money, monetary policy, and fiscal policy

Money, Monetary Policy, Money, Monetary Policy, and Fiscal Policyand Fiscal Policy

Who Am I?Who Am I?

MoneyMoney

MoneyMoneyAnything that is generally accepted as Anything that is generally accepted as

final payment for goods and servicesfinal payment for goods and servicesMoney is NOT the same as wealth Money is NOT the same as wealth

or income or income Wealth is the total collection of assets Wealth is the total collection of assets

that store value that store value Income is a flow of earnings per unit of Income is a flow of earnings per unit of

time time

MoneyMoney

The Barter System: goods and The Barter System: goods and services are traded directly. services are traded directly. There is no money exchanged.There is no money exchanged.

Problems:Problems:1.1. Before trade could occur, each trader Before trade could occur, each trader

had to have something the other had to have something the other wanted.wanted.

2.2. Some goods cannot be split. If 1 goat Some goods cannot be split. If 1 goat is worth five chickens, how do you is worth five chickens, how do you exchange if you only want 1 chicken?exchange if you only want 1 chicken?

MoneyMoney

Example: A heart surgeon might Example: A heart surgeon might accept only certain goods but accept only certain goods but not others because he doesn’t not others because he doesn’t like broccoli. like broccoli.

To get the surgery, a pineapple To get the surgery, a pineapple grower must find a broccoli grower must find a broccoli farmer that likes pineapples.farmer that likes pineapples.

MoneyMoney

Money serves these three purposesMoney serves these three purposes1.1. Medium of exchangeMedium of exchange

– It can be used to purchase goods and It can be used to purchase goods and servicesservices

2.2. Unit of AccountUnit of Account– It can be used to compare the value of It can be used to compare the value of

different goods and servicesdifferent goods and services

3.3. Store of ValueStore of Value– It can be held to buy something in the It can be held to buy something in the

futurefuture

Money SupplyMoney Supply

Measuring the Money SupplyMeasuring the Money Supply M1 (high liquidity)M1 (high liquidity)

Currency, Checking, travelers checksCurrency, Checking, travelers checks M2 (moderate liquidity) M1 plus:M2 (moderate liquidity) M1 plus:

Savings and investment funds (money market, Savings and investment funds (money market, mutual funds, ATM accessed savings) that allow mutual funds, ATM accessed savings) that allow investors to make easy transfers and withdrawalsinvestors to make easy transfers and withdrawals

M3 (Low liquidity) M2 plus:M3 (Low liquidity) M2 plus: Time deposits over $100,000 (CDs, etc.)Time deposits over $100,000 (CDs, etc.)

MoneyMoney

What is the difference between What is the difference between credit cards and debit cards?credit cards and debit cards?

Are credit cards money?Are credit cards money?A credit card is NOT money. It is a A credit card is NOT money. It is a

short-term loan (usually with a short-term loan (usually with a higher than normal interest rate). higher than normal interest rate).

Ex: You buy a shirt with a credit Ex: You buy a shirt with a credit card, VISA pays the store, you pay card, VISA pays the store, you pay VISA the price of the shirt plus VISA the price of the shirt plus interest and fees.interest and fees.

MoneyMoney

Ex: You buy a shirt with a credit Ex: You buy a shirt with a credit card, VISA pays the store, you pay card, VISA pays the store, you pay VISA the price of the shirt plus VISA the price of the shirt plus interest and fees.interest and fees.

Total credit cards in circulation in U.S: Total credit cards in circulation in U.S: 576.4 million576.4 million

Average number of credit cards per Average number of credit cards per cardholders: 3.5 cardholders: 3.5

Average credit card debt per Average credit card debt per household : $15,788household : $15,788

MoneyMoney

Commodity moneyCommodity moneyGold, silver, copper, etc.Gold, silver, copper, etc.

Representative money Representative money The gold standard, there must be gold The gold standard, there must be gold

backing all of the money in an economybacking all of the money in an economyFiat moneyFiat money

Fiat money is not worth anything by Fiat money is not worth anything by itself, it is only worth something itself, it is only worth something because the government says so and we because the government says so and we agree.agree.

Money SupplyMoney Supply

There is no gold standard. Money is There is no gold standard. Money is just an I.O.U. from the government just an I.O.U. from the government “for all debts, public and private.” “for all debts, public and private.”

What makes money effective?What makes money effective?1.1. Generally AcceptedGenerally Accepted - Buyers and - Buyers and

sellers have confidence that it IS sellers have confidence that it IS legal tender.legal tender.

2.2. Scarce Scarce - Money must not be easily - Money must not be easily reproduced.reproduced.

3.3. Portable and Dividable Portable and Dividable - Money must - Money must be easily transported and divided. be easily transported and divided.

Monetary PolicyMonetary Policy

The Federal Reserve SystemThe Federal Reserve SystemCreated in 1914 in response the many Created in 1914 in response the many

previous bank failuresprevious bank failuresThe Fed Board of GovernorsThe Fed Board of Governors

7 members appointed by the Pres. And 7 members appointed by the Pres. And confirmed by the Senateconfirmed by the Senate

12 regional Fed Reserve Banks12 regional Fed Reserve Banks

Monetary policyMonetary policy

The Tools of Monetary PolicyThe Tools of Monetary Policy1.1. Changes in the Discount RateChanges in the Discount Rate

– When the fed lowers the discount rate, When the fed lowers the discount rate, banks are encouraged to make more loans banks are encouraged to make more loans and the money supply increasesand the money supply increases

– When the fed raises the discount rate, When the fed raises the discount rate, banks are encouraged to make fewer loans banks are encouraged to make fewer loans and the money supply decreasesand the money supply decreases


The Tools of Monetary PolicyThe Tools of Monetary Policy2. Open Market Operations2. Open Market Operations

When the Fed buys or sells U.S. securities When the Fed buys or sells U.S. securities to influence the money supplyto influence the money supply

Fed buys, bank deposits increase, banks Fed buys, bank deposits increase, banks have more money to lend, and the money have more money to lend, and the money supply increasessupply increases

Fed sells, bank deposits decrease, banks Fed sells, bank deposits decrease, banks have less money to lend, and the money have less money to lend, and the money supply decreasessupply decreases


The Tools of Monetary PolicyThe Tools of Monetary Policy3. Changes in the reserve requirement3. Changes in the reserve requirement

The reserve requirement is the minimum The reserve requirement is the minimum percentage that banks must keep to back percentage that banks must keep to back up checking-type accountsup checking-type accounts

Lowering the reserve requirement will Lowering the reserve requirement will increase money supplyincrease money supply

Raising the reserve requirement will Raising the reserve requirement will decrease money supplydecrease money supply

Monetary PolicyMonetary Policy Example: Assume the reserve ratio in the US is 10%Example: Assume the reserve ratio in the US is 10% You deposit $1000 in the bank You deposit $1000 in the bank The bank must hold $100 (required reserves)The bank must hold $100 (required reserves) The bank lends $900 out to Bob (excess reserves) The bank lends $900 out to Bob (excess reserves) Bob deposits the $900 in his bankBob deposits the $900 in his bank Bob’s bank must hold $90. It loans out $810 to JillBob’s bank must hold $90. It loans out $810 to Jill Jill deposits $810 in her bankJill deposits $810 in her bank SO FAR, the initial deposit of $1000 caused the SO FAR, the initial deposit of $1000 caused the CREATIONCREATION

of another $1710 (Bob’s $900 + Jill’s $810)of another $1710 (Bob’s $900 + Jill’s $810)

Money Multiplier = 1/Reserve RatioMoney Multiplier = 1/Reserve RatioA reserve ratio of 10% has a money multiplier of 10A reserve ratio of 10% has a money multiplier of 10A $2 billion increase to money supply will actually A $2 billion increase to money supply will actually

increase the money supply by 20 billionincrease the money supply by 20 billion

Monetary PolicyMonetary Policy

The Feds other responsibilities:The Feds other responsibilities:The Fed works as a clearing house for all The Fed works as a clearing house for all

checkschecksThe Fed is also known as the lender of The Fed is also known as the lender of

last resortlast resortIn cases of emergency the Fed will come to In cases of emergency the Fed will come to

the aid of ailing banksthe aid of ailing banksThe Fed also performs stress tests on The Fed also performs stress tests on

member banks.member banks.

Fiscal PolicyFiscal Policy


Changes in federal government Changes in federal government spending of tax revenues designed to spending of tax revenues designed to promote full employment, price stability, promote full employment, price stability, and reasonable rates of economic and reasonable rates of economic growthgrowth


Expansionary Fiscal PolicyExpansionary Fiscal Policy

Increase in government spending and / Increase in government spending and / or a decrease in taxes designed to or a decrease in taxes designed to increase aggregate demand in the increase aggregate demand in the economy. The intent is to increase GDP economy. The intent is to increase GDP and decrease unemploymentand decrease unemployment


Contractionary Fiscal PolicyContractionary Fiscal Policy

A decrease in gov. spending and / or an A decrease in gov. spending and / or an increase in taxes designed to decrease increase in taxes designed to decrease aggregate demand in the economy. The aggregate demand in the economy. The intent is to control inflationintent is to control inflation


Keynesian approachKeynesian approachDemand-side economicsDemand-side economics

Focuses on changing aggregate demand in Focuses on changing aggregate demand in order to promote full employmentorder to promote full employment

Keynes argued that government stimulus Keynes argued that government stimulus could jolt the economy out of a severe could jolt the economy out of a severe recession or depressionrecession or depression


Supply-Side Fiscal PolicySupply-Side Fiscal PolicyThe idea that fiscal policy might directly The idea that fiscal policy might directly

affect aggregate supply. For example, a affect aggregate supply. For example, a corporate tax cut may give businesses corporate tax cut may give businesses incentive to expand or invest in capital incentive to expand or invest in capital goods with the money saved.goods with the money saved.


StagflationStagflationA contraction in the economies A contraction in the economies

aggregate output (aggregate supply) aggregate output (aggregate supply) combined with an increase in inflation. combined with an increase in inflation. Stagflation occurred in the U.S. in 1973 Stagflation occurred in the U.S. in 1973 and 1980. It usually results when the and 1980. It usually results when the economy is already facing moderately economy is already facing moderately high inflation and a price shock occurs high inflation and a price shock occurs (world wheat shortage or oil shortage)(world wheat shortage or oil shortage)


Laissez-faireLaissez-faireClassical economists believed that free Classical economists believed that free

markets without government markets without government intervention were the best way to intervention were the best way to achieve the economy’s potential output.achieve the economy’s potential output.

Classical economists believed that Classical economists believed that although there might be occasional although there might be occasional downturns in the economy, natural downturns in the economy, natural market forces would correct things in market forces would correct things in the long term.the long term.


Discretionary fiscal policy vs. Discretionary fiscal policy vs. automatic stabilizersautomatic stabilizersDiscretionary Fiscal Policy requires Discretionary Fiscal Policy requires

congressional and presidential action to congressional and presidential action to change gov. taxing or spendingchange gov. taxing or spending

Automatic stabilizers automatically Automatic stabilizers automatically adjust to the ups and downs of the adjust to the ups and downs of the economy. Unemployment insurance is a economy. Unemployment insurance is a good example during a down economy, good example during a down economy, progressive taxing is a good example progressive taxing is a good example during an up economyduring an up economy

Fiscal policyFiscal policy

The problem with LagsThe problem with LagsRecognition lagRecognition lag

Are we in a recession? How bad is the Are we in a recession? How bad is the recession? How much needs to be done? recession? How much needs to be done? Difficult questions because a recession isn’t Difficult questions because a recession isn’t identified until 6 months after it beginsidentified until 6 months after it begins

Decision making lagDecision making lagAction by policy makers usually takes Action by policy makers usually takes

months to approvemonths to approve


The problem with lagsThe problem with lagsImplementation lagImplementation lag

The approved action then takes time to implement The approved action then takes time to implement The recent stimulus checks are a good exampleThe recent stimulus checks are a good example

I received mine 4 months after the bill was passedI received mine 4 months after the bill was passedEffectiveness lagEffectiveness lag

Once implemented fiscal policy can take from 9 to Once implemented fiscal policy can take from 9 to 18 months for the full impact to be realized. Will 18 months for the full impact to be realized. Will the economy still need the agreed upon policy?the economy still need the agreed upon policy?

Fiscal or Monetary PolicyFiscal or Monetary Policy

The President is advocating a bill that will The President is advocating a bill that will cut taxes by 5%.cut taxes by 5%.

Fed chairman Ben Bernanke is planning Fed chairman Ben Bernanke is planning on lowering the discount rate by ¼ point.on lowering the discount rate by ¼ point.

The Fed Open Market Committee The Fed Open Market Committee (F.O.M.C.) announced today that it will (F.O.M.C.) announced today that it will selling U.S. securitiesselling U.S. securities

Both houses of the legislature have Both houses of the legislature have passed a bill that will spend $15 billion on passed a bill that will spend $15 billion on infrastructure.infrastructure.

Fiscal or Monetary policy?Fiscal or Monetary policy?

Zippy received his first unemployment Zippy received his first unemployment check today.check today.

The Fed increased the reserve The Fed increased the reserve requirement today to 28%.requirement today to 28%.

The President announced today that The President announced today that the 2009 budget will be slashed in half.the 2009 budget will be slashed in half.

The government announced a tax The government announced a tax rebate today equaling $1000 per rebate today equaling $1000 per person.person.

Bonds vs. StocksBonds vs. Stocks

Pretend you are going to start a Pretend you are going to start a lemonade stand. You need some lemonade stand. You need some money to get your stand started.money to get your stand started. What do you do?What do you do?

• You ask your grandmother to lend you You ask your grandmother to lend you $100 and write this down on a piece of $100 and write this down on a piece of paper: "I owe you (IOU) $100, and I paper: "I owe you (IOU) $100, and I will pay you back in a year plus 5% will pay you back in a year plus 5% interest." interest."

• Your grandmother just bought a Your grandmother just bought a bond.bond.

Stocks vs. BondsStocks vs. Bonds

Bonds are loans, or IOUs, that Bonds are loans, or IOUs, that represent debt that the represent debt that the

government or a corporation must government or a corporation must repay to an investor. The bond repay to an investor. The bond

holder has NO OWNERSHIP of the holder has NO OWNERSHIP of the company.company.

Ex: War Bonds During World War Ex: War Bonds During World War IIII

Corporate bonds, municipal bonds, government bonds, Corporate bonds, municipal bonds, government bonds, etc.etc.


•To get more money, you sell half of your To get more money, you sell half of your company for $50 to your brother Tom. company for $50 to your brother Tom.

•You put this transaction in writing: "Lemo You put this transaction in writing: "Lemo will issue 100 will issue 100 shares of stockshares of stock. Tom will buy . Tom will buy 50 shares for $50." 50 shares for $50."

•Tom has just bought 50% of the business. Tom has just bought 50% of the business. He is allowed to make decisions and is He is allowed to make decisions and is entitled to a percent of the profits.entitled to a percent of the profits.


Stockowners can earn a profit in two Stockowners can earn a profit in two ways:ways:

1. 1. DividendsDividends, which are portions of a corporation’s , which are portions of a corporation’s profits, are paid out to stockholders.profits, are paid out to stockholders.

The higher the corporate profit, the higher the The higher the corporate profit, the higher the dividend.dividend.

2. A 2. A capital gaincapital gain is earned when a stockholder sells is earned when a stockholder sells stock for more than he or she paid for it. stock for more than he or she paid for it.

A stockholder that sells stock at a lower price than A stockholder that sells stock at a lower price than the purchase price suffers a the purchase price suffers a capital losscapital loss..

money, monetary policy, and fiscal policy

Documents

credit cards money

representative money

scarce money

money supplythere

dividable money

money effective

money supply increases

economyfiat moneyfiat