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The Fed


									The Fed
The Federal Reserve System

  Started in 1913
  Served as the first true central bank
  Divided up into 12 regional federal
   reserve banks
Member banks store some of their cash reserves
at the Fed. Res. Bank in their district
Federal Reserve Board

    Appointed by the President of the United
Short term loans

    Each regional bank allows member
     banks to borrow money to meet short
     term demands

    Why do you think they do this?

  Federal Deposit Insurance Insurance
  Created after the great depression
  Insures deposits up to $100,000

    What do you think people do that have
     more than $100,000 to put into the
The Federal Reserve’s most
powerful function is monetary policy

             Three tools the Fed can use to
              change the money supply are:
               Changing the discount rate
                (interest rate)
               Changing the required reserve
               Open market operations
Changing the discount rate

 This involves
  changing the rate of
  interest banks can
  charge on money
 The Fed can either
  increase or decrease
  this rate
Changing the required reserve rate

   Changing the amount of
    money that banks have to
    keep on hand
   This reduces the amount
    they can hand out for
   This makes it more
    difficult to receive a loan
Open Market Operations

   The government buys
    and sells securities on
    the open market
   When the Fed buys
    securities they are
    putting money into the
    economy market
   When the Fed sells
    securities they are
    taking money out of the
Besides deposits by customers banks can get
money in two other places

  1. From the Fed. Reserve
  2. From other member banks
Increase or Decrease in the Money
    Fed Buys Bonds            I

    Feds Sells Bonds          D

    The Discount Rate is      D

    I buy bonds and pay       D
     with a check

    The reserve ratio is      I
Money Multiplier
   The ratio of the         Formula:
    maximum increase in the
    money supply to an       Increase in Money
    increase in bank          Supply =
    reserves, determined by
    the required reserve     Initial cash deposit x 1/RRR
                                 Example the required reserve ratio is 10%
                                 So the money multiplier is 1/.1(10%)
                                 A deposit of 1,000 dollars would be
                                 1,000 x 10 = 10,000
                                 Leads to a 10,000 dollar increase in the
                                  money supply

  RRR is 5% or .05
  Your deposit is $100
  100 x (1/.05) = 100 x 20 = $2000

    The deposit of 100 leads to a $2000
     dollar increase in the money supply
Phases of the business cycle

 -Boom (expansion)
 -Bust (contraction)
 Boom (recovery)

 A period of economic
  growth as measured
  by a rise in real GDP
 Characterized by
  plentiful jobs, falling
  unemployment, and
  business prosperity
 When the Real GDP stops rising
 The maximum height of economic expansion
Bust (recession)

   After reaching its peak, the economy enters a
    period of contraction, an economic decline
    marked by falling real GDP, unemployment
Trough (TRAWF)

 When the economy has bottomed out
 When the real GDP stops falling
Three types of Contraction

  Recession
  Depression
  Stagflation

 If real GDP falls
  for two
  quarters (six
  straight months)
 A prolonged

  Occurs if a recession      Worst and longest
   is especially long          economic collapse in
   and severe over 18          the history of the
   months                      modern industrial
  Very high                   world, lasting from
   unemployment and            the end of 1929 until
   low manufacturing           the early 1940s.
   output                      Beginning in the
                               United States

  A decline in GDP combined with a rise in
   the price level
  a nasty combination of hyperinflation,
   high unemployment and persistently
   sluggish growth that foiled policy-makers
   a generation ago.
  Last time we saw it was in the 1970’s

    Gross Domestic Product
        Adding everything made in the economy or
         by a specific country
Current Dollar GDP

    The Value of GDP with no adjustment for
Constant Dollar GDP

    The dollar value of GDP adjusted for

    Why would this be a valuable statistic?
Two Methods to Measure GDP

  Expenditure Method
  Income Method
Expenditure Method

  Sum of all spending in the economy
  Consumer purchases, investment
   spending, government spending, and net

    What are net exports?
Expenditure Spending

  C -Personal consumption expenditures
  I – Gross private domestic investment
   (building, equipment, inventories)
  G – Government Spending
  X-M net exports – imports

    GDP = C + I+ G + (X-M)
Indicate whether each of the following
expenditures is a part of consumption (C )
government spending (G), Investment (I), or
exports (X)

 1. The Air force buys a stealth bomber        G
 2. A pair of Levis Jeans is sold in Rome      X
 3. Japanese tourists buy souvenirs in         X
 4. A family buys a new house                  I
 5. A family buys a thanksgiving turkey        C
 6. A toy company increases inventory          I
 7. Electric company buys new generator        I
 8. Family pays electric bill                  C
Income Method
       Sum of all incomes used in production
           Also called National Income
           All of the wealth earned in the economy
       Made up of:
           Wages and salaries
           Proprietors (businesses) income/Corporate Profits
           Interest
           Rent
               Capitol Consumption allowances

               Indirect taxes
The main difference
    Expenditure approach      Income approach
     calculates GDP by          calculates GDP by
     adding up all of the       adding up all of the
     transactions in the        transactions in the factor
     product market             market
Review Poster

    Three Functions of Money
    Six Characteristics of Money
    Three sources of money’s value
    Three functions of the Fed
    Business Cycle and Monetary Policy

  The General
   increase in prices
Purchasing power

  ________________________________
  As prices rise, the purchasing power of
   money declines
Consumer Price index
   Is a measurement that shows how the average price of a
    standard group of goods changes over time
   Consumer Price Index (CPI) is computed each month by
    the Bureau of Labor Statistics
Calculating CPI

    CPI= ________________________________
    Market basket is make up of a group of items
     meant to represent what the typical consumer
     buys. Includes food/drink, housing, apparel,
     transportation, medical care, entertainment,
     education, other goods/services
    Cost for market basket today = $360
    Base period cost for market basket = $200
    Calculate the CPI
Types of Inflation

  ____________________-
  ____________________
  ____________________
    Demand Pull Inflation
 When the
  the excess demand spills over into demand pull inflation.
 Example: Nintendo Wii Price: $249
 Because of demand pull inflation the market price is $405
 Can you think of any other examples of demand pull inflation?
    Cost Push Inflation
   Inflation from changes in the
    cost of production of goods
    and services.
    , labor, or capitol results in
    cost push inflation.
   Come up with an example of
    Cost Push inflation.
Monetary Inflation

  Inflation caused by
  Who would be
   responsible for
   controlling this type
   of inflation?
Quick Quiz

    What is the most common measure of

    Define inflation

    What are the three types of inflation?
In each of the following situations what is
probably the cause of the inflation?
    The Fed buys increasing
     amounts of bonds.

    Everyone goes out and
     charges their credit cards up to
     their limits.

    Political Unrest in the Middle
     East causes oil prices to rise.

    People see that prices are
     rising and they stock up on

    A huge fire destroys the forests
     of the Northwest.
Civilian Labor force

    The number of people age 16 or older
     who are either employed or are
     unemployed, but actively looking for
Types of unemployment

  Frictional
  Structural
  Cyclical
Frictional Unemployment

    Occurs when people   Can you think of any
     change jobs, enter    examples?
     the job market, or
     reenter the job
Structural Unemployment

    Occurs because of        Can you think of any
     changes in the basic      examples?
     characteristics of the
     market, a change in
     consumer tastes, or
     new technology in
Cyclical unemployment

    occurs because the      Can you think of any
     total demand for         examples?
     goods and services
     is insufficient to
     employ all workers in
     the labor force
Full Employment

    Is the use of all
     available resources
     to produce the
     desired amount of
     goods and services
     and there is a natural
     rate of
Natural rate of Unemployment

    The rate of
     occurring when there
     is no cyclical
     unemployment. It is
     the combined total of
     frictional and
Hidden Unemployment

    Includes those            Can you think of any
     people who would           examples?
     like to have a job,
     but are not actively
     looking for work,
(S) for structural unemployment, (C) for cyclical
unemployment, and (F) for frictional unemployment
      Unemployed VCR repairman            S
      Sales people laid off during a      C
      A new graduate looking for          F
       her first job
      A Buffalo Steel worker who          S
       loses his job when the plant
       moves to Arizona
      A t-shirt maker who loses his       C
       job due to aggregate demand
      A man goes back to work             F
       after his daughter starts
Public Finance
Public Finance Three questions

    What does the government spend
     money on?

    How does the government collect

    What is the best way for the government
     to collect money?
Federal Spending/State&Local Spending

    Federal                                 State/Local
        National Defense                        Education
        Fiscal Federalism                       Public welfare
        Transfer Payments                       Health/hospitals
             Social security                    Police/fire/correction
             Federal pensions                    s
             Medicare
                                                 Interest on debts
             Interest on national debt
Entitlement Programs

    Recipients are legally entitled to the
     programs, can not be reduced
        Social Security, Fed. Gov. Pensions,
         Medicaid, Medicare
Indicate which Congress can reduce (C ), and which
cannot (CN) be reduced because they are entitlement

   Veterans Benefits            CN
   Social Security              CN
   Medicaid                     CN
   Defense                      C
   Space exploration            C
   Interest Payments            CN
   Environmental Programs       C
   Education Programs
                                  C
Where do they get the Money?

 Federal Revenues        State & Local Rev. User
   Personal income tax     fees and mis.
   Payroll taxes           Sales tax
   Corporate income        property tax
   tax                     income taxes (does not exist in
                           some states)
   Excise tax
                           federal grants (fiscal federalism)
Paid by Federal gov. (F) or State
/ Local gov. (SL)

   Education                 SL
   Army pensions             F
   Police department         SL
   Highways                  SL
   Space exploration         F
   Environmental clean up    F
   Prisons
   Navy                        SL
                                F
Main Sources of Revenue

   -Income Tax
   -   Sales Tax
   - Property Tax
Government Purchase (P)
Transfer payment (T)
Justin gets a fed. Grant to help pay for      P
Molly receives a food stamp from the          T
Tyrone works on a road crew repairing         P
Jeremiah uses his Medicare to fill a
  prescription                              T
Army purchases new tanks                    P

Silvia cashes her social security check     T
What does the Federal
government spend money on?
  About 1/3 of the GDP in the United States passes
   through the federal government
  The government purchases about 18% of all
   goods/services in the economy

        The largest government expenditure is national
         defense (16.5% of the budget)

    The rest of the money collected by the federal
     government is involved in transfer payment programs
What two areas of spending do you think have
increased the most for state and local

   Prisons

   Health Care
Fiscal Federalism
    To pay for programs state and local
     governments are granted money from the
     federal government.

    Fed. Gov. often mandates the specific
     programs that the grants may be used for;
     grants are usually not enough to cover costs of

    Contributes to the financial squeeze of state
     and local governments
Revenue sources federal (f), state
(s), local (l) or a combination?

     Personal income tax      F, S
     The sales tax
     Excise tax               S
     Grants in aid            F, S
     Corporate tax            S, L
     The Property tax         F
     Payroll tax              L
                               F
What taxes are paid?

   A person gets a pay check.

   A person spends some of his/her pay check.

   A person uses some of his/her money to buy a house.
How should governments collect

     Two things should be kept in mind
      Equity and Efficiency
                                  Taxes should be levied in
 Horizontal- people who           such a way as to minimize
 are equally able to pay should   their interference with the
 bear the same tax burden         allocation of resources and
 Vertical- people with higher     their discouragement of
 incomes pay a larger             production
 percentage of their income in             Exception
                                  Sin taxes- placed on goods
                                  hat the government wishes
                                  to discourage the use of
Thee types of tax strategies

  Progressive
  Regressive
  Proportional
Progressive Taxes

    A higher percentage of tax is levied on
     larger incomes
Regressive tax

    Lower income earners pay a larger
     percentage of their income in taxes than
     higher earners
Proportional Taxes

    The same percentage of income is paid
     in taxes at different income levels
Which tax style do you think is
most fair? Best for the economy?
Which is Regressive ( R),
Progressive (PV), Proportional
   A. Income Tax           C. Income Tax
       10,000      2000   -   10,000      2000
       20,000      3000   -   15,000      3000
       40,000      4000   -   20,000      4000

    B. Income Tax
    20,000          2000
    24,000          3000
    28,000          4000

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