the Fed’s buying and selling of government securities. 23 of 37

A bond is an _____ in which the issuer of the bond agrees to pay the owner of the bond the amount of the _____ _______ (“par value”)of the bond on a future date. IOU facevalue Bonds -- a way for the government (or corporations) to _______ money to finance new projects or expansions. Bond buyers are essentially __________ money to the bond issuers. borrow loaning

Treasury Bills Treasury Notes Treasury Bonds mature in less than 1 year mature in 1 year – 10 years mature in 10 years or more from their issue date T-Bills T-Notes T-Bonds

Southwest Airlines owns bonds. The Fed goes to the bond market and buys a $50,000 worth of bonds from Southwest  The Fed pays Southwest $50,000 which it deposits into its account with Wells Fargo bank  Open-Market Operations – buying and selling of gov’t securities (bonds).

The Fed takes the $50,000 worth of bonds and puts them in the Fed’s vault (which is NOT circulated in the economy) and  The Fed takes $50,000 out of its vault to pay Southwest by depositing it into SW’s account with Wells Fargo bank

The supply of money circulating in the economy has ____ This is an example of a(n) expansionary / contractionary monetary policy 

interest rates lead individuals & firms to __________ more which will in turn increase ______________ & ___________  shifts _____ to the right. If the Fed has expanded the money supply  interest rates will ____ because there will be ______ money out there to lend out  lower PL Q=realGDP=Y LRAS YPYP AD SRAS Y2Y2 P1P1 AD  investment borrow more AD 2 Y1Y1 P2P2 consumption 29 of 37

How about the Fed goes out and sells $50,000 worth of T-Bonds to Southwest... which way do arrows go? So has the Fed increased the supply of money circulating in the economy or decreased it?

AP workbook p. 203, Act 38 do charts on overhead with class

Money Market quantity of money interest rate The demand for money is based on whether to hold your wealth as... (1) interest-bearing assets such as _________, or _________......or (2) as money which doesn’t earn ________. savings acctstocks interest So what’s the shape of the demand curve for money....what if interest rates are high...will Q be high or low? money market MD Q2Q2 i1i1 Q1Q1 i2i2

The opportunity cost of holding money is the ________________. quantity of money interest rate left money market MD 0 Q2Q2 i1i1 Q1Q1 i2i2 Money Market right The demand for money depends on the PL and on Y As PL   MD shifts ______ As Y   MD shifts ______ MD 2 MD 1 33 of 37

quantity of money interest rate MD Q2Q2 i1i1 Q1Q1 i2i2 Money Market The supply of money is presumed set by the Fed. What do you think it looks like? MS If the Fed contracts the MS  Q ____ & i _____ If the Fed expands the MS  Q ____ & i _____ MS 2    MS 3 i3i3 Q3Q3

quantity of money interest rate MD Q2Q2 i1i1 Q1Q1 i2i2 MSMS 2 Q of I interest rate ID Q2Q2 i1i1 Q1Q1 i2i2 Q = Real GDP = Y price level AD Y2Y2 Y1Y1 investment money market On the AP/IB exams you’ll be expected to explain step-by-step how an action by the Fed affects the economy.

quantity of money interest rate MD Q2Q2 i1i1 Q1Q1 i2i2 MSMS 2 Q of I interest rate ID Q2Q2 i1i1 Q1Q1 i2i2 Q = Real GDP = Y price level AD Y2Y2 Y1Y1 AD 2 investment money market The Fed purchases gov’t securities  Fed issues IOU’s for the purchase causing MS ____  interest rate ____  I ____ & C ____  AD ____  

AP workbook p , Act min 37 of 37 quantity of money interest rate MD i1i1 Q1Q1 MS money market