Chapter 17 Money Creation, the Federal Reserve System, and ...

© SOUTH-WESTERNCONTEMPORARY ECONOMICS: LESSON 17.11

CHAPTER 17

Money Creation,

the Federal Reserve System,

and Monetary Policy

17.1 How Banks Work

17.2 Monetary Policy in the Short Run

17.3 Monetary Policy in the Long Run


CHAPTER 17

Money Creation,

the Federal Reserve System,

and Monetary Policy

How does the Fed create money?

Why don’t you demand all the money you can get your hands

on?

What’s the price of holding money?

How does the supply of money in the economy affect your

chances of finding a job, your ability to finance a new car, and the

interest rate you pay on credit cards?

What’s the impact of changes in the money supply on the

economy in the short run and in the long run?

Consider


LESSON 17.1

How Banks Work

Discuss what’s involved in getting a new

banking operation up and running.

Describe how the banking system can

expand the money supply by a multiple

of excess reserves.

Objectives


LESSON 17.1

How Banks Work

net worth

asset

liability

balance sheet

required reserve ratio

Key Terms

required reserves

excess reserves

money multiplier


Operating a Bank

Getting a charter

Bank balance sheet

Reserve accounts


Getting a Charter

Charter—the right to operate

Net worth—assets minus liabilities, also

called owners’ equity

Asset—any physical property or financial

claim owned by the bank


Bank Balance Sheet

Liability—an amount the bank owes

Balance sheet—a financial statement

showing assets, liabilities, and net worth

at a given time.

Assets = Liabilities + net worth


Reserve Accounts

Required reserve ratio—dictates the

minimum proportion of deposits the bank

must keep in reserve

Required reserves—checkable deposits

multiplied by the required reserve ratio

Excess reserves—reserves that exceed

required reserves


Money Multiplier

The Fed makes a move

Round one

Round two and beyond

Reserve requirements and money

expansion

Limitations on the multiplier


LESSON 17.2

Monetary Policy

in the Short Run

Explain the shape of the money demand curve.

Explain how changes in the money supply affect

interest rates and real GDP in the short run.

Discuss the federal funds rate and why the Fed

uses this rate to set monetary policy goals.

Objectives


LESSON 17.2

Monetary Policy

in the Short Run

money demand

money supply

federal funds market

federal funds rate

Key Terms


Money Demand

A medium of exchange

A store of value

The cost of holding money

Money demand and interest rates


Money Supply and

the Market Interest Rate

Money supply

Market interest rate

An increase in the money supply

Effect of lower interest rates

Increasing interest rates


Effect of an Increase

in the Money Supply


Effects of a

Lower Interest Rate


Ways to Expand

the Money Supply

Purchasing U.S. government securities

Reducing the discount rate

Lowering the required reserve ratio


Ways to Reduce

the Money Supply

Selling U.S. government securities

Increasing the discount rate

Raising the required reserve ratio


The Federal Funds Rate

Federal funds market

Aggressive rate cuts

Why target this rate?

Recent history of federal funds rate


Recent Ups and Downs

in the Federal Funds Rate


LESSON 17.3

Monetary Policy

in the Long Run

Understand why changes in the money supply

affect only prices in the long run, not real GDP.

Examine the historical link between money

supply growth and inflation.

Determine why political independence of

central banks results in lower inflation.

Objectives


LESSON 17.3

Monetary Policy

in the Long Run

euro

Key Term


Long-Run Effect

of Money Supply Changes

Production in the long run

Changes in aggregate demand


An Increase in the Money

Supply in the Long Run


Long-Run Evidence

Money supply growth and inflation in

U.S. history

Money supply growth and inflation

around the world


Other Issues

in Monetary Policy

Fed independence

Central bank independence and inflation

Independence trend

Could deflation pose a problem?

Lags and monetary policy

Chapter 17 Money Creation, the Federal Reserve System, and ...

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