Money, Monetary Policy, and Fiscal Policy

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Money, Monetary Policy, and Fiscal Policy
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Who Am I?
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Money

• Money
• Anything that is generally accepted as final
  payment for goods and services
• Money is NOT the same as wealth or income
• Wealth is the total collection of assets that
  store value
• Income is a flow of earnings per unit of time

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Money

• The Barter System goods and services are traded
  directly. There is no money exchanged.
• Problems
• Before trade could occur, each trader had to have
  something the other wanted.
• Some goods cannot be split. If 1 goat is worth
  five chickens, how do you exchange if you only
  want 1 chicken?

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Money

• Example A heart surgeon might accept only
  certain goods but not others because he doesnt
  like broccoli.
• To get the surgery, a pineapple grower must find
  a broccoli farmer that likes pineapples.

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Money

• Money serves these three purposes
• Medium of exchange
• It can be used to purchase goods and services
• Unit of Account
• It can be used to compare the value of different
  goods and services
• Store of Value
• It can be held to buy something in the future

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Money Supply

• Measuring the Money Supply
• M1 (high liquidity)
• Currency, Checking, travelers checks
• M2 (moderate liquidity) M1 plus
• Savings and investment funds (money market,
  mutual funds, ATM accessed savings) that allow
  investors to make easy transfers and withdrawals
• M3 (Low liquidity) M2 plus
• Time deposits over 100,000 (CDs, etc.)

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Money

• What is the difference between credit cards and
  debit cards?
• Are credit cards money?
• A credit card is NOT money. It is a short-term
  loan (usually with a higher than normal interest
  rate).
• Ex You buy a shirt with a credit card, VISA pays
  the store, you pay VISA the price of the shirt
  plus interest and fees.

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Money

• Ex You buy a shirt with a credit card, VISA pays
  the store, you pay VISA the price of the shirt
  plus interest and fees.
• Total credit cards in circulation in U.S 576.4
  million
• Average number of credit cards per cardholders
  3.5
• Average credit card debt per household 15,788

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Money

• Commodity money
• Gold, silver, copper, etc.
• Representative money
• The gold standard, there must be gold backing all
  of the money in an economy
• Fiat money
• Fiat money is not worth anything by itself, it is
  only worth something because the government says
  so and we agree.

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Money Supply

• There is no gold standard. Money is just an
  I.O.U. from the government for all debts, public
  and private.
• What makes money effective?
• Generally Accepted - Buyers and sellers have
  confidence that it IS legal tender.
• Scarce - Money must not be easily reproduced.
• Portable and Dividable - Money must be easily
  transported and divided.

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Monetary Policy

• The Federal Reserve System
• Created in 1914 in response to previous bank
  failures in the U.S.
• The Fed Board of Governors
• 7 members appointed by the Pres. And confirmed by
  the Senate
• 12 regional Fed Reserve Banks

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Monetary policy

• The Tools of Monetary Policy
• Changes in the Discount Rate
• When the fed lowers the discount rate, banks are
  encouraged to make more loans and the money
  supply increases
• When the fed raises the discount rate, banks are
  encouraged to make fewer loans and the money
  supply decreases

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Monetary policy

• The Tools of Monetary Policy
• 2. Open Market Operations
• When the Fed buys or sells U.S. securities to
  influence the money supply
• Fed buys, bank deposits increase, banks have more
  money to lend, and the money supply increases
• Fed sells, bank deposits decrease, banks have
  less money to lend, and the money supply
  decreases

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Monetary policy

• The Tools of Monetary Policy
• 3. Changes in the reserve requirement
• The reserve requirement is the minimum percentage
  that banks must keep to back up checking-type
  accounts
• Lowering the reserve requirement will increase
  money supply
• Raising the reserve requirement will decrease
  money supply

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Monetary Policy

• Example Assume the reserve ratio in the US is
  10
• You deposit 1000 in the bank
• The bank must hold 100 (required reserves)
• The bank lends 900 out to Bob (excess reserves)
• Bob deposits the 900 in his bank
• Bobs bank must hold 90. It loans out 810 to
  Jill
• Jill deposits 810 in her bank
• SO FAR, the initial deposit of 1000 caused the
  CREATION of another 1710 (Bobs 900 Jills
  810)
• Money Multiplier 1/Reserve Ratio
• A reserve ratio of 10 has a money multiplier of
  10
• A 2 billion increase to money supply will
  actually increase the money supply by 20 billion

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Monetary Policy

• The Feds other responsibilities
• The Fed works as a clearing house for all checks
• The Fed is also known as the lender of last
  resort
• In cases of emergency the Fed will come to the
  aid of ailing banks
• The Fed also performs stress tests on member
  banks.

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Fiscal Policy

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

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Fiscal Policy

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

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Fiscal Policy

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

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Fiscal Policy

• Keynesian approach
• Demand-side economics
• Focuses on changing aggregate demand in order to
  promote full employment
• Keynes argued that government stimulus could jolt
  the economy out of a severe recession or
  depression

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Fiscal Policy

• Supply-Side Fiscal Policy
• The idea that fiscal policy might directly affect
  aggregate supply. For example, a corporate tax
  cut may give businesses incentive to expand or
  invest in capital goods with the money saved.

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Fiscal Policy

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

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Fiscal Policy

• Laissez-faire
• Classical economists believed that free markets
  without government intervention were the best way
  to achieve the economys potential output.
• Classical economists believed that although there
  might be occasional downturns in the economy,
  natural market forces would correct things in the
  long term.

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Fiscal Policy

• Discretionary fiscal policy vs. automatic
  stabilizers
• Discretionary Fiscal Policy requires
  congressional and presidential action to change
  gov. taxing or spending
• Automatic stabilizers automatically adjust to the
  ups and downs of the economy. Unemployment
  insurance is a good example during a down
  economy, progressive taxing is a good example
  during an up economy

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Fiscal policy

• The problem with Lags
• Recognition lag
• Are we in a recession? How bad is the recession?
  How much needs to be done? Difficult questions
  because a recession isnt identified until 6
  months after it begins
• Decision making lag
• Action by policy makers usually takes months to
  approve

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Fiscal Policy

• The problem with lags
• Implementation lag
• The approved action then takes time to implement
• The recent stimulus checks are a good example
• I received mine 4 months after the bill was
  passed
• Effectiveness lag
• Once implemented fiscal policy can take from 9 to
  18 months for the full impact to be realized.
  Will the economy still need the agreed upon
  policy?

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Fiscal or Monetary Policy

• The President is advocating a bill that will cut
  taxes by 5.
• Fed chairman Ben Bernanke is planning on lowering
  the discount rate by ¼ point.
• The Fed Open Market Committee (F.O.M.C.)
  announced today that it will selling U.S.
  securities
• Both houses of the legislature have passed a bill
  that will spend 15 billion on infrastructure.

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Fiscal or Monetary policy?

• Zippy received his first unemployment check
  today.
• The Fed increased the reserve requirement today
  to 28.
• The President announced today that the 2009
  budget will be slashed in half.
• The government announced a tax rebate today
  equaling 1000 per person.

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Bonds vs. Stocks

• Pretend you are going to start a lemonade stand.
  You need some money to get your stand started.
  What do you do?
• You ask your grandmother to lend you 100 and
  write this down on a piece of paper "I owe you
  (IOU) 100, and I will pay you back in a year
  plus 5 interest."
• Your grandmother just bought a bond.

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Stocks vs. Bonds

• Bonds are loans, or IOUs, that represent debt
  that the government or a corporation must repay
  to an investor. The bond holder has NO OWNERSHIP
  of the company.
• Ex War Bonds During World War II
• Corporate bonds, municipal bonds, government
  bonds, etc.

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Stocks vs. Bonds

• To get more money, you sell half of your company
  for 50 to your brother Tom.
• You put this transaction in writing "Lemo will
  issue 100 shares of stock. Tom will buy 50 shares
  for 50."
• Tom has just bought 50 of the business. He is
  allowed to make decisions and is entitled to a
  percent of the profits.

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Stocks vs. Bonds

• Stockowners can earn a profit in two ways
• 1. Dividends, which are portions of a
  corporations profits, are paid out to
  stockholders.
• The higher the corporate profit, the higher the
  dividend.
• 2. A capital gain is earned when a stockholder
  sells stock for more than he or she paid for it.
  
• A stockholder that sells stock at a lower price
  than the purchase price suffers a capital loss.