17.1 How Banks Work 17.2 Monetary Policy in the Short Run 17.3 Monetary Policy in the Long Run

Transcription

1 CHAPTER 17 Money Creation, the Federal Reserve System, and Monetary Policy 17.1 How Banks Work 17.2 Monetary Policy in the Short Run 17.3 Monetary Policy in the Long Run 1 CONTEMPORARY ECONOMICS: LESSON 17.1

2 CHAPTER 17 Money Creation, Consider the Federal Reserve System, and Monetary Policy How does the Fed create money? Why don t you demand all the money you can get your hands on? What s the price of holding money? How does the supply of money in the economy affect your chances of finding a job, your ability to finance a new car, and the interest rate you pay on credit cards? What s the impact of changes in the money supply on the economy in the short run and in the long run? 2 CONTEMPORARY ECONOMICS: LESSON 17.1

3 Objectives LESSON 17.1 How Banks Work Discuss what s involved in getting a new banking operation up and running. Describe how the banking system can expand the money supply by a multiple of excess reserves. 3 CONTEMPORARY ECONOMICS: LESSON 17.1

4 Key Terms LESSON 17.1 How Banks Work net worth required reserves asset excess reserves liability money multiplier balance sheet required reserve ratio 4 CONTEMPORARY ECONOMICS: LESSON 17.1

5 Operating a Bank Getting a charter Bank balance sheet Reserve accounts 5 CONTEMPORARY ECONOMICS: LESSON 17.1

6 Getting a Charter Charter the right to operate Net worth assets minus liabilities, also called owners equity Asset any physical property or financial claim owned by the bank 6 CONTEMPORARY ECONOMICS: LESSON 17.1

7 Bank Balance Sheet Liability an amount the bank owes Balance sheet a financial statement showing assets, liabilities, and net worth at a given time. Assets = Liabilities + net worth 7 CONTEMPORARY ECONOMICS: LESSON 17.1

8 Reserve Accounts Required reserve ratio dictates the minimum proportion of deposits the bank must keep in reserve Required reserves checkable deposits multiplied by the required reserve ratio Excess reserves reserves that exceed required reserves 8 CONTEMPORARY ECONOMICS: LESSON 17.1

9 Money Multiplier The Fed makes a move Round one Round two and beyond Reserve requirements and money expansion Limitations on the multiplier 9 CONTEMPORARY ECONOMICS: LESSON 17.1

10 LESSON 17.2 Objectives Monetary Policy in the Short Run Explain the shape of the money demand curve. Explain how changes in the money supply affect interest rates and real GDP in the short run. Discuss the federal funds rate and why the Fed uses this rate to set monetary policy goals. 10 CONTEMPORARY ECONOMICS: LESSON 17.2

11 LESSON 17.2 Key Terms Monetary Policy in the Short Run money demand money supply federal funds market federal funds rate 11 CONTEMPORARY ECONOMICS: LESSON 17.2

12 Money Demand A medium of exchange A store of value The cost of holding money Money demand and interest rates 12 CONTEMPORARY ECONOMICS: LESSON 17.2

13 Money Supply and the Market Interest Rate Money supply Market interest rate An increase in the money supply Effect of lower interest rates Increasing interest rates 13 CONTEMPORARY ECONOMICS: LESSON 17.2

14 Effect of an Increase in the Money Supply 14 CONTEMPORARY ECONOMICS: LESSON 17.2

15 Effects of a Lower Interest Rate 15 CONTEMPORARY ECONOMICS: LESSON 17.2

16 Ways to Expand the Money Supply Purchasing U.S. government securities Reducing the discount rate Lowering the required reserve ratio 16 CONTEMPORARY ECONOMICS: LESSON 17.2

17 Ways to Reduce the Money Supply Selling U.S. government securities Increasing the discount rate Raising the required reserve ratio 17 CONTEMPORARY ECONOMICS: LESSON 17.2

18 The Federal Funds Rate Federal funds market Aggressive rate cuts Why target this rate? Recent history of federal funds rate 18 CONTEMPORARY ECONOMICS: LESSON 17.2

19 Recent Ups and Downs in the Federal Funds Rate 19 CONTEMPORARY ECONOMICS: LESSON 17.2

20 LESSON 17.3 Objectives Monetary Policy in the Long Run Understand why changes in the money supply affect only prices in the long run, not real GDP. Examine the historical link between money supply growth and inflation. Determine why political independence of central banks results in lower inflation. 20 CONTEMPORARY ECONOMICS: LESSON 17.3

21 LESSON 17.3 Key Term Monetary Policy in the Long Run euro 21 CONTEMPORARY ECONOMICS: LESSON 17.3

22 Long-Run Effect of Money Supply Changes Production in the long run Changes in aggregate demand 22 CONTEMPORARY ECONOMICS: LESSON 17.3

23 An Increase in the Money Supply in the Long Run 23 CONTEMPORARY ECONOMICS: LESSON 17.3

24 Long-Run Evidence Money supply growth and inflation in U.S. history Money supply growth and inflation around the world 24 CONTEMPORARY ECONOMICS: LESSON 17.3

25 Other Issues in Monetary Policy Fed independence Central bank independence and inflation Independence trend Could deflation pose a problem? Lags and monetary policy 25 CONTEMPORARY ECONOMICS: LESSON 17.3