Introduction to Economics
Macroeconomics
The US Economy
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Outline: Lecture Nine

Macroeconomic Policy
 Monetary

Policy
Review of Macro: O’Sullivan and Sheffrin
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How Effective Has the Fed Been?

Fed Goals: A Stable Economy
 maximum
employment
 stable prices
 moderate long-term interest rates

Fed Objectives or Targets
 quantity
of reserves
 price of reserves: Federal Funds Rate
 federal
funds rate, FFR, is the interest rate banks
charge one another for borrowing reserves for a day
or so; mostly large urban banks borrowing from
small suburban and rural banks
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Monetary Policy Tradeoff
Is the Fed too Inflation Oriented?
 Note: the CPI inflation rate tends to
decrease during and after recessions

 to
control inflation, the Fed may be tempted
into policies that precipitate recessions and/or
make them more severe

Note: the unemployment rate tends to
increase during and after recessions
 some
critics in Congress think the Fed is too
restrictive, i.e. not sufficiently expansionary in
policy
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How Effective Has the Fed Been?
 Fed
Objectives or Targets
quantity
of reserves
price of reserves: Federal Funds Rate
 federal
funds rate, FFR, is the interest rate
banks charge one another for borrowing
reserves for a day or so; mostly large urban
banks borrowing from small suburban and
rural banks
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Impact of the Supply of Reserves
on the Federal Funds Rate
FFR,
price of
reserves
Demand for Reserves by Banks
Supply of Reserves: Fed
quantity of reserves
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Impact of the Supply of Reserves
on the Federal Funds Rate
FFR,
price of
reserves
Demand for Reserves by Banks
Supply of Reserves: Fed
quantity of reserves
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Fed Policy Target: Quantity of Reserves
70000
60000
50000
Millions
40000
30000
20000
10000
60
65
70
75
80
85
90
95
http://www.bog.frb.fed.us/releases/H3/hist/h3hist1.txt
Total Reserves, 1959.01-1997.07
Fed Policy Target: Price of Reserves
20
15
10
5
0
55
60
65
70
75
80
85
90
Federal Funds Rate, 54.07-97.05
95
Observed Decline of the Nominal
FFR During Recesssions

During a recession, the Fed should be
following an expansionary monetary policy,
buying Treasuries, and expanding reserves
 the
increased supply of reserves should tend to
decrease the price of reserves, i.e. the FFR
During a recession, the inflation rate falls,
and consequently, so will the nominal
Federal Funds Rate
 Difficult to distinguish these two effects

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Other Measures of Fed Effectiveness

Reserve Aggregates
 Excess
Reserves
 Free Reserves
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Consumers, Firms, Banks, and the Fed Determine Reserve Aggregates
Banks
Banks
Fed
Deposits with Fed
Loans from Fed, OMO
x
+
Bank Vault Cash
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Fed
Reserve ratios
=
=
Total Reserves
Consumers
Businesses
Bank Deposits
-
Required Reserves
=
Excess
Reserves
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Fed Policy Record, 48.01-97.07
10000
8000
6000
4000
2000
0
50
Source: Survey
of Current Business,
January, 1995
55
60
65
Fed Loans
70
75
80
85
90
Excess Reserves
95
Fed Monetary Policy:
Insufficient Excess Reserves?

Expansionary Policy
 ease
credit
 provide positive free reserves

Contractionary Policy
 tighten
credit
 force banks to borrow at discount window,
causing negative free reserves
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Bank Reserve Aggregates, 10-21-98
Total Reserves( cash in Bank Vaults
& Deposits with Fed)
Nonborrowed Reserves
$43.9 B
Required Reserves
$42.6 B
Excess Reserves*
$1.3 B
Free Reserves**
$1.1 B
$43.7 B
* Excess Reserves = Total Reserves - Required Reserves
** Free Reserves = Excess Reserves - Borrowed Reserves
Source: TheWall Street Journal, Friday 8-22-97, p.C 18
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Fed Policy Record, 48.01-97.07
10000
8000
6000
4000
2000
0
50
Source: Survey
of Current Business,
January, 1995
55
60
65
Fed Loans
70
75
80
85
90
Excess Reserves
95
Fed Policy: 48.01-97.07
2000
0
-2000
-4000
-6000
-8000
50
55
60
65
70
75
80
Free Reserves
85
90
95
Fed Loans of Reserves to Banks
Before each recession, Fed loans peak and
exceed excess reserves
 As a consequence, free reserves are negative
before each recession

 recall:
free reserves = excess reserves - Fed loans
 negative free reserves are called “net borrowed
reserves”
 they
are an index of the Fed trying to tighten credit
 evidently the Fed was tightening credit sufficiently to
contribute to the recession

Note: Fed keeps excess reserves low during
inflationary 70’s; opposite policy in the 90’s
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US Postwar Expansions
Trough - Peak
Oct. ‘45 - Nov. ‘48
Oct. ‘49 - July ‘53
May ‘54 - Aug. ‘57
April ‘58 - April ‘60
Feb. ‘61 - Dec. ‘69
Nov. 70 - Nov. ‘73
March ‘75 - Jan. ‘80
July’80 - July ‘81
Nov. ‘82 - July ‘90
March ‘91 - ?
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Duration, Months
37
45
39
24
106
36
58
12
92
?, 77+ 90
21
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Midterm Review

O’Sullivan and Sheffrin
 Ch.
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20: The Big Ideas in Macro
Measuring the Output of the Economy
 Unemployment
 Inflation
 Keynesian Economics: Controlling the
Business Cycle

 booms
can lead to inflation
 recessions can lead to unemployment
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21: Behind the Economic Statistics

Expenditure Perspective: GDP
 Consumption
 Gross
Private Investment
 Government Purchases
 Net Exports
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Review Part II: Chapter Three

Conceptual Framework: Circular Flow
Firms
Income
Firms
Labor
Supply
Goods
Demand
Goods
Households
Households
Income Perspective
Expenditure Perspective
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Expenditure Perspective: Open
Firms
Exports
(Sales)
Supply
Goods
Demand
Goods
Imports
(puchases)
Households
Government
Households: Consumption of Goods and Services
Firms: Investment in Plant and Equipment
Government: Purchase of Goods and Services
All Three: Exports - Imports = Net Exports
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21: Behind the Economic Statistics

Is a recession coming?
 how
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would you figure that out?
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21: Behind the Economic Statistics

Expenditure Perspective: GDP
 Consumption
 Gross
Private Investment
 Government Purchases
 Net Exports

Inflation
 what
is it?
 how do we measure it?
 why is it a problem?
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Source: Yardeni’s Economics Network, http://www.yardeni.com/
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21: Behind the Economic Statistics

Expenditure Perspective: GDP
 Consumption
 Gross
Private Investment
 Government Purchases
 Net Exports

Inflation
 what
is it?
 how do we measure it?
 why is it a problem?

Unemployment
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Unemployed Persons, Millions, 1929-1997
.
14
1933 trough
1982 trough
12
1938 trough
1991 trough
8
6
4
2
1945 trough
Year
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97
93
89
85
81
77
73
69
65
61
57
53
49
45
41
37
33
0
29
Millions
10
24: Coordinating Economic Activity
If nominal GDP grows faster than real GDP,
what happens?
 If real GDP stops growing or declines, what
happens?

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25: Keynesian Economics and Fiscal Policy
The Keynesian Cross
 The Basic Ideas

 GDP =
National Income (equilibrium)
 equilibrium GDP can differ from full
employment GDP

What Should We Do IF We Slip Into
Depression?
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Less than Full Employment Equilibrium
Consumption, C
GDP = C + I
Investment, I
GDP
C = C0 + mpc* Y
I
450
GDP = Y
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Full Employment Income
YFE
Income, Y
35
27: Money, the Banking System
and the Federal Reserve
What is money?
 Why are banking systems unstable?
 Why do we need a central bank?
 What is monetary policy?

 goals
 objectives
 tools
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The Functions of Money

medium of exchange
 instead
of barter, i.e. exchange of goods &
services for goods and services, we can
exchange goods & services for money and vice
versa
 eliminates
the search costs & inconvenience of
barter

store of value
 we
can hold money as an asset
 because
it is a medium of exchange, it is liquid, i.e.
we can convert money into goods & assets quickly

unit of account
measure of value, “ a dollar’s worth of ...”

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Definitions of Money

M1(a measure of media of exchange) =
 currency
held by the public, outside of banks
 checkable deposits
 demand
deposits
 NOW (negotiable order of withdrawal) accounts
• savings & loans, mutual savings banks
 traveler’s

checks
M2 = M1 +
 money
market accounts at banks
 money market mutual fund accounts
 certificates of deposit, CD’s, less than $100,000

M3 = M2 + CD’s over $100,000
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