Counter Cyclical Policies

Structure of the Federal Reserve System

The US Central Bank

The System was created in 1913

Board of Governors runs the system with an appointed Chairman

          The chairman is appointed by the President, approved by the Senate

          This is currently Janet Yellen

          Famous prior Chairmen:  Paul Volcker, Alan Greenspan, Ben Bernanke

12 Fed Banks control Fed actions and currency distribution in their regions:

          A = Boston

          B = New York City

          C = Philadelphia

          D = Cleveland

          E = Richmond

          F = Atlanta

          G = Chicago

          H = St. Louis

          I  = Minneapolis

          J  = Kansas City

          K = Dallas

          L = San Francisco

         

The Federal Open Market Committee (FOMC) or (OMC) is in charge

          of the buying and selling of Fed Bonds…

          BB = BB (The Fed Buys Bonds to create Big Bucks = More Money Supply)    

          SB = SB (The Fed Sells Bonds to create Small Bucks = Less Money Supply)

The Federal Deposit Insurance Corporation (FDIC) has members of most banks in   

          the US and helps manage operations of member banks.  It also insures

          deposits of the private sector that are place in the banks

The Fed has many “tools” to help run the US banking and money supply systems.

          The main tools are the:

The buying and selling of Bonds
          The Fed Fund Rate Target

          The Discount Rate

          The Reserve Requirement

Interest Rate Basics

Fed Funds Rate

          FDIC member banks loan each other overnight funds in order

          to balance deposit accounts each day.  The interest rate they

          use to loan each other this money is the Fed Fund Rate.

          The Federal Reserve "targets" this rate by suggesting its

          raising or lowering and uses bonds to accomplish the targets.

          The Federal Reserve measures the rate in "basis points".

          100 basis points = 1%.

Discount Rate

          FDIC member banks, and other eligible institutions, may borrow

          short term loans directly from the Federal Reserve.  This is

          the "discount window", and is set above the Fed Fund Rate.

          Banks do not like to use the window, since it appears to be

          a move of "last resort" to have to turn to the federal government

          for loan funds.  The FOMC sets the Discount Rate.

Prime Rate

          This is the interest rate banks charge their most "credit

          worthy" borrowers.  Historically, the prime rate, in the US,

          has been set about 3% above the Fed Fund Rate.

                  

Private Rates

          These loan rates are set by supply and demand, the abilities

          of companies to loan out private monies, and subsidized

          federal monies.  Examples would include car companies

          "selling" "zero interest" loans, special student rate loans, etc.

          When companies use these tactics, they hope to regain

          profit with time limits to the special rates, less bargaining on

          the overall product price, heavy late payment fees, etc.

          Any rate below the Fed Fund Rate probably has some kind

          of financial trick attached to the contract.

Countercyclical Fiscal Policies

Domestic US Market:

Always conducted by Congress

Fighting a Recession:	Fighting Inflation:
Policy Name = Expansionary	Policy Name = Contractionary
Taxes = Cut	Taxes = Raise
Gov. Spending = Increase	Gov. Spending = Decrease
Budget Result = Deficit	Budget Result = Surplus
Aggregate Model:	Aggregate Model:
C should = increase	C should = decrease
G should = increase	G should = decrease
AD should = increase	AD should = decrease
Money Market:	Money Market:
DM will= increase	DM will= decrease
i should = increase	i should= decrease
(Ig on Aggregate Model will)= decrease	(Ig on Aggregate Model will)= increase
Loanable Funds…Market:	Loanable Funds…Market:
The budget issue will cause: deficit	The budget issue will cause: surplus
S LF = decrease	S LF = increase
DLF = increase	DLF = decrease

Connections: Countercyclical Monetary Policies

Domestic US Market

Always conducted by Federal Reserve (Central Bank)

Fighting a Recession:	Fighting Inflation:
Name = Easy Money or Expansion.	Name = Tight Money or Contract.
Bonds = Buy (Big Bucks)	Bonds = Sell (Small Bucks)
FFR Target = lower	FFR Target = raise
DR = lower	DR = raise
RR = lower	RR = increase
Money Market/Loanable Funds:	Money Market/Loanable Funds:
MS should = increase	MS should = decrease
Bank Loans = increase	Bank Loans = decrease
i, r should = decrease	i, r should = increase
Aggregate Model:	Aggregate Model:
Ig should = increase	Ig should = decrease
AD should = increase	AD should = decrease

Crowding Out

What is it?	A critique and flaw of Keynesian  policies that are applied to fight a recession. (An expansionary policy!)
Why does it happen?	The policy of cutting Taxes and raising Spending will create a budget deficit.
So?	The budget deficit must be funded and to do this Congress orders the sale of US bonds. (This is NOT a Monetary Policy tool used by the Fed)
Where does this money comes from?	Mostly from US citizens and companies and investment firms. (Some from foreign countries)
Therefore?	Money that could be spent on Consumption or used for Private Savings is now being used to buy   bonds.
On the Money Market?	This will cause the Money Demand curve to shift outward.  Remember this is a Fiscal event!
On the Loanable Funds Market?	This will cause the Supply  curve to shift inward  because we are not Saving money privately any more.
Also, on the Loanable Funds ?	This can cause the Demand  curve to shift outward    because the private and public demand for $ increases_.
On both graphs?	The nominal and real interest rate will increase.
Therefore, on the Investment D graph	The increase in nominal and real interest   rates will cause Ig to decrease.
Isn’t this counterproductive?	Yes.
Why do it?	Fiscal Policy supporters (Keynesians) insist that gains in C  and G  will outweigh any loss in future Ig.
Why?	C and G are greater than Ig and they are Short Run improvements.  Ig is longer run and Keynesians don’t worry about that.  In the long run we are all dead.
Anymore?	Yes, this is summarized on the Aggregate Model.  The AD will move outward due to the increases in C and G and then “maybe” move inward due to a loss of Ig, but not as much as the increase.  Therefore the economy improves.

Crowding Out

What is it?	A critique and flaw of Keynesian  policies that are applied to fight a recession. (An expansionary policy!)
Why does it happen?	The policy of cutting Taxes and raising Spending will create a budget deficit.
So?	The budget deficit must be funded and to do this Congress orders the sale of US bonds. (This is NOT a Monetary Policy tool used by the Fed)
Where does this money comes from?	Mostly from US citizens and companies and investment firms. (Some from foreign countries)
Therefore?	Money that could be spent on Consumption or used for Private Savings is now being used to buy   bonds.
On the Money Market?	This will cause the Money Demand curve to shift outward.  Remember this is a Fiscal event!
On the Loanable Funds Market?	This will cause the Supply  curve to shift inward  because we are not Saving money privately any more.
Also, on the Loanable Funds ?	This can cause the Demand  curve to shift outward    because the private and public demand for $ increases_.
On both graphs?	The nominal and real interest rate will increase.
Therefore, on the Investment D graph	The increase in nominal and real interest   rates will cause Ig to decrease.
Isn’t this counterproductive?	Yes.
Why do it?	Fiscal Policy supporters (Keynesians) insist that gains in C  and G  will outweigh any loss in future Ig.
Why?	C and G are greater than Ig and they are Short Run improvements.  Ig is longer run and Keynesians don’t worry about that.  In the long run we are all dead.
Anymore?	Yes, this is summarized on the Aggregate Model.  The AD will move outward due to the increases in C and G and then “maybe” move inward due to a loss of Ig, but not as much as the increase.  Therefore the economy improves.