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					In t e rn a t i o n a l
   &
Trade
Ce n t ral Ba n k i n g
 TEACHER’S GUIDE
      International Trade Central Banking                  &
TABLE           OF       CONTENTS
Lesson Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Student Activity Worksheets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
    Activity 1: How Different Are Central Banks? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
    Activity 2: How Does Central Bank Independence Affect Inflation Rates? . . . . . . . . . . . . . . . . . . . 9
    Activity 3: How Are Central Banks Involved in the International Economy?. . . . . . . . . . . . . . . . . 11
    Activity 4: What’s New in the World of Central Banking? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Teacher Answer Keys . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
    Activity 1: How Different Are Central Banks? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
    Activity 2: How Does Central Bank Independence Affect Inflation Rates? . . . . . . . . . . . . . . . . . . 16
    Activity 3: How Are Central Banks Involved in the International Economy?. . . . . . . . . . . . . . . . . 18
    Activity 4: What’s New in the World of Central Banking? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Student Quizzes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
    Activity 1 Quiz . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
    Activity 2 Quiz . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
    Activity 3 Quiz . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
    Quiz Answer Keys. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
    Table 1: Inflation Rates (1996—1999) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
    Table 2: A Measure of Central Bank Independence During the 1980s . . . . . . . . . . . . . . . . . . . . . 29
    OANDA Currency Converter Guide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
    “Why Central Bank Independence Helps to Mitigate Inflationary Bias” . . . . . . . . . . . . . . . . . . . . 31
    “Central Bank Independence and Inflation” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
    “Monetary Policy and Exchange Rates in Small Open Economies” . . . . . . . . . . . . . . . . . . . . . . . 37
    “International Linkages” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
    Federal Reserve Press Releases. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
    Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43




The contents of these lesson plans do not necessarily reflect the views of the management of the Federal
Reserve System or of the Board of Governors of the Federal Reserve System.
Permission to reprint or photocopy is granted for educational purposes if the source is credited.
Downloadable files of all lesson plans are available on the Internet at
http://www.frbsf.org/education/curriculum/index.html.




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                 International Trade Central Banking      &
         INTERNATIONAL TRADE                               AND       CENTRAL BANKING
ESTIMATED TIME REQUIRED:
         Two 50—minute class periods with homework.

OVERVIEW:
         This lesson will introduce students to the structure, purposes, and functions of the Federal Reserve System
         in the United States. Using compare/contrast techniques, students will learn about the Federal Reserve
         System by investigating similarities and differences among the central banks in different countries. In
         addition, students will learn how the Federal Reserve is related to the international economy and trade.

INTRODUCTION:
         The Federal Reserve System, or “The Fed” for short, is the United States’central bank. It was created in
         1913 and is charged with establishing and maintaining public confidence in the monetary and banking
         system of the United States.
         The confidence that exists today wasn’t always there during much of the country’s early history. At one
         time, the United States had more than 30,000 types of currency, which almost any organization—even
         stores—could issue!
         Today, the Fed has three main functions—setting monetary policy, supervising financial institutions, and
         providing financial services. The Fed’s unique “decentralized central bank” structure adds to its success.
         Many countries have used the Fed as a model to create their own central banks, but considerable
         differences still exist among central banks in countries around the world1.
         The activities of the Federal Reser ve and the international economy are related in several ways. Monetary
         policy decisions consider developments in international economies and movements of exchange rates.
         Furthermore, interest rates can affect the value of the dollar and that can influence the relative prices of
         imports and exports.Also, the Federal Reserve in cooperation with the U.S.Treasury conducts foreign
         currency operations—buying and selling dollars in exchange for foreign currency. However, such
         intervention has been rare and is only used in extreme cases.
         The following lesson will help students understand how central banks around the world compare and how
         actions of the central bank affect and are affected by events in the international economy.

LEARNING OBJECTIVES:
         At the end of this lesson, students will accomplish the following:
             • Explain the three main functions of the Fed (monetary policy, banking supervision and regulation,
               and financial services) and compare these functions to another country’s central bank.
             • Analyze the events leading to the formation of the Federal Reserve System and another country’s
               central bank.
             • Investigate how central bank independence is related to inflation rates.
             • Learn how exchange rates can be affected by monetary policy actions.




         1“The   Fed Today Video.” Federal Reserve System. Winter 2001. Available at: http://www.FederalReserveEducation.org.

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              International Trade Central Banking  &
MATERIALS NEEDED:
            • Activity 1 Handout:“How Different Are Central Banks?”
            • Activity 2 Handout:“How Does Central Bank Independence Affect Inflation?”
            • Activity 3 Handout:“How Are Central Banks Involved in the International Economy?”
            • Activity 4 Handout:“What’s New in the World of Central Banking”
            • Access to research materials (preferably via the Internet) for the homework section
SUGGESTED STUDENT PREPARATION:
        Many of the concepts in this lesson are based on material contained in The Fed Today lesson plan and
        video. Both are available at no charge from http://www.FederalReserveEducation.org. Students should at
        least view the video before beginning this lesson.
        In addition, there is a Web site that accompanies the Fed Today lesson plans:
        http://www.kc.frb.org/fed101html/index.cfm

TEACHER PREPARATION:
        1. Review the Fed 101 Web site located at http://www.kc.frb.org/fed101html/index.cfm.
        2. Prepare copies of Activities 1—4 for students.
        3. Prepare copies of Tables 1 and 2 for students.
        4. Prepare copies of the articles for students (see Resources section of this packet).




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LESSON PROCEDURES:
        Activity 1:                                                         Teachers Tip:
        “HOW DIFFERENT ARE                                       If your students need more information about
                                                                   the Federal Reserve, explore the web site of
        CENTRAL BANKS?”                                              your local Federal Reserve Bank or use
        1. Introduce the lesson by telling students that they          www.FederalReserveEducation.org
           will learn more about the central bank in the
           country they are studying by comparing and contrasting it with the Federal Reserve System in the
           United States. This is an appropriate time for students to view The Fed Today video to form a base of
           knowledge for this lesson.
        2. Guide students through Step 1 of Activity 1 by discussing key characteristics of the Federal Reserve
           System. Ensure that students understand the following three concepts:
             • Some people lost faith in the United States banking system in the late 1800s and early 1900s.
               President Woodrow Wilson signed the Federal Reserve Act in 1913 to establish the Federal Reserve
               System to create stability in the banking system.
             • The Federal Reserve System is both public and private. The Board of Governors is a public agency
               and each of the 12 Reserve Banks is a private entity.
             • The Federal Reserve System has three main functions: monetary policy, banking supervision and
               regulation, and financial services.
        3. Ask students to discuss some similarities and differences that they already know exist among other
           countries’ central banking systems and the Federal Reserve System. If students are unsure, prompt with
           any of the following three key ideas:
             • Central bank structure may be very different
               across countries—the European Central Bank,
               for example, operates in several countries.
                                                                            Teachers Tip:
             • Many central banks were established much              If the information your students find about
               earlier or much later than 1913.                       their country is not in English, try offering
             • Events leading to the creation of other                extra credit if a person can be found in the
               countries’ central banks may be similar to the             community that can help to translate.
               history of the Federal Reserve System.
        4. Allow students to do Internet or library research individually or for homework to discover how the
           central bank in another country compares to the Federal Reserve System to complete Step 2 of Activity 1.




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      International Trade Central Banking   &
Activity 2:
HOW DOES CENTRAL BANK INDEPENDENCE
AFFECT INFLATION?
1. Introduce Activity 2 to students by stating that the inflation rate in a country is often related to the
   degree of central bank independence.
2.Ask students to explain and write a definition of inflation in Step 1 of Activity 2. Talk about examples
   of inflation if students are unfamiliar with the concept.
Example:
        In 1990, a basket of goods cost $10.00. An identical basket of goods cost $13.00 in 2000. This is
        an example of inflation; $10.00 in 2000 will not buy the same amount of goods as it would in
        1990. In 2000, you need an extra three dollars to buy the same items. By definition, inflation is a
        rise in the general level of prices over a sustained period of time.
See Lesson 4 in The Fed Today Lesson plans for a more in—depth description of inflation.
3. Help students find the country they are studying on Table 1 and calculate the simple average inflation
   rate between 1996 and 1999.
4. Discuss possible reasons that some countries have very high inflation rates. Explain how inflation could
   be viewed as a tax imposed on the purchasing power of money. Use the World Bank’s explanation of
   the inflation tax as a guide if needed (Available at
   http://www1.worldbank.org/publicsector/tax/inflationtax.html)
5.To introduce Step 2, guide students in comparing and contrasting the independence of their country’s
   central bank in relation to the Federal Reserve System. Encourage students to use what they learned
   about the structure of their country’s central bank in Activity 1 to complete this. The data in Table 2
   that ranks central bank legal independence will guide students
   in this exercise. For those countries not included in Table 2,
   other information such as the central bank’s legal charter or
   the turnover of its governors could be used to answer this
                                                                            Teachers Tip:
   question (for more information, see the suggested answers for         Ask students how they think world
   this activity). Also, students should keep in mind that the data        events in the past few years may
   in Table 2 is for the 1980s (the only data available) and any
   significant developments in recent years could influence the             affect what this data indicates.
   answer given to this question.
6. Instruct students to read the two articles noted in Step 3. (This step could also be done as homework as
   a follow—up to Steps 1 and 2 that were completed in class.) The third optional article could be used
   for particularly motivated students or those who are working with a smaller country and want more
   information.
7. Lead a student discussion about the two articles. Ensure that students understand the meaning of an
   inverse relationship between inflation and independence, but suggest that there may be other factors that
   contribute to a country’s inflation rate. For example, even a central bank that is largely controlled by
   the government could still be successful in controlling inflation.




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      International Trade Central Banking &
Activity 3:
HOW ARE CENTRAL BANKS INVOLVED                                         IN THE
INTERNATIONAL ECONOMY?
1. Direct students to the OANDA Currency Converter available at:
   http://www.oanda.com/convert/classic. The OANDA Guide in the Resources section of this lesson
   plan offers more instruction on how to use the Currency Converter tool.
2. Use the OANDA Currency Converter to find the exchange rate for the current day, six months ago,
   and one year ago.
3. Help students differentiate between appreciation and depreciation (see Glossary for definitions).
4. Direct students to read “International Linkages” and answer the question posed in Step 2.
5. Using what was learned in the reading of “International Linkages,” students should be able to complete
   Step 3 of Activity 3. NOTE: The scenario for students to complete is the exact opposite of the
   scenario outlined in the second paragraph of “International Linkages.” The final two boxes may be
   more difficult for students to fill in and may require additional research. In any case, the suggested
   answers are only the most likely results of the given scenario—there could be other results that would
   be correct answers if students could support them.




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      International Trade Central Banking    &
Activity 4:
WHAT’S NEW                 IN THE        WORLD           OF     CENTRAL BANKING?
1. Instruct students to locate two press releases or news articles (one that relates to the central bank in the
   country they are studying and one that relates to the Federal Reserve System). If students are unable to
   find suitable material on the Web site of their country’s central bank or in a financial newspaper or
   magazine, suggest they use an encyclopedia.
2. Discuss the articles’content with students and
   explore areas in which different countries are
   dealing with similar or different issues.
                                                                       Teachers Tip:
                                                              Let groups of 3-4 students work together to
                                                             research the central bank of another country.




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 STUDENT WORKSHEETS
• Activity 1:
   How Different Are Central Banks?
• Activity 2:
   How Does Central Bank Independence Affect Inflation Rates?
• Activity 3:
   How Are Central Banks Involved in the International Economy?
• Activity 4:
   What’s New in the World of Central Banking?




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               International Trade Central Banking          &
        Activity 1
STUDENT WORKSHEET

        HOW DIFFERENT ARE CENTRAL BANKS?
        Step 1:
        The Federal Reserve System has several characteristics that make it function well as a central bank. Using
        what you already know about the Federal Reser ve or one of the resources on the Federal Reserve
        Education Web site (www.FederalReserveEducation.org), complete the first column of the table below.
        Step 2:
        Describe the structure and function of the central bank in another country by completing the second
        column of the table below. The following information sources may assist you.
            • Federal Reserve Board—Foreign Central Banks List:
              http://www.federalreserve.gov/centralbanks.htm
            • The Library Network List of Central Banks: http://jolis.worldbankimflib.org/Special/annualre.htm
            • Your local library
                             Country: United States                  Country:
                             Central Bank: Federal Reserve System    Central Bank:
        In what year was
        the central bank
        established?


        What factors
        contributed to the
        formation of the
        central bank?


        What are the        Hint: The Federal Reserve has three main functions.
        central bank’s main
        functions?
        Briefly explain how
        each works.


        If monetary policy      Hint:The Federal Reser ve Act specifies the goals of
        is one of the           the Federal Reserve System’s monetary policy (See
                                Purposes and Functions which is available at
        functions of the        http://www.federalreserve.gov/pf/pf.htm.)
        central bank, what
        are the stated goals
        of monetary policy?




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               International Trade Central Banking  &
         Activity 2
STUDENT WORKSHEET

         HOW DOES CENTRAL BANK INDEPENDENCE
         AFFECT INFLATION?
         Step 1:
INVESTIGATING THE INFLATION RATE
         What is inflation?


         Locate your country in Table 1 and calculate the simple average inflation rate between 1996 and 1999.
         (Note: the simple average is a reasonably good approximation of inflation over time, but the geometric
         average will be more accurate because it considers compounding. Calculating a geometric average is too
         complicated for this exercise.)




         Although many countries try to limit inflation, some countries have consistently high inflation. Can you
         think of a reason for this?




         Step 2:
INQUIRING ABOUT CENTRAL BANK INDEPENDENCE
         Some country’s central banks are very involved with the country’s government and others operate like a
         private corporation, but most operate with a combination of government influence and independent
         decision—making. The level of central bank independence can be affected by several factors such as
         whether the central bank’s governor and board are appointed by the government, the length of these
         appointments, whether government representatives sit on the bank’s board, whether government approval
         of monetary policy decisions is required, and whether “price stability” is an explicit central bank goal.
         Central bank independence is important in the economics literature because researchers find that nations
         with independent central banks tend to have lower inflation rates on average than countries with less
         independent central banks.
         Compare and contrast the independence of your country’s central bank with that of the Federal Reserve
         System. Complete the table below using the data in Table 2 or other research information.
                                       Independence Rating                   Name one reason for your rating
                                       (High, Medium, Low)
         Independence of your
         country’s central bank
         Independence of the
         Federal Reserve System

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                 International Trade Central Banking  &
          Step 3:
PUTTING   IT   ALL TOGETHER
          Read the following articles:
           Cogley,Timothy. “Why Central Bank Independence Helps to Mitigate Inflationary Bias.” Federal Reserve
           Bank of San Francisco Weekly Letter. Number 96—08. 23 Feb 1996. Available at
           http://www.frbsf.org/econrsrch/wklyltr/wl9608.html
           Parry, Robert T. “Central Bank Independence and Inflation.” Federal Reserve Bank of San Francisco
           Weekly Letter. Number 95—16. 21 Apr 1995.
           FOR MORE INFORMATION ON SMALL OPEN ECONOMIES: (optional)
           Dennis, Richard. “Monetary Policy and Exchange Rates in Small Open Economies.” Federal Reserve
           Bank of San Francisco Economic Letter, Number 01—16. 25 May 2001. Available at
           http://www.frbsf.org/publications/economics/letter/2001/el2001—16.html.


          Cogley states “...across countries, there appears to be an inverse relation between average inflation and the
          degree of central bank independence.” In other words, lower inflation rates typically appear in countries
          with higher levels of central bank independence.
          Given the evidence of inflation rates and independence levels in Steps 1 and 2 in the country you studied,
          do you agree with Cogley’s statement? Explain.




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               International Trade Central Banking
        Activity 3
STUDENT WORKSHEET

        HOW ARE CENTRAL BANKS INVOLVED                                      IN THE
        INTERNATIONAL ECONOMY?
        Step 1:
USE THE INTERNET TO    LEARN ABOUT YOUR COUNTRY’S CURRENCY

        Use the OANDA Currency Converter (http://www.oanda.com/convert/classic)
        to complete the table below.
        Country Name
        Currency Name
                                                 Today                6 months ago        1 year ago
        Date
        Exchange rate between your
        country’s currency & the U.S. Dollar
        (Example:
        1 U.S. Dollar = 10.3 Mexican Pesos)
        Over the last year, has YOUR country’s currency shown appreciation or depreciation compared to the
        U.S. Dollar? Explain.




        Step 2:
READ ABOUT THE FEDERAL RESERVE’S ROLE IN THE INTERNATIONAL                   ECONOMY      AND   RESPONSE
TO INTERNATIONAL ECONOMIC CONDITIONS

         “International Linkages.” Purposes and Functions. Federal Reserve Board, 1994, pgs.62—63.
         Available at: http://www.federalreserve.gov/pf/pf.htm.
         “Federal Reserve Press Release.” 29 Sep 1998.
         Available at: http://www.federalreserve.gov/fomc/#calendars.
         “Federal Reserve Press Release.” 6 Nov 2002.
         Available at: http://www.federalreserve.gov/fomc/#calendars.
        Explain what is meant by the following statement from Purposes and Functions:
        “Federal Reserve policies shape and get shaped by international developments.”




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              International Trade Central Banking    &
        Step 3:
RELATING CENTRAL BANK ACTIONS TO EXCHANGE RATES
        As you learned while reading “International Linkages,” even though U.S. monetary policy DOES NOT
        make policy decisions that target exchange rates, central bank actions can affect exchange rates.
        Complete the flow chart below with arrows to indicate the likely direction each item will move as a result
        of the given scenario, assuming all other economic conditions remained unchanged. The first box is
        completed for you.


                                                      SCENARIO:
                                     The Federal Open Market Committee (FOMC)
                                         decides to lower U.S. interest rates.


                                                    Value of the U.S. Dollar




                       U.S. Price of Imported Goods                       Foreign Price of U.S. Goods
                                                                             Traded Internationally




                                          What effect this could have on U.S
                                    Net Exports, otherwise known as the trade balance.
                                           (Hint: Net Exports = Exports—Imports)




                   Could changes in export and                           Explain what effect this could have on
                  import prices and output affect                                    U.S. output.
                    the price level in the U.S.?                            (Hint: Output or GDP = Consumption +
                                                                             Investment + Government + Net Exports)




                                                        12
              International Trade Central Banking   &
        Activity 4
STUDENT WORKSHEET

        WHAT’S NEW                 IN THE       WORLD          OF    CENTRAL BANKING?
        Part 1:
        Find a current newspaper article about or press release from the central bank in the country you are
        studying. Summarize the three main points of the reading using the bullet points below. (Note: if you
        can’t find anything on your country’s central bank Web site or in a financial newspaper or magazine, try
        using the encyclopedia.)
        •
        •
        •
        Attach a copy of the article to this handout.




        Part 2:
        Find a current newspaper article about or a press release from the Federal Reserve System. Summarize the
        three main points using the bullet points below
        •
        •
        •.
        Attach a copy of the article to this handout.




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TEACHER ANSWER KEYS
• Activity 1:
   How Different Are Central Banks?
• Activity 2:
   How Does Central Bank Independence Affect Inflation Rates?
• Activity 3:
   How Are Central Banks Involved in the International Economy?
• Activity 4:
   What’s New in the World of Central Banking?




                           14
              International Trade Central Banking   &
        Activity 1
TEACHER ANSWER KEY

        HOW DIFFERENT ARE CENTRAL BANKS?
        Step 1:
        The Federal Reserve System has several characteristics that make it function well as a central bank. Using
        what you already know about the Federal Reser ve or one of the resources on the Federal Reserve
        Education Web site (www.FederalReserveEducation.org), complete the first column of the table below.
        Step 2:
        Describe the structure and function of the central bank in another country by completing the second
        column of the table below. The following information sources may assist you.
            • Federal Reserve Board—Foreign Central Banks List:
              http://www.federalreserve.gov/centralbanks.htm
            • The Library Network List of Central Banks: http://jolis.worldbankimflib.org/Special/annualre.htm
            • Your local librar y
                                       Country: United States                              Country: Answer will vary
                                       Central Bank: Federal Reserve System                Central Bank: Answer will vary
        In what year was the central   1913                                                Answer will vary
        bank established?
        What factors contributed to    Bank panics were the main factor in the             Answers will vary depending on
        the formation of the central   United States that led to the creation of the       the country — however a common
        bank?                          Federal Reserve System in the U.S.                  answer will likely be the desire to
                                                                                           create a more stable economic and
                                                                                           banking environment.

        What are the central bank’s    Monetary Policy - involves managing the             Answers will vary depending on
        main functions?                nation’s money supply to keep inflation low         the country students are studying.
        Briefly explain how each       and the economy growing.
        works.                         Banking Supervision and Regulation —
                                       involves writing regulations and supervising
                                       and monitoring financial institutions to make
                                       sure they are safe, sound, and able to respond if
                                       faced with a financial crisis.
                                       Financial Services — meeting public demand
                                       for currency and coin, providing electronic
                                       payments, and serving as the “Banker’s Bank”
                                       by maintaining accounts for the U.S.Treasury.
        If monetary policy is one of   The Federal Reserve Act specifically states that    Answers will vary depending on
        the functions of the central   “in conducting monetary policy, the Federal         the country students are studying.
        bank,what are the stated       Reserve System and the Federal Open Market
        goals of monetary policy?      Committee should seek to ‘promote effectively
                                       the goals of maximum employment, stable
                                       prices, and moderate long-term interest rates.’”
                                       For more information see the Monetary Policy
                                       section of Purposes and Functions which is
                                       available at
                                       http://www.federalreserve.gov/pf/pf.htm.


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         Activity 2
TEACHER ANSWER KEY

         HOW DOES CENTRAL BANK INDEPENDENCE
         AFFECT INFLATION?
         Step 1:
INVESTIGATING THE INFLATION RATE
         What is inflation?
         Taken from the Fed 101 Lesson Plans: (Lesson 4)
              • Inflation is defined as a rise in the general level of prices over a sustained period of time.
              • Inflation can be caused by too many dollars chasing too few goods.
              • Inflation can be caused by increased costs of making and selling goods.

         Locate your country in Table 1 and calculate the simple average inflation rate between 1996
         and 1999.
         Use the following formula for the simple average:      (1996 Rate + 1997 Rate + 1998 Rate + 1999 Rate)
                                                                                        4
         For the U.S. the calculation is:                                      (3+2+2+2) = 2.25
                                                                                     4
         Although many countries try to limit inflation, some countries have consistently high
         inflation. Can you think of a reason for this?
         Many countries have high inflation rates because they use monetary policy to collect taxes. Inflation can be viewed as a
         tax because it reduces the purchasing power of those who hold currency. The government can influence the inflation rate
         by changing the rate at which money is printed and put into circulation.
         For more information see http://www1.worldbank.org/publicsector/tax/inflationtax.html
         Step 2:
INQUIRING ABOUT CENTRAL BANK INDEPENDENCE
         Compare and contrast the independence of your country’s central bank with that of the
         Federal Reserve System. Complete the table below using the data in Table 2 or other
         research information.
         1) The independence of your country’s central bank
         2) The independence of the Federal Reserve System
         Answers will vary depending on the country a student is studying. However, some commonalties among answers will
         likely be observed. For instance, a central bank’s independence can be judged by its actual legal charter;more
         independent banks will have price stability as their sole objective and a less independent bank may have to balance price
         stability among other objectives. Central bank governor turnover can also be a useful indicator of central bank
         independence. Longer terms, and less governor turnover, may indicate that the executive branch is less able to influence
         central bank policy decisions.




                                                               16
                 International Trade Central Banking       &
          Step 3:
PUTTING   IT   ALL TOGETHER
          Read the following two articles:
           Cogley,Timothy. “Why Central Bank Independence Helps to Mitigate Inflationary Bias.” Federal Reserve
           Bank of San Francisco Weekly Letter. Number 96—08. 23 Feb 1996.
           Available at http://www.frbsf.org/econrsrch/wklyltr/wl9608.html
           Parry, Robert T. “Central Bank Independence and Inflation.” Federal Reserve Bank of San Francisco
           Weekly Letter. Number 95—16. 21 Apr 1995.
           FOR MORE INFORMATION ON SMALL OPEN ECONOMIES: (optional)
           Dennis, Richard. “Monetary Policy and Exchange Rates in Small Open Economies.” Federal Reserve
           Bank of San Francisco Economic Letter, Number 01—16. 25 May 2001.
           Available at http://www.frbsf.org/publications/economics/letter/2001/el2001—16.html.


          Cogley states “...across countries, there appears to be an inverse relation between average inflation and the
          degree of central bank independence.” In other words, lower inflation rates typically appear in countries
          with higher levels of central bank independence.
          Given the evidence of inflation rates and independence levels in Steps 1 and 2 in the country you studied,
          do you agree with Cogley’s statement? Explain.
          Answers will vary depending on the country a student is studying. However, the most common answer will be
          agreement with Cogley’s statement that inflation and central bank independence are inversely related. Especially in
          developed countries, many studies have shown that a greater degree of independence will lead to lower inflation rates.




                                                              17
                 International Trade Central Banking       &
          Activity 3
STUDENT WORKSHEET

          HOW ARE CENTRAL BANKS INVOLVED                                                   IN THE
          INTERNATIONAL ECONOMY?
          Step 1:
USE THE INTERNET TO        LEARN ABOUT YOUR COUNTRY’S CURRENCY

          Use the OANDA Currency Converter (http://www.oanda.com/convert/classic)
          to complete the table below.
          Country Name                                Mexico (sample)—Student answers will vary depending on country
          Currency Name                               Mexican Peso
                                                      Today                        6 months ago            1 year ago
          Date                                        Nov. 18, 2002                June 18, 2002           Nov. 18, 2001
          Exchange rate between your                  1 U.S. Dollar =              1 U.S. Dollar =         1 U.S. Dollar =
          country’s currency and the                  10.2 Mexican Pesos           9.6 Mexican Pesos       9.2 Mexican Pesos
          U.S. Dollar
          (Example:
          1 U.S. Dollar = 10.3 Mexican Pesos)
          Over the last year, has YOUR country’s currency shown appreciation or depreciation compared to the
          U.S. Dollar? Explain.
          The Mexican Peso has depreciated compared to the U.S. dollar over the last year. In Nov. 2001, it cost 9.2 Mexican
          Pesos to buy one U.S. Dollar, and in Nov. 2002, it cost 10.2 Mexican Pesos to buy one U.S. Dollar.


          Step 2:
READ   ABOUT THE    FEDERAL RESERVE’S ROLE                IN THE INTERNATIONAL              ECONOMY
          Explain what is meant by the author’s statement:
          “Federal Reserve policies shape and get shaped by international developments.”
          Because the U.S. economy has become increasingly linked with economies around the world, it is logical that decisions
          made by the Federal Reserve System must take international developments into consideration. For example, a Federal
          Reserve policy decision to change interest may affect exchange rates between the U.S. Dollar and other currencies (see
          Step 3 of this activity for more information). In addition, economic developments in the rest of the world are considered
          by the Federal Open Market Committee when decisions on interest rates are made, as noted in the press releases.




                                                             18
              International Trade Central Banking        &
        Step 3:
RELATING CENTRAL BANK ACTIONS TO EXCHANGE RATES
        As you learned while reading “International Linkages,” even though U.S. monetary policy DOES NOT
        make policy decisions that target exchange rates, central bank actions can affect exchange rates.
        Complete the flow chart below with arrows to indicate the likely direction each item will move as a result
        of the given scenario, assuming all other economic conditions remained unchanged. The first box has
        been completed for you.
                                                           SCENARIO:
                                          The Federal Open Market Committee (FOMC)
                                              decides to lower U.S. interest rates.


                                                       Value of the U.S. Dollar




                          U.S. Price of Imported Goods                          Foreign Price of U.S. Goods
                                                                                   Traded Internationally




                                              What effect this could have on U.S
                                        Net Exports, otherwise known as the trade balance.
                                                 (Hint: Net Exports = Exports—Imports)




                     Could changes in export and                               Explain what effect this could have on
                    import prices and output affect                                        U.S. output.
                      the price level in the U.S.?                        (Hint: Output or GDP = Consumption + Investment +
                                                                                      Government + Net Exports)
                  Yes, U.S. price levels will likely rise.
                                                                              These developments would likely raise
                                                                             U.S. output. If imported goods are more
                                                                                expensive, U.S. manufacturers that
                                                                               are able to produce and sell goods at
                                                                                 lower prices may increase output.




                                                             19
              International Trade Central Banking   &
        Activity 4
STUDENT WORKSHEET

        WHAT’S NEW                 IN THE         WORLD        OF    CENTRAL BANKING?
        Part 1:
        Find a current newspaper article about or press release from the central bank in the Country you are
        studying. Summarize the three main points of the reading using the bullet points below. (Note: if you
        cannot find anything on your country’s central bank Web site or in a financial newspaper or magazine, try
        using the encyclopedia.)
        •
        •                     Answers will vary
        •
        Attach a copy of the article to this handout.
        Part 2:
        Find a current newspaper article about or press release from the Federal Reserve System. Summarize the
        three main points using the bullet points below.
        •
        •                     Answers will vary
        •
        Attach a copy of the article to this handout.




                                                        20
                    &
   International Trade Central Banking

STUDENT QUIZZES
• Activity 1
• Activity 2
• Activity 3
• Quiz Answer Key




                    21
     International Trade Central Banking &
Activity 1
STUDENT QUIZ
Student Name:                                        Country Studied:

             1) Which is a function of the Federal Reserve System?
                A—Managing the Payments System
                B—Monetary Policy
                C—Banking Supervision and Regulation
                D—All of the above are functions
                E—None of the above are functions
             2) What is the goal of monetary policy in the Federal Reserve System?
                A—Maximum employment
                B—Maintaining fixed exchange rates
                C—Maintaining stable prices
                D—Both A and C are correct
                E—A, B, and C are all correct
             3) The Federal Reserve System was created following a series of financial panics.
               True or False?
                A—True
                B—False
4) Name two similarities between the Federal Reserve System and the central bank in the
country you studied.




5) Name one difference between the Federal Reserve and the central bank in the country you
studied.




BONUS: Name one thing that led to the formation of a central bank in the country you
studied.




                                           22
     International Trade Central Banking    &
Activity 2
STUDENT QUIZ

Student Name:                                           Country Studied:

             1) Inflation                            (fill in the blank)                           .
                 A—would occur if the price of just one good or service increased.
                 B—involves the rise in the price of a “basket” of goods.
                 C—negatively affects people with fixed incomes.
                 D—Both A and C.
                 E—Both B and C.


             2) Some governments use a high rate of inflation to raise revenues. True or False?
                 A—True
                 B—False


             3) Explain your answer to Question 2 with one reason.




             4) Moneyland reported the inflation rates shown in the table below. Compute the
                average inflation rate during the 1996 and 2000. Show your work.
             Year             Inflation Rate
             1996             5.0 percent
             1997             3.3 percent
             1998             1.7 percent
             1999             1.5 percent
             2000             1.8 percent                        Answer:
             5) Which of the following WOULD affect central bank independence?
                     A—The government selects the central bank governor and board members.
                     B—Government officials are members of the central bank board.
                     C—Term limits of central bank governors coincide with government officials.
                     D—All of the above.
                     E—None of the above.


                                               23
     International Trade Central Banking &
Activity 3
STUDENT QUIZ
Student Name:                                         Country Studied:
             1) When a foreign currency depreciates against the U.S. Dollar it takes more of
                that currency to buy the same amount of dollars. True or False?
                A—True
                B—False
             2) Federal Reserve System monetary policy decisions can have an impact on other
                countries. True or False?
             A—True
             B—False
             3) Which of the following international factors might be cited by the Federal
                Open Market Committee (FOMC) as a reason for a change in the interest rate
                on federal funds, the primary tool of monetary policy?
                A—Weakness in foreign economies
                B—Adding new members to the European Union
                C—Heightened geopolitical risks
                D—Both A and C are correct
                E—All of the above are correct
             4) An increase in the value of the U.S. dollar should have which of the
                following effects?
                A—Price of goods imported to the U.S. will fall
                B—Price of U.S. goods sold internationally will increase
                C—Net exports (Exports—Imports) will decline, U.S. trade balance will worsen
                D—All of the above are correct
                E—None of the above are correct
             5) When formulating monetary policy, the Fed considers which of the following?
                A—U.S. domestic conditions
                B—International conditions
                C—Movements in exchange rates
                D—All of the above
                E—Only A and C
             BONUS: Higher prices for imported goods may affect the overall price level
             (or the inflation rate). True or False?
                A—True
                B—False
                                             24
               International Trade Central Banking&
        QUIZ ANSWER KEY
        Activity 1
STUDENT QUIZ
        1—D
        2—D
        3—A
        4—Answers will vary
        5—Answers will vary
        BONUS—Answers will vary


        Activity 2
STUDENT QUIZ
        1—E
        2—A
        3—Many countries have high inflation rates because they use monetary policy to collect taxes. Inflation is
        viewed as a tax because it reduces the purchasing power of those in the country that hold currency. The
        government can influence the inflation rate by changing the rate at which money is printed and put into
        circulation.
        4—2.66
        5—D


        Activity 3
STUDENT QUIZ
        1—A
        2—A
        3—D
        4—D
        5—D
        BONUS—A




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