John Maynard Keynes

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John Maynard Keynes

• There is no subtler, no surer means of
  overturning the existing basis of society than to
  debauch the currency.

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Milton Friedman

• Inflation is always and everywhere a monetary
  phenomenon"

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Inflation

• The relationship between overall price level and
  the amount of money has been seen for centuries
• Alexander the Great spending captured treasures
  of the Persians caused inflation in Greece

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Inflation

• Spain caused prices to increase throughout Europe
  by spending gold from New World colonies

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History of the Central Bank

• Does the federal government have the power to
  start a bank?
• Constitutional Convention had voted against it

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Hamilton and the Central Bank

• Alexander Hamilton argued that implied powers of
  the constitution allowed for a central bank

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Hamilton and the Central Bank

• He argued that the Central Bank would discipline
  banks from printing too much money and making too
  many loans
• Many people distrusted banks for this very reason
  unwise loans led to many bank failures and lost
  savings

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History of the Central Bank

• 1st Bank of the United (1791-1811)
• Not a central bank, just a place for tax money to
  be deposited
• Congress did not renew the charter in 1811
• Distrust of banks and states rights primary
  reasons

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History of the Central Bank

• Difficulty financing the War of 1812 convinced
  Congress of the use of a Central Bank
• Stephen Girard gave 8 million to finance the war
  when the US ran out of money in 1813

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History of the Central Bank

• 2nd Bank of the United (1816-1836)
• Started operating like a central bank
• Attempts to create a national currency
• Held reserves of state bank notes
• Threatened to cash them in for gold to control
  state banks
• Clearing house function for state banks they
  liked
• Helped banks by accepting their notes and
  allowing the transfer of gold/silver later

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History of the Central Bank

• Andrew Jackson saw the bank policies as
  benefiting big cities in the east at the expense
  of growth in the west
• In 1832 he vetoed the recharter of the bank

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History of the Central Bank

• Nicholas Biddle had tried to get recharter before
  1836
• 1832 2nd Bank loses its power due to veto
• Vs.

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History of the Central Bank

• Bank runs and crashes
• 1907 saw a particularly devastating increase in
  bank runs
• December 23, 1913 Woodrow Wilson signs the
  Federal Reserve Act into law

Wilson had called a special session of Congress
and threatened them with working through
Christmas if they didnt pass the Act
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The U.S. Federal Reserve System

• The monetary authority of the U.S.
  economyresponsible for serving as the nations
  central bank and for formulating monetary policy.

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The Federal Reserve

• The Federal Reserve (Fed) System is made up of
  the Federal Reserve Board in Washington, D.C.,
  the Federal Open Market Committee (FOMC), and 12
  regional Federal Reserve Banks.

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Structure of the Fed

• The Fed is run by its Board of Governors.
• Seven members appointed by the President of the
  United States for 14 year terms.

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Structure of the Fed

• The Chairman of the Board is the most important
  position presiding, directing, and testifying
  about Fed policy. She/He is appointed by the
  President from among the Board members for 4 year
  terms.

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Key features of membership of Board of Governors

• 7 members
• Appointed to 14 year terms
• Only eligible to serve one full 14 year term (can
  serve part of unfilled term to which appointed)
• Lots of turnover
• Pay is approximately 180,000 per year
• While no particular credentials are required for
  appointment, membership is mostly made up of
  professional economists (with doctorates)

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Structure of the Fed

• Federal Open-Market Committee (FOMC) - FOMC
  consists of 7 Governors 5 presidents of the 12
  banks (NY Fed President is always a member of the
  FOMC)
• Bank presidents serve one year rotating terms
• All 12 bank presidents attend the meetings and
  give advice

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STRUCTURE OF THE FEDERAL RESERVE
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Chairman of FOMC Janet Yellen
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FOMC Vice - Chairman William Dudley
Mr. Dudley is the President of the NY Fed
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Board of Governors on the FOMC
Daniel K. Tarullo
Jerome H. Powell
There are 2 open positions on the Board
Sarah Bloom Raskin
Jeremy C. Stein
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Current Bank Presidents on FOMC
Richard Fisher Dallas Bank President
Narayana Kocherlakota Minneapolis Bank President
Sandra Pianalto Cleveland Bank President
Charles Plosser Philadelphia Bank President
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Structure of the Fed

• 12 Federal Reserve banks are quasi-public banksa
  blend of private ownership public controlbanks
  are owned by the commercial banks in their
  district, but policy is set by the Board of
  Governors

The Fed is both a public and private entity
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Three Primary Functions of the Fed

• Regulate the private banking industry to make
  sure banks follow federal laws intended to
  promote safe and sound banking practices.
• Act as a bankers bank, making loans to other
  banks as a lender of last resort.
• Control the supply of money i.e. Monetary Policy.

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The Feds Policy Goals

• Monetary policy is made by the Federal
  Open-Market Committee with two goals in mind
• Price stability
• Full employment

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What is Monetary Policy???

• Monetary Policy is a central banks changes to
  the money supply to influence interest rates and
  assist the economy in achieving a
  full-employment, non-inflationary level of total
  output

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4 Tools of Monetary Policy

• Reserve Requirement
• The minimum level of deposit reserves commercial
  banks must hold.
• Discount Rate
• The interest rate the Fed charges commercial
  banks for loans.
• Open-Market Operations
• Buying and selling government bonds.
• Pay Interest on Bank Reserves
• Since 2008.

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Three Key Interest Rates

• Federal funds rate
• Interest rate that banks charge each other for
  short term loans for reserve purposes (overnight
  to very few days)
• Federal reserve discount rate
• Interest rate charged by Fed to member banks for
  short term loans for reserve purposes (for few
  weeks)
• Prime interest rate
• Interest rate (short term) that banks charge
  their most credit worthy customers

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Current (3/5/14) Key interest rates are

• Federal Funds Rate (targeted)
• 0 to .25 percent
• Federal Reserve Discount rate
• .75 percent
• Prime interest rate (at least at largest banks)
• 3.25 percent

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(No Transcript)
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3 FOMC Options

• Make interest rates fall
• Expand (or increase) the money supply
• Make interest rates rise
• Contract (or decrease) the money supply
• Keep interest rates the same

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Money Supply Changes by the Fed

• Open-Market Operations The primary way in which
  the Fed changes the money supply through the
  purchase and sale of U.S. government bonds with
  newly printed money.
• To increase the money supply, the Fed buys
  government bonds from the public.
• Buy Bigger
• To decrease the money supply, the Fed sells
  government bonds to the public.
• Sell Smaller

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Monetary Policy Prescription

• If the Fed sees the economy facing the problem of
  high unemployment what should they do?
• Discount Rate?
• Reserve Requirement?
• Open Market Operations?
• Interest on Bank Reserves?

Buy
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Monetary Policy Prescription

• If the Fed sees the economy facing the problem of
  high inflation what should they do?
• Discount Rate?
• Reserve Requirement?
• Open Market Operations?
• Interest on Bank Reserves?

Sell
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Problems in Controlling the Money Supply

• Two problems that the Fed must wrestle that
  arise due to fractional-reserve banking
• The Fed does not control the amount of money that
  households choose to hold as deposits in banks.
• The Fed does not control the amount of money that
  bankers choose to lend.

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Problems in Controlling the Money Supply

• The Fed walks a tight rope because they are
  trying to predict GDP growth
• MV PQ
• Growth of money supply growth in GDP
• If they put too much money in they will cause
  inflation, if not enough money then may slow
  growth

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What should the Fed do?

• CPI Unemployment GDP
• Aug 1.5 7.2 2012(3rd) 2.8
• Sep 1.1 7.2 2012(4th) 0.1
• Oct 0.9 7.2 2013(1st) 1.1
• Nov 1.2 7.0 2013(2nd) 2.5
• Dec 1.5 6.7 2013(3rd) 4.1
• Jan 1.6 6.6 2013(4th) 2.4

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Monetary Policy and Economic Stability

• Shifts in monetary policy exert an impact on
  output and prices with a time lag.
• The time lags of monetary policy are variable and
  sometimes quite lengthy.
• Because of these time lags, persistent shifts
  back and forth from restrictive to expansionary
  monetary policy are likely to do more harm than
  good. They are likely to be a source of economic
  instability.

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Federal Reserve Independence

• Protects the Fed from political pressures so they
  can effectively control the money supply
  maintain price stability
• Controlling inflation is often unpopularand then
  theres stagflation Governors terms are 14
  years each and staggeredno President could
  possibly appoint the whole Board

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Arguments Against the FED

• Governments in the past have had temptation to
  create inflation for their benefit
• Taxes are unpopular
• Gold standard would prevent this

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The Keys to Sound Money and Price Stability

• Central banks and their officials should be held
  accountable for following a sound money policy
  and keeping the nations rate of inflation within
  a narrow range or be dismissed.
• A currency board in one nation could establish a
  fixed rate of exchange between its domestic
  currency and a selected foreign counterpart with
  a sound money policy. This is often attractive
  for small countries.
• A country could adopt another nations currency
  to provide stability. For example, the euro or
  dollar are often used.