~How did the panic of 1907 affect US ~How did the panic of 1907 affect US banking?banking?

~What are the purposes and ~What are the purposes and characteristics of the Federal Reserve characteristics of the Federal Reserve

system?system?

►Panic of 1907Panic of 1907 Causes:Causes: 1. Nation’s monetary system at the time had 1. Nation’s monetary system at the time had

no mechanism for expanding the amount of no mechanism for expanding the amount of money in circulationmoney in circulation►C and B unable to borrow money, so started to use C and B unable to borrow money, so started to use

their savings = Bankrupt Banks in 1907their savings = Bankrupt Banks in 1907

2. Systems of Pyramided Reserves failed 2. Systems of Pyramided Reserves failed ►Pyramided Reserves Pyramided Reserves (virtually all smaller, local (virtually all smaller, local

banks deposit some of their reserves at lager city banks deposit some of their reserves at lager city banks deposit into larger commercial banks) banks deposit into larger commercial banks)

Effect:Effect:►Federal Reserve Act in 1913Federal Reserve Act in 1913►Created the Central Bank called the Created the Central Bank called the Federal Federal

ReserveReserve

►Role Of the FedRole Of the Fed Goals: Furnish an elastic currency and more Goals: Furnish an elastic currency and more

effective supervision of banking in the USeffective supervision of banking in the US 1. Supervises member banks 1. Supervises member banks 2. Holds cash reserves (funds available for 2. Holds cash reserves (funds available for

short term borrowing for COM. Banks and GOV.) short term borrowing for COM. Banks and GOV.) 3. Moves money into out of circulation (stabilize 3. Moves money into out of circulation (stabilize

monetary and banking system) monetary and banking system)

►Characteristics of the Fed Characteristics of the Fed Lack of a single central bankLack of a single central bank Ownership and control by member banksOwnership and control by member banks

►US Government does not own stock in the fed US Government does not own stock in the fed

Optional membership in the fed for some Optional membership in the fed for some banksbanks►National Charter banks have to join Fed, but State National Charter banks have to join Fed, but State

Charter banks don’t (less than 40% of commercial Charter banks don’t (less than 40% of commercial banks are apart of the fed)banks are apart of the fed)

►Organizations of the FedOrganizations of the Fed National LevelNational Level

►Makes key decisionsMakes key decisions►Board of Governors (7 members 14 yr terms) Board of Governors (7 members 14 yr terms)

Federal Open Market CommitteeFederal Open Market Committee regulates supply of moneyregulates supply of money

District level (12 District Reserves)District level (12 District Reserves)►25 offices located throughout the nation25 offices located throughout the nation

REVIEW QUESTIONSREVIEW QUESTIONS

►List the major caused of the Panic of List the major caused of the Panic of 1907, and explain how the government 1907, and explain how the government worked to resolve the panic.worked to resolve the panic.

►Explain the role of the Fed. How does the Explain the role of the Fed. How does the Fed differ from central banks in other Fed differ from central banks in other countries?countries?

►Why is the Federal Reserve system Why is the Federal Reserve system organized on national and district levels?organized on national and district levels?

►What services does the Fed provide What services does the Fed provide to banks?to banks?

►How does the Fed serve the federal How does the Fed serve the federal government?government?

2. Wal-Mart deposits 2. Wal-Mart deposits check into Account in check into Account in Bank Covington, GABank Covington, GA

Local bank deducts Local bank deducts $100 form his account$100 form his account

& Cancels Check.& Cancels Check.Purchase on His StatementPurchase on His Statement

1.1. John usesJohn usesCheck is used at Check is used at Local Wal-Mart Local Wal-Mart

for $100.00.for $100.00.Covington, GACovington, GA

3. COV. Bank add $100 to3. COV. Bank add $100 toWal-Mart account & Wal-Mart account &

Sends check to Sends check to FED in ATL.FED in ATL.

4. ATL FED sends 4. ATL FED sends Check and transfer Check and transfer

Payment ($100)Payment ($100)To John’s BankTo John’s Bank

►Services to GovernmentServices to Government As a Government Bank As a Government Bank

►Provides services similar to Provides services similar to what is provides to individualswhat is provides to individuals

►1. Federal Depository of 1. Federal Depository of federal revenues federal revenues

►2. Holds Treasury Checking 2. Holds Treasury Checking Account (Social Security Account (Social Security checks, Tax Refund)checks, Tax Refund)

►3. Advise the Legislative and 3. Advise the Legislative and Executive Branches on their Executive Branches on their economic programseconomic programs

►Supervising Member BanksSupervising Member Banks ““watchdog” for member bankswatchdog” for member banks Monitor loans and investments and conduct Monitor loans and investments and conduct

►Regulating the money SupplyRegulating the money Supply Reserve prints money and distribute Reserve prints money and distribute

currency currency ►How does the Fed increase or How does the Fed increase or

decrease the US money supply?decrease the US money supply? The Fed in NYC buys and sells securities on The Fed in NYC buys and sells securities on

the open market.the open market. Tells Fed when to (I) or (D) money supplyTells Fed when to (I) or (D) money supply

►M1M1 Simplest measure of the money Simplest measure of the money

supplysupply Consist of only funds that are easily Consist of only funds that are easily

accessible accessible ►All Currency in Circular FlowAll Currency in Circular Flow►All Checks and Account Deposits All Checks and Account Deposits

►M2M2 Broader measure of the money Broader measure of the money

supply supply ►More accurate b/c includes markets More accurate b/c includes markets

accounts, mutual fund share, and accounts, mutual fund share, and savings deposit savings deposit

►M3M3 Broadest Measurement Broadest Measurement

►All large Time Deposits over $100,000 All large Time Deposits over $100,000

Review Questions Review Questions ►What services does the FED What services does the FED

provide to banks?provide to banks?►How does the Fed serve the How does the Fed serve the

government?government?►What are the four different What are the four different

measurements of the US money measurements of the US money supply? Which funds are included supply? Which funds are included in each measurement?in each measurement?

~Why does the Fed rely either ~Why does the Fed rely either an easy-money policy or a tight-an easy-money policy or a tight-

money policy?money policy?

►Monetary Policy and Aggregated Monetary Policy and Aggregated DemandDemand Monetary Policy-Monetary Policy- plan or Contract the plan or Contract the

money supply in order to influence the cost money supply in order to influence the cost and availability and availability

1. 1. Easy-Money PolicyEasy-Money Policy~ expands the ~ expands the money supply, increase aggregated money supply, increase aggregated demand, create jobs and (D) unemployment demand, create jobs and (D) unemployment , (I) economic growth, (I) economic growth►Lower Interest Rate Lower Interest Rate

2. 2. Tight-money policy~Tight-money policy~ higher interest higher interest rates and a contraction of the money rates and a contraction of the money supply, Reduce Agg. Demandsupply, Reduce Agg. Demand►Raise Interest RateRaise Interest Rate

Three major instruments of Three major instruments of monetary policy monetary policy

►Open Market Operations Open Market Operations This is the buying and selling of securities. This is the buying and selling of securities.

This is the most important control of the Fed.This is the most important control of the Fed. When the Fed buys securities it increases the When the Fed buys securities it increases the

reserves of the commercial banksreserves of the commercial banks

►The Reserve RequirementThe Reserve Requirement The Fed influences the banks ability to lend The Fed influences the banks ability to lend

through the reserve ratio.through the reserve ratio. If the fed increases the reserve requirement If the fed increases the reserve requirement

they take away part of the banks excess they take away part of the banks excess reserves. This takes away the banks ability to reserves. This takes away the banks ability to create money.create money.

Three major instruments of Three major instruments of monetary policymonetary policy

►The Discount RateThe Discount Rate The Fed loans money to banks if they The Fed loans money to banks if they

are in need of money. The rate of are in need of money. The rate of interest that they charge is the discount interest that they charge is the discount rate.rate.

►Strengths of the Monetary PolicyStrengths of the Monetary Policy 1) Speed and flexibility over the fiscal policy. 1) Speed and flexibility over the fiscal policy.

It could be done on a daily basis if need be.It could be done on a daily basis if need be. 2) Isolation from political pressure2) Isolation from political pressure

► Strengths of the Monetary PolicyStrengths of the Monetary Policy 1) Speed and flexibility over the fiscal policy. It could be done 1) Speed and flexibility over the fiscal policy. It could be done

on a daily basis if need be.on a daily basis if need be. 2) Isolation from political pressure2) Isolation from political pressure

► Shortcomings and problemsShortcomings and problems 1) Cyclical Asymmetry:1) Cyclical Asymmetry:

►EZ money does not mean that banks will loan or that people EZ money does not mean that banks will loan or that people will borrow.will borrow.

►People may use the excess money to pay off loans.People may use the excess money to pay off loans. 2) Changes in V.2) Changes in V.

►Velocity can sometimes go the opposite direction. If m Velocity can sometimes go the opposite direction. If m increases, V may actually decrease. This will of course affect increases, V may actually decrease. This will of course affect total spending.total spending.

► If i decreases people will hold m for asset demand. This If i decreases people will hold m for asset demand. This affects V.affects V.

3) Money demand is interest elastic. (It depends on 3) Money demand is interest elastic. (It depends on the elasticity of the Dm curve)the elasticity of the Dm curve)

4) Investment is interest elastic. (It depends on the 4) Investment is interest elastic. (It depends on the elasticity of the I curve)elasticity of the I curve)

5) Inflow of international capital from the increase in 5) Inflow of international capital from the increase in interest rates leads to an expansion of AD.interest rates leads to an expansion of AD.

DISCRETIONARY FISCAL DISCRETIONARY FISCAL POLICY POLICY

the deliberate manipulation of taxes and the deliberate manipulation of taxes and government spending by Congress to government spending by Congress to alter real output and employment, control alter real output and employment, control inflation, and stimulate economic growth. inflation, and stimulate economic growth.

►BUILT IN STABILIZER BUILT IN STABILIZER anything which increases the anything which increases the

government's deficit (or reduces its government's deficit (or reduces its surplus) during a recession and increases surplus) during a recession and increases its surplus (or reduces its deficit) during its surplus (or reduces its deficit) during inflation without requiring explicit action inflation without requiring explicit action by policy makers. by policy makers.

Ways to helpWays to help ► RECESSIONRECESSION: :

cut taxes and increase government spending. cut taxes and increase government spending.

► INFLATIONINFLATION: : raise taxes and decrease government spending.raise taxes and decrease government spending.

► Keynesian approach assumed that a tradeoff Keynesian approach assumed that a tradeoff between unemployment and inflation is possible.between unemployment and inflation is possible. When unemployment is too high, the goal is to When unemployment is too high, the goal is to

increase AD (without causing or aggravating inflation.) increase AD (without causing or aggravating inflation.) When there is little unemployment and inflation When there is little unemployment and inflation

prevails, the goal is to decrease AD and increase prevails, the goal is to decrease AD and increase unemployment levels to eliminate inflation. unemployment levels to eliminate inflation. ►The problem is this has not worked since the 1970's. The problem is this has not worked since the 1970's.

STAGFLATIONSTAGFLATION

► Inflation during Inflation during periods of periods of unemployment unemployment

► macroeconomics used macroeconomics used to describe a period to describe a period characteristic of high characteristic of high price inflation price inflation combined with combined with economic stagnation, economic stagnation, unemployment, or unemployment, or economic recession. economic recession.

RATIONAL RATIONAL EXPECTATIONSEXPECTATIONS argues that people expect changes in economic argues that people expect changes in economic

policy and act to offset the intended results of policy and act to offset the intended results of such changes. They claim that recession and such changes. They claim that recession and booms are exaggerated as a result of booms are exaggerated as a result of government policy rather than smoothed out. government policy rather than smoothed out.

►KeynesiansKeynesians believe that the free-market has problems and it is up to believe that the free-market has problems and it is up to

the government to react and control these problems. the government to react and control these problems.  They believe the markets are not totally competitive so They believe the markets are not totally competitive so

the prices and wages can not be driven down. This the prices and wages can not be driven down. This means that both fiscal and monetary policies are means that both fiscal and monetary policies are needed.needed.

GDP = C + I + G + XnGDP = C + I + G + Xn

MONETARISM MONETARISM ►argue that steady argue that steady

economic growth economic growth and price stability and price stability can be achieved can be achieved with a steady with a steady increase in the increase in the money supply (at money supply (at about the same rate about the same rate as Real GNP as Real GNP growth).growth). the supply should just the supply should just

increase at a pre increase at a pre announced steady 3-5 announced steady 3-5 percent. percent.

SUPPLY-SIDE SUPPLY-SIDE ECONOMICSECONOMICS believe fiscal policy should be believe fiscal policy should be

designed to provide incentives designed to provide incentives to increase aggregate supply to increase aggregate supply (lowering taxes). (lowering taxes).

► supply creates its own supply creates its own demand," the idea that one demand," the idea that one must sell before one can must sell before one can afford to buy. Therefore afford to buy. Therefore good economic policy good economic policy encourages increased encourages increased production, vice attempts to production, vice attempts to stimulate demand stimulate demand

►Automatic Stabilizers:Automatic Stabilizers: our tax system is such that net tax our tax system is such that net tax

revenues (net taxes minus transfers and revenues (net taxes minus transfers and subsidies) vary directly with GDP. Almost subsidies) vary directly with GDP. Almost all taxes yield more revenue when GDP all taxes yield more revenue when GDP increase. (Income, payroll, sales...)increase. (Income, payroll, sales...)

►Loanable funds marketLoanable funds market www.econ.ilstu.edu/ntskaggs/ECO105/www.econ.ilstu.edu/ntskaggs/ECO105/

Lectures/student_notes/oh_3-09.ppt Lectures/student_notes/oh_3-09.ppt