APE Unit 5: Participation Set Packet #5 - Monetary Policy, Open Markets and International Trade - Packet Due Date:

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/45 Participation Packet: /15 Notes: Name Date Period APE Unit 5: Participation Set Packet #5 - Monetary Policy, Open Markets and International Trade - Packet Due Date: 5 points. 3 points. Chapter Title
/45 Participation Packet: /15 Notes: Name Date Period APE Unit 5: Participation Set Packet #5 - Monetary Policy, Open Markets and International Trade - Packet Due Date: 5 points. 3 points. Chapter Title Status/Point Value 1. What is Money Problem Set 2. The Federal Reserve Problem Set 3. Monetary Equation of Exchange Problem Set 4. Multiple Expansion of Demand Deposits Problem Set 5. Crowding-Out and Loanable Funds Problem Set 6. Bank Balance Sheet Problem Set 7. Monetary and Fiscal Policy Problem Set 8. International Trade and Balance of Trade Problem Set 9. Foreign Exchange Problem Set Total /60 1 What is Money Problem Set Overview 2 The Federal Reserve Problem Set In this WebQuest you will explore the role of the Federal Reserve in controlling the money supply and how actions of the Fed impact the nation s economy. The Federal Reserve System is also known as The Fed. Many people don t realize the importance and power of the Federal Reserve. It was created to provide the nation with a safer, more flexible, and more stable monetary and financial system. The Fed plays an integral role in the United States government and economy. Your group s mission is to determine our (the Fed s) role in the government, money supply, economic growth, and central banking. Task #1 - Federal Reserve Video Watch the video found at this link: and as you watch complete the following questions: The Federal Reserve is made up of three parts: the Board of, the banks and the Federal Committee. Congress wrote the in The Fed combines centralized authority with a healthy dose of independence. The Board of Governors has members, called governors. Governors write the that make commercial banks financially sound and that make the nation economically strong. The governors most important responsibility is participating in the Federal Open Market Committee, or. The FOMC is the Fed s chief body for monetary. Each FOMC meeting ends with a on actions that will affect the country s money supply. There are districts in the Federal Reserve, each of which is served by a regional Reserve bank. Reserve banks have three main responsibilities: 1) providing services, contributing to policy and commercial banks in their regions. A Reserve bank is often called the bank. Banks deposit billions of dollars at the Fed in cash, check, wire transfers or some other form of. Besides serving commercial banks, the Fed maintains accounts for the, processes government checks and assists the Treasury in issuing and redeeming securities. at Reserve banks are all experts on different aspects of our national economy. Most economists agree that the economy performs well when inflation is. As a result, low inflation is a long-term goal of the Fed. In addition to publishing and public speaking, economists prepare their Reserve bank presidents for FOMC meetings, where members together set a target interest rate, called the rate. To hit the fed funds rate target, the FOMC issues a directive to the New York Fed s domestic trading desk, which will then buy or sell on the open market, which ultimately affects how much money banks have available to lend. Banking supervision refers to the of the written rules that define what is acceptable behavior for financial institutions and is carried out by staff at the 12 Reserve banks. At the end of an on-site review, Fed examiners issue the bank a rating that reflects whether the institution is in or whether it has weaknesses that require corrective action and close monitoring. One way the Fed ensures safety and soundness of the banking system is by making short-term loans to banks through its. Task #2 - The Banking System Use the CNN website located at: to complete the Banking Scavenger Hunt worksheet: The federal government insures bank accounts against loss up to $. The catch with putting your money in a CD is: The average fee banks charge you to use another institution s ATM is $ on top of the average $ the other institution will charge you to use its ATM. You can bank without a bank. Explain what this statement means and list three examples. A fall 2009 survey from Bankrate.com found the average balance required for a no fee, interest-bearing account was $ if you want to avoid monthly fees. True/False: All no-fee accounts limit the number of checks you may write and charge high fees if you exceed that limit. (If the statement is false, re-write it to make it true.) If you use ATMs frequently, why is it important to be sure your bank has ATMs conveniently located near you? True/False: All banking customers get the same fees no matter what. Explain your answer. If you cash out a CD before the maturity date, your will pay a penalty which is typically. Average bounced check fees range from $ to $. True/False Deposits in credit unions are insured by the FDIC. (If the statement is false, re-write it to make it true.) List three differences between banks and credit unions? True/False Both money markets accounts and money market deposit accounts are insured against loss by the FDIC. (If the statement is false, re-write it to make it true.) Task #3 Chairman of the Federal Reserve The Chairman of the Fed is the head of the central banking system of the United States and one of the most important decision-makers in American economic policies. Use the links provided to answer the questions below about the Chairman of the Fed: Links for information: does the Chairman/woman become appointed? What is the term of office for the Chairman/woman? What are some of the responsibilities of this position? Who is Alan Greenspan? Why is he important? How important is the position of Chairman of the Federal Reserve? Explain. Task #4 Federal Open Markets Committee (FOMC) The FOMC is charged with overseeing open market operations in the United States, and is the principal tool of US national monetary policy. Use the links provided to find the information below: Links for information: Who sits on the FOMC? What is the importance of the FOMC? How do they influence the monetary policy? What are the three tools for controlling the money supply? Which tool is used the most? What is the goal of the FOMC? How does the FOMC impact the economy? Task #5 Application Use the follow link to read about possible Fed rate hikes: Use this article to answer the following questions.. Write a quick summary of the article. o What tool of monetary policy is being used by the Fed in this article? o What is the Fed hoping will happen as a result? Describe in some detail using your knowledge of economics. o Do you agree with the monetary policy that is being pushed or? Explain your answer. Webquest adapted from and revised by Ms. White 11/2011 and Mr. Maino 10/ Monetary-Equation of Exchange Problem Set Monetary policy is the manipulation of the money supply with the objective of affecting macroeconomic outcomes such as GDP growth, inflation, unemployment, and exchange rates. Monetary policy in the United States is conducted by the Federal Reserve, in particular, by the FOMC. In the chapter we take a closer look at monetary policy by examining how money supply, and thus the Fed, affects aggregate demand. We also compare the effectiveness of monetary and fiscal policy. I. The Money Market To understand the role of money in the macroeconomy we first need to look at money demand and money supply. By money supply we are usually referring to M1 or M2. The Demand for Money Keynes (yes, him again) believed the demand for money came from 3 sources: Transactions demand. People hold money to buy stuff. Precautionary demand. People hold money for emergencies (cash for a tow truck, savings for unexpected job loss). Speculative demand. People hold money to take advantage of a financial opportunity at a later date. The decision to hold money involves a tradeoff. Holding M1 is advantageous in buying goods and services, however assets in M1 (cash, checking accounts) earn very little, if any, interest. Holding assets with a competitive interest rate, like bonds is not convenient for buying goods and services. We can think of the interest rate as the opportunity cost or price of holding money. The demand for money (M1) is downward-sloping with respect to interest rates: An increase in national income will shift the money demand curve to the right, because people buy more stuff. Also, technology like ATM/debit cards will shift the money demand curve to the left because people do not have to hold as much M1 since it is easier to access a savings account. Money Supply As seen above, we assume that money supply is set by the Federal Reserve at the level they choose, so money supply is vertical at the quantity chosen by the Fed. By shifting the money supply, the Fed can change equilibrium interest rates. Suppose the Fed buys bonds on the open market. This increases the money supply, shifting the MS curve to the right, causing interest rates to fall: II. Money and Aggregate Demand: A Keynesian View A change in interest rates will in turn affect the spending decisions of consumers and firms. With lower interest rates it is cheaper for firms to invest and for consumers to buy durable goods, and this will shift the aggregate demand curve to the right, increasing output: Similarly, decreasing the money supply would raise interest rates, decrease investment and consumption, and decrease aggregate demand: III. Monetary Policy: Keynesian vs. Monetarist Views In the Keynesian model above, interest rates & investment are the transmission mechanism of monetary policy i.e. that is the way monetary policy affects macroeconomic outcomes. However, there are other points of view. The Monetarists believe that monetary policy affects prices, but not real GDP or unemployment. The impact of monetary policy can be expressed using the equation of exchange: MV = PQ Where M= the quantity of money in circulation, V = the velocity of money, P = the price level, and Q = real GDP. Velocity is the number of times a dollar is used to purchase goods and services in a given year. If we assume that V is stable (it doesn't change very often), the a change in the money supply, M must change P or Q. So no matter what happens to interest rates, total spending changes. If we assume the Q is near full capacity (the vertical part of the AS curve) then changes in M only affect P (see figure 15.5, page 301). This difference in the Keynesian and Monetarists views also leads to different remedies for fighting inflation and unemployment Fighting Inflation Keynesians would advocate a decrease in the money supply (contractionary monetary policy), which would increase interest rates, decrease spending, decrease AD, and decrease prices and real output. Monetarists would argue that if inflation is too high, then interest rates are already high: nominal interest rate = real interest rate + anticipated inflation rate So, Monetarists believe that decreasing the money supply will cause nominal interest rates to FALL (not rise) because the anticipated inflation rate will fall eventually. Monetarists advocate steady, predictable money growth to keep anticipated inflation and nominal interest rates low. Note that both Keynesians and Monetarists advocate a decrease in the money supply to fight inflation, but they expect it to work for different reasons. Fighting Unemployment Keynesians would advocate an increase in the money supply (expansionary monetary policy), which would decrease interest rates, increase spending, increase AD, increase prices and output, and decrease unemployment. But monetarists believe that an increase in the money supply will affect mostly prices, not output. This would raise inflationary expectations and actually INCREASE nominal interest rates. Monetarists do not believe that expansionary monetary policy is effective, unless the economy is WAY below full-employment (on the horizontal part of the AS curve). In general, Monetarists believe in fixed money supply targets, or a rule for how much to change the money supply. Keynesians disagree, and believe in more flexibility or discretion , with the Fed adjusting money supply to respond to economic conditions. This debate is known as rules vs. discretion. Tables 15.2 and 15.3 summarize the differences between Keynesians and Monetarists on the efficacy of fiscal and monetary policy. Source: The equation of exchange has two primary uses: 1. It represents a founding principle used by the quantity theory of money, which relates increases in the money supply to increases in the overall level of prices. 2. Additionally, solving the equation for 'M' can serve as an indicator of the demand for money. In other words, the Monetary Equation of Exchange formula directly demonstrates the impact that monetary policy is having on the economy. 4 Multiple Expansion of Demand Deposits Problem Set 5 Crowding-Out and Loanable Funds Problem Set 6 Bank Balance Sheet Problem Set The purpose of a bank is to take liabilities (deposits) and turn them into assets (loans made to borrows). It is by this process that the banks can charge interest and make money. A banks capital then are its assets minus its liabilities (assets liabilities). To see the relationship between assets and liabilities, we use a bank balance sheet (also called a T-Account). This is described below along with some helpful AP test hints. The FRQ that follows is an example of how you will see a bank balance sheet on the exam. Bank Liabilities -Right Side of the T-Account Sheet this is anything that is owed to someone else (e.g. checkable deposits and any loans the bank has taken out) Demand Deposits (DD) or checkable deposits o Cash deposits from the public or the FED o They are considered liabilities because these deposits belong to the depositors o They are also part of the M1 money supply Owners Equity (Stock Shares) o There are values of stocks held by the public ownership of bank shares Key Concept for AP concerning liabilities o If demand deposits come from someone s cash holdings, then the DD is already part of the money supply and the multiplier only increase the initial deposited amount o If the demand deposit comes in from the purchase of bonds (by the FED) then this creates new cash and therefore creates new money supply (more M1 money) Bank Assets -Left Side of the T-Account Sheet anything of value that is owned or that one has claim to (e.g. reserves that the banks holds and loans that bank has made to the borrowers) Required Reserves (RR) o These are the percentage of demand deposits that must be held in the vault so that some depositors have access to their money. This amount can vary, but AP usually uses 5%, 10% or 20% for easy calculations. This is also considered part of the M1 money supply Excess Reserves (ER) o These are the source of new loans. These amounts are applied to the Monetary Multiplier/Reserve Multiplier (DD = RR plus ER) o This is also considered part of the M1 money supply Bank Property Holdings (building and fixtures) Securities (Federal Bonds) o Customer Loans o These are bonds purchased by the bank, or new bonds sold to the bank by the FED. These bonds can be purchased from the bank, turned into cash that immediately becomes available as Excess reserves This can be amounts held by banks from previous transactions, owed to the bank by prior customers. This is the amount that banks have loaned out after they have removed any RR or ER amounts. Please Note: For the AP test, assets and liabilites will always be equal. This is why this is called a balance sheet. Use the above information to answer this FRQ in the space provided below. Please show your work. (a) (bi) (bii) (biii) (c) 7 Monetary and Fiscal Policy Compared Problem Set 8 International Trade and Balance of Trade Problem Set 9 Foreign Exchange (FOREX) Problem Set
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