Fiscal & Monetary Fiscal & Monetary PolicyPolicy

Fiscal & Monetary Fiscal & Monetary PolicyPolicy

How the Federal Government canHow the Federal Government canInfluence the American EconomyInfluence the American EconomyHow the Federal Government canHow the Federal Government canInfluence the American EconomyInfluence the American Economy

MacroeconomicsMacroeconomicsActions by the government using fiscal policy and monetary policy in an attempt to create and/or maintain steady economic growth

Fiscal Policy: Government spending and tax policies

Monetary Policy: Actions by the Federal Reserve Bank to regulate the nation’s money supply

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To promote economic growth - the government will try to put more money in circulation

To keep the economy from growing too quickly (inflation) - the government will try to pull money out of circulation

Money is any good that is widely accepted in exchange and in the repayment of debts

Functions of Money

Medium of Exchange it is accepted in exchange

for goods and services

Unit of Account Used to express values

(That house is worth $500,000)

Store of Value It maintains value over time(Can use it six month from

now)

The Money SupplyThe Money Supply

M1: Currency, checking accounts and traveler’s checks

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M2: Includes everything in M1 plus . . . savings accounts, money market funds for individuals and Certificates of Deposit (COD’s) under $100,000 — can’t be directly used to make an exchange (purchase)

The Federal Reserve The Federal Reserve SystemSystem

America’s Central Bank

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Federal Reserve Districts

The Federal Reserve Systemwas established in 1913

•The Board of Governors of the Federal Reserve System is the governing body of the Fed. •There are 7 Board members - each serves for 14 years

The U.S. is divided into 12 Federal Reserve districts

•The Federal Open Market Committee (FOMC) is a major policy-making group within the Fed. •This 12-member board controls Open Market Operations - buying and selling government bonds

What does the Fed do?What does the Fed do?Control the money supply

Hold Bank Reserves

Supply the economy with paper money [printed at the Bureau of Engraving in Washington, D.C.]

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Provide check-clearing services

Supervise member banks

Serve as the lender of last-resort for banks having cash management problem

Bank Bank ReservesReserves

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All banks that are members of the Federal Reserve System are required to keep a reserve account at their local Fed bank - similar to a checking account for the bank

Total Reserves - The amount of money in a banks’ reserve account plus the amount it has in its own vault

Total Reserves can be divided into two types: Required and Excess

Bank ReservesBank ReservesRequired reserves - the minimum amount of money [reserves] that a bank must hold against its deposits as mandated by the Fed

Reserve requirement - Regulation set by the Fed that requires a bank to keep a certain percentage of its deposits on-hand [in bank vault or with the Fed

Excess Reserves - Any reserves held that are beyond the amount required by the Fed. Banks can use this money to make loans

By changing the reserve requirement, the Fed can increase or decrease the

money supplyDecreasing the

Reserve Requiremen

tmeans that banks have

more money to lend out

Increasing the

Reserve Requiremen

tmeans that banks haveless money to lend out

Tools of the Tools of the Federal Federal Reserve Reserve

BankBank

•Reserve Requirements

•Open Market Operations

•Discount Rate

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Bank Bank ReservesReservesReserve requirement - Regulation set by

the Fed that requires a bank to keep a certain percentage of its deposits on-hand

By changing the reserve requirement, the Fed can increase or decrease the

money supplyDecreasing the

Reserve Requirementmeans that banks havemore money to lend out

Increasing the

Reserve Requirementmeans that banks haveless money to lend out

Open Market Open Market OperationsOperationsThe Federal Open Market Committee

(FOMC) conducts open market operations by buying and selling government

securities (bonds)Buying securities puts more money in circulation - helping the economy growSelling securities takes money out of circulation - slowing the economy

Goal: Bigger Economy -

Buy Securities

Goal: Smaller Economy -

Sell Securities

The Discount The Discount RateRateThe Discount Rate is the

interest rate the Fed charges a bank for a loan The Federal Funds Rate is the

interest rate that one bank charges another bank for a

loan Banks will borrow money from the least

expensive source

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When banks borrow money from the Fed, the money supply

increasesWhen banks borrow money from each other, there is no change in the overall

money supply

The Discount RateThe Discount Rate

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To increase the money supply, the Fed lowers the discount rate

Banks would be more likely to borrow money from the Fed

To decrease the money supply, the Fed raises the

discount rate

Banks would be less likely to borrow money from the Fed

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To promote economic growth - the government will try to put more money in circulation

To keep the economy from growing too quickly (inflation) - the government will try to pull money out of circulation