Chapter 11 Goals

1
Chapter 11 Goals

• Understand the Structure of the Federal Reserve
  System (Fed)
• Understand the tools the Fed has to engage in
  monetary policy
• Understand the importance of the Open Market
  Committee (OMC)
• Know the recent changes in banking practices

2
Federal Reserve System

• Established in 1913 to hold commercial ban
  reserves
• A system composed of various bodies,
  organizations, and committees, for regulating the
  U. S. money supply

gtmap of districts
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Structure of the Federal Reserve

• The Board of Governors, 7
• The Federal Advisory Council
• Federal Open Market Committee, 12
• Reserve Banks, 12
• Federal Reserve Member Banks, financial
  institutions

4
Organization of the Federal Reserve System
General supervision
Board of Governors 7 appointed members
Reserve Banks 12 districts
Advise
Compose
Advisory Councils
Federal Open Market Committee
5
Fed Control of the Money Supply

• General controls
• Affect the overall supply of money
• Selective controls
• Affect the use of money for specific purposes

6
Bank Reserves

• Reserves
• vault cash
• Deposits at Federal Reserve District Banks
• Required Reserves
• Amount of reserves that member banks must hold
  against checkable deposits
• Excess Reserves
• Reserves a bank may have over and above the
  legally established required reserves

7
Open Market OperationsBuy govt Securities when
Reserve Requirement 10
Potential Checkable Deposits 500,000
FOMC buys Securities 50,000
All Banks
Excess Reserves 50,000
Checkable Deposit Loans 900,000
Original Checkable Deposits 100,000
Required Reserves 100,000
8
Key Role of Excess Reserves

• Effectiveness of Feds efforts to either limit or
  expand the money supply depend on the status of
  excess reserves
• Purchase of securities in the open market by the
  FED increases member banks ability to expand the
  money supply by increasing excess reserves
• Sale of securities reduces member banks ability
  to expand the money supply by reducing excess
  reserves

9
Discount Rate

• The interest rate at which depository
  institutions borrow funds from the Reserve Banks
• Discounting Process
• Very short term borrowing by banks to replenish
  reserves
• Signals
• Lowering discount rate signals the Fed wants to
  encourage an expansion of money supply
• Raising discount rate gives the opposite signal

gtrecent discount rates
10
Commercial Loan Rates Federal Funds Rate

• Prime rate
• Rate at which individuals and firms with the best
  collateral can borrow
• Federal Funds Market
• Fairly well organized market where interbank
  borrowing occurs, overnight loans to meet reserve
  requirements, Fed target rate

11
Other Fed Controls

• Moral Suasion, a number of different measures
  that the Federal Reserve Board uses to influence
  the activities of banks
• letters to banks
• public statements
• credit rationing
• suspension of banks borrowing privileges
• effective to the degree banks/businesses are
  willing to cooperate
• Selective controls
• Stock market margin requirements

12
Federal Reserve Policy

• Fed is independent and autonomous within the
  government, self supporting
• Fed is responsible only to Congress, so may not
  always agree with current presidential
  administration
• Full Employment and Balanced Growth Act of 1978
  (the Humphrey-Hawkins Act) the Fed Chairman
  appears before Congress twice per year

13
Changes in banking

• 1980s and 1990s deregulation
• Reduction in the number of banks
• Affects on costs
• Affect on competition

14
Issues in Banking

• Electronic Banking
• Financial transactions that entail the electronic
  transfer of funds
• Stored value and smart cards
• Stored value cards provide a convenient
  substitute for cash and checks
• Home banking
• Allow customers to debit or credit accounts, and
  conduct other transactions via the internet

15
Chapter 13 Goals

• Define labor force
• Measure unemployment rate
• Full employment
• Types of unemployment frictional, structural,
  cyclical
• Trends in unemployment
• Full employment act
• Report by Fed chair

16
Size and Composition of the Labor Force

• Civilian labor force
• all persons in the total labor force except
  members of the resident armed forces
• Labor force participation rate
• The civilian labor force as a of the civilian
  non-institutionalized population

17
Employed Unemployed Labor Force

• Employed labor force
• All employed workers
• Unemployed labor force
• All persons in the labor force who are not
  currently working but are seeking work

gtcurrent data
18
Trends in the Labor Force Employment

• Older workers (65 years old and over)
• Decreased as a percentage of civilian labor force
• Female workers
• Number and percentage have increased
• Skilled and unskilled workers
• Percentage of unskilled workers in U.S. labor
  force has decreased
• Service-oriented jobs
• Increase in number and percentage of civilian
  work force

19
Trends in the Labor Force Employment

• Agricultural employment
• Definite move away from agricultural occupations
• Organized workers
• Union membership has decreased as a percentage of
  the civilian labor force
• Diversity
• Increases in the number of Hispanics, blacks,
  Asians

20
Types of Unemployment

• Frictional
• Arises from normal operation of the labor market
• Job terminations by employees, discharges, or
  relocation
• Cyclical
• Arises from less than full use of productive
  capacity in an economy due to recession

21
Types of Unemployment

• Structural
• Caused by imbalance between worker skills and
  skills demanded by the labor market
• Some argue that unemployment may also be
  consequence of subsidies provided by public and
  private socioeconomic programs
• Unemployment compensation
• Supplementary unemployment benefits

22
Full Employment

• Meaning of full employment
• full utilization of natural resources, technology
  and science, farms, factories, knowledge, and
  trade skills
• Full employment unemployment rate
• rate of unemployment that can be expected from
  normal frictional unemployment in an otherwise
  fully employed labor force

23
Unemployment

• Unemployment
• workers in the labor force are not currently
  working at all
• Underemployment
• workers in the labor force are working, but not
  to full capacity
• Natural rate of unemployment
• rate of unemployment that would occur if the
  economy was producing at its full potential, full
  employment

24
Employment Policy

• Problems with unemployment
• Reduced output
• Acceptable level of unemployment
• Economic policy
• Social and political policy

25
Chapter 12 Goals

• Explain general AD/AS model
• Understand Keynesian focus on spending
• Know what the different theories are for the
  shape of AS
• Effectiveness of fiscal policies and shape of AS

26
Aggregate Demand - AD

• Curve which shows the total amount of real output
  that buyers in an economy will purchase at
  various price levels
• Real output
• Output adjusted for changes in the price level

27
Aggregate Demand - AD

• Reasons for negative slope
• Higher price levels in the U.S. relative to price
  levels in the rest of the world discourage
  exports and encourage imports
• Higher price level reduces the real purchasing
  power of assets or wealth
• Higher price levels lead to higher interest rates
  ? declines in borrowing by business and spending
  by consumers

28
Aggregate Supply - AS

• Plot of the various quantities of total real
  output that producers will offer for sale at
  various prices
• Disagreements about shape of AS between long and
  short run and how firms and owners of resources
  respond to changes in the price level and how
  quickly

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AS and AD Curves
P P1
AS
Intersection of AS and AD determine the
equilibrium level of average prices and total
output in the economy
AD
0 Y1 Y
30
Classical Analysis

• Equilibrium only at full employment and if not
  will correct itself
• Market economy self-regulating
• Competition moves economy towards equilibrium
• If unsold inventory exists, prices decrease
• All saving is invested because of flexible
  interest rates
• Competition between workers eliminates
  unemployment

31
Keynesian Analysis, price level given

• Economy can get stuck at equilibrium with
  significant levels of unemployment
• No automatic forces operate to solve this
  problems
• Sticky wages
• Economy cannot take care of itself ? government
  has a responsibility to pull the economy out of a
  recession
• Also known as income-expenditure analysis

32
Keynesian Analysis

• Total demand for goods and services may be less
  than the supply of goods produced
• Focused on aggregate expenditures AE
• Aggregate expenditures AE
• Total planned spending for goods and services by
  consumers, businesses, government, and foreign
  buyers

33
Two-Sector Economy

• Consumption
• Largest component of spending
• Depends primarily on disposable income

34
Saving

• Keynes challenged the classical belief that
  planned saving depended entirely on the interest
  rate
• Keynes believed that consumers saving habits
  were based primarily on their income
• Saving function shows the relationship between
  the amount of disposable income consumers receive
  and the amount they save

35
Investment - I

• Classical economists believed that the most
  important determinant of planned investment
  spending was the interest rate
• Keynes argued that profit expectations are the
  most important determinant of planned investment
  spending by business
• Simple model treats planned investment spending
  as having a given value that is determined by
  factors outside of the model

36
Government Spending and Taxes

• Government spending (G) leads to an increase in
  aggregate expenditures ? injection
• Decrease in aggregate expenditures because of
  taxes (T) ? leakage
• G is assumed to be determined by factors other
  than income ? has a constant value
• Increase (decrease) in T causes the saving
  function to shift down (up) by the amount of the
  tax increase

37
Net Exports

• Exports (X) purchases by foreigners ? add to
  aggregate expenditures ? injection
• Imports (IM), spending of consumers, businesses,
  and government on foreign output ? reduces
  aggregate expenditures ? leakage
• Both are assumed to be determined by factors
  outside the model ? net exports (X IM) can be
  regarded as a given constant

38
Complete AE relationship

• AE C I G (X IM)
• Equilibrium
• AE equals total output
• Planned leakages planned injections
• Below equilibrium, injections gt leakages ? income
  and output rise
• Above equilibrium, injections lt leakages ? income
  and output fall

39
AE and AD

• Both represent demand for total output
• AE shows the relationship between demand and
  income
• AD shows the relationship between demand and the
  price level

40
Classical and Keynesian Views of Aggregate Supply
P
AS
P
P0
AS
AD2
AD2
AD1
AD1
0 Y Y
0 Y1 Y Y
Equilibrium always occurs at the level of output
associated with full employment ? AS is vertical
at full employment ? AD determines the price level
In short-term, equilibrium could be reached at an
output level involving less than full employment
and he suggested a horizontal AS curve because of
the unemployed resources
41
Aggregate Demand and Composite Aggregate Supply
P
AS
AD5
AD4
AD3
AD2
AD1
0 Y1 Y2 Y
Y
42
Macroeconomic policy

• Problems
• Unemployment (greater than natural rate)
• Inflation (erratic, unaticipated)
• Source of problem
• AD shift (unemployment or inflation)
• AS shift (unemployment and inflation)
• Tools
• Fiscal policies (G, T)
• Monetary policies (Ms, i)