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Money and the Federal Reserve

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Title: Money and the Federal Reserve


1
Chapter 5
  • Money and the Federal Reserve

These slides supplement the textbook, but should
not replace reading the textbook
2
What is barter?
  • The practice of trading one good or service for
    another

3
What is a double coincidence of wants?
  • A situation in which two traders are willing to
    exchange their products directly

4
What is currency?
  • Anything that can be used to signify someones
    credit and someones debit in a financial
    transaction

5
What are the 4 basic functions of money?
  • Medium of exchange
  • Unit of account
  • Store of value
  • Standard deferred payment

6
What is amedium of exchange?
  • Money is accepted in exchange for a good or
    service

7
What aunit of account?
  • Money is used to compare the relative value of
    different goods and services

8
What is astore of value?
  • Money is used as a means of saving

9
What is astandard ofdeferred payment?
  • Money is used to keep track of the method and the
    amount of money is to be paid back in the future

10
What are the properties of money?
  • Scarcity
  • Portability
  • Divisibility

11
What is commodity money?
  • Anything that serves both as money and as a
    commodity

12
What is token money?
  • Money that exceeds the value from which it was
    made, for example, quarters

13
What are examples of money?
  • Federal Reserve Notes
  • Coins
  • Checks
  • Travelers checks

14
What does the term liquidity mean?
  • The easier something is to spend the more liquid
    it is, the more difficult it is to spend the less
    liquid it is

15
Which form of money is most liquid?
  • It all depends on the circumstances

16
What is fiat money?
  • Money not redeemable for any commodity its
    status as money is conferred by the government

17
What is legal tender?
  • Currency that constitutes a valid and legal offer
    of payment for debts

18
Does gold or silver back up our money?
  • No, our money is not backed up by anything

19
What happenedin 1968?
  • U.S and a number of European nations stopped
    selling gold on the London market, allowing the
    market to freely determine the price of gold

20
What happenedin 1971?
  • From 1968 to 1971, only central banks could
    trade with the U.S. at 35/oz. Finally, in 1971,
    even this bit of gold convertibility died

21
Why does money have value?
  • It is useful and relatively scarce

22
What determines the value of money?
  • The general price level

23
Why are banks called depository institutions?
  • Because they accept deposits from the public

24
What arecommercial banks?
  • Depository institutions that make loans to the
    public

25
What aredemand deposits?
  • Accounts at financial institutions that pay no
    interest and on which depositors can write checks
    to obtain their deposits

26
How do banks make profit?
  • After interest paid or services rendered minus
    costs equals banks profit

27
Who were the first bankers?
  • Goldsmiths in the middle ages

28
What is the Federal Reserve System?
  • The central bank and monetary authority of the
    United States known as the Fed

29
What is the function of the Fed?
  • To ensure the availability of enough money and
    credit in the banking system to support a growing
    economy

30
When was the federal reserve system established?
  • The Federal Reserve Act of 1913

31
Does the Fed loan money to private companies?
  • No, they only do business with financial
    institutions

32
Why would the Fed want to decrease the money
supply?
  • To lower inflation

33
Why would the Fed want to increase the money
supply?
  • To stimulate employment

34
How many Federal Reserve banks are there?
  • The U. S. is divided into 12 Federal Reserve
    districts, each district has a Federal Reserve
    Bank

35
Who makes the decisions for the Federal Reserve?
  • The Board of Governors and the Open Market
    Committee

36
How long do most board members serve?
  • 14 years, after which they cannot serve again

37
How long does the chairman of the board serve?
  • The Chairman serves 4 years, but can serve again

38
What is the Federal Open Market Committee?
  • Made up of the 7 board members and 5 presidents
    of Federal Reserve Banks

39
What is the role of the Federal Open Market
Committee?
  • The FOMC makes decisions as to the buying and
    selling of government securities

40
Member Banks
  • owns stock in Federal Reserve
  • only national banks are required to be members

41
Why are some banks not members of Federal Reserve?
  • High minimum capital requirements
  • Restrictions regulations
  • Can use Feds major facilities anyway

42
What do the letters FDIC stand for?
  • The Federal Deposit Insurance Corporation

43
When was the FDIC established?
  • 1933

44
What is the function of the FDIC?
  • To ensure deposits in any banking institution
    that purchases FDIC insurance

45
How much are deposits insured for?
  • Each account in a bank is insured up to 250,000
    per depositor per bank

46
What is the Full Employment and Balanced Growth
Act of 1978?
  • Among other things the Federal Reserve was
    mandated to do everything in its authority to
    achieve full employment and stable prices

47
What was theGlass-Steagall Act of 1932?
  • Separated depository banks from Wall Street
    investment banks, it regulated the commercial
    banks but not the investment banks

48
What was theFinancial Services Modernization Act
of 1999?
  • Because of lobbying efforts of Citigroup and
    other large banks who wanted to underwrite and
    trade financial instruments such as
    collateralized debt obligations the
    Glass-Steagall Act was repealed

49
What is a Collateralized Debt Obligation?
  • A CDO is an structured asset backed security
    whose value and payments are derived from a
    portfolio of fixed income underlying assets, such
    as mortgages

50
How does a CDO work?
  • A CDO is a promise to pay cash flows to investors
    in a prescribed sequence, based on how much the
    CDO collects from the pool of assets, the higher
    tranches first and the lower tranches last

51
What is the name of the market where money is
bought and sold?
  • The loanable funds market

52
Why would the Fed want to expand the money supply?
  • If we have unemployment the Fed wants to increase
    the money supply to stimulate employment

53
Why would the Fed want to contract the money
supply?
  • If we have inflation the Fed wants to decrease
    the money supply to bring down prices

54
What does the term liquidity mean?
  • A measure of the ease with which an asset can be
    converted into money without significant loss in
    its value

55
What does liquidity have to do with the money
supply?
  • With inflation the Fed wants banks to be less
    liquid
  • With unemployment the Fed wants banks to be more
    liquid

56
What makes a bank more or less liquid?
  • A lot of cash in excess reserves - very liquid
  • Little cash in excess reserves - less liquid

57
What is arequired reserve ratio?
  • The ratio of reserves to deposits that banks are
    required to hold

58
What arerequired reserves?
  • The dollar amount of reserves a bank is legally
    required to hold

59
Where are banks reserves held?
  • Deposits with the Fed and cash in the banks vault

60
What are excess reserves?
  • Bank reserves in excess of required reserves

61
What money do banks lend out?
  • Excess reserves

62
If a bank has 6,000 in checkable deposits with a
reserve ratio of .2 how much can the bank lend?
  • No more than 4,800

63
How does the Fed influence the money supply?
  • Change reserve requirements
  • Change discount rate
  • Change federal funds rate
  • Buy/sell govt. securities

64
What arereserve requirements?
  • The percentage of a banks assets that must be
    kept in cash and therefore cannot be lent out

65
Who setsreserve requirements?
  • Reserves are determined by the Fed for all
    financial institutions

66
If we have inflation what will the Fed do to
reserve requirements?
  • Raise reserve requirements thereby decreasing
    banks excess reserves

67
If we have unemployment what will the Fed do to
reserve requirements?
  • Lower reserve requirements thereby increasing
    banks excess reserves

68
What is thediscount rate?
  • The interest that banks pay when they borrow
    money from the Fed

69
What will the Fed do to the discount rate during
periods of inflation?
  • The Fed will raise the discount rate to
    discourage borrowing and thus spending

70
What will the Fed do to the discount rate during
periods of unemployment?
  • The Fed will lower the discount rate to encourage
    borrowing and thus spending

71
What is thefederal funds rate?
  • The interest rate that banks pay to borrow excess
    reserves from another bank

72
What will the Fed do to the federal funds rate
during periods of inflation?
  • The Fed will raise the federal funds rate to
    discourage borrowing and thus spending

73
What will the Fed do to the federal funds rate
during periods of unemployment?
  • The Fed will lower the federal funds rate to
    encourage borrowing and thus spending

74
What is theprime interest rate?
  • The interest rate that big banks charge their
    best and most credit worthy customers

75
What is a government security?
  • A short term bond that the federal government
    sells

76
What is the open market?
  • A place where bonds are bought and sold

77
What areopen market operations?
  • The act of the Fed buying or selling government
    securities at the open market

78
Why does the government sell securities?
  • This is its way of borrowing money

79
What will the Fed do if we have unemployment?
  • The Fed will buy government securities making
    banks more liquid so they can lend out more money

80
What will the Fed do if we have inflation?
  • The Fed will sell securities making banks less
    liquid so they will have less money to lend

81
Which monetary tool is most often used?
  • Open-market operations

82
What is moral suasion?
  • A host of different measures that the Fed uses to
    influence the activities of banks in one way or
    another

83
What is the largest component of assets of the
Fed?
  • U.S. government securities

84
What is the largest component of the Feds
liabilities?
  • Federal Reserve notes

85
Why is the Fed so profitable?
  • Because it pays no interest on its liabilities
    but earns interest on its assets

86
If the Fed wants to increase the money supply by
1,000 million, what should it do?
  • With a reserve requirement of 10 it should
    increase the money supply by 100 million

87
What is the money multiplier with a reserve
requirement of 1/10?
  • 10

88
What is the Money Multiplier formula?
  • 1/Required reserve ratio

89
If the required reserve ratio is 1/10 and all
banks are exactly meeting their reserve
requirement - how do we calculate the money
multiplier?
90
  • One divided by one tenth equals 10

.
Multiplier
1
.
1

10
10
1
10

X
1
91
  • 100
  • 90
  • 81
  • 74
  • 63
  • ...

original deposit
total money
1,000
92
If the Fed wants to decrease the money supply by
1,000 million, what should it do?
  • With a reserve requirement of 10 it should
    decrease the money supply by 100 million

93
Why is the Fed better at fighting inflation than
unemployment?
  • The Fed cant force people to borrow more money

94
What things will cause interest rates to rise?
  • Demand for money increases
  • The Fed raises the Discount or Federal Funds Rate
  • The Fed sells government securities

95
What things will cause interest rates to fall?
  • Demand for money decreases
  • The Fed lowers the Discount or Federal Funds Rate
  • The Fed buys government securities

96
What is Quantitative Easing?
  • A politically polite term for monetizing the
    debt, the Fed creates money to buy bonds

97
END
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