Econ 104 1st Edition Lecture 24 Outline of Last Lecture I Shifts in SRAS II Sticky Prices III Stagflation IV Antioxidant and redox regulation of gene transcription Outline of Current Lecture II Housing Bubble III Great Recession IV Money vs Barter V Balance Sheet of a Bank VI Simple Deposit Multiplier VII Federal Reserve Current Lecture I II The Housing Bubble Prior to Financial Crisis and Great Recession a Low interest rates resulted in an increase in spending on housing i The excess demand for housing led to an increase in home prices 1 Some consumers bought houses to flip a Buy low sell high The Housing Bubble bursts a As more and more homeowners defaulted on their mortgages home prices plummeted and investors were no longer interested in buying CDO s i Lenders Banks can no longer sell mortgages ii Wall Street Investment banks can no longer sell CDO s iii Investors investors no longer want to buy CDO s iv Foreclosures banks would try to sell the homes but no one would buy v Everyone was going bankrupt b This all led to a financial system freeze up i The financial crisis led to a credit crunch 1 Banks became hesitant to lend to households and businesses who wanted to borrow a Result consumption investment and AD fell dramatically These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute III IV V c Impact of financial crisis on the US economy i Credit crunch banks hesitant to lend supply of loanable funds shifts left increase in r ii Dodd Frank Act 2010 Households and businesses have difficulty obtaining loans decline in C and I iii Decline in Household wealth decline in C 1 Real estate wealth 7 trillion decline 2 Stock market wealth 7 trillion decline Money versus barter a Barter economy where goods and services are traded directly i Requires a double coincidence of wants ii Very time consuming b Trading is much easier when money becomes available i The use of money simplifies and therefore increase the number of market transactions 1 People sell what they want in exchange for money to buy what they want 2 Money promotes economic growth by increasing the nation s PPF Money a Money M1 i Coin and currency checkable deposits and traveler s checks b How do banks create money i Accept deposits and make loans ii This in turn increases checking account deposits increases M1 Balance sheet of a bank a Assets i Reserves deposits that a bank has not loaned out consist of 1 Required Reserves RR banks must hold 10 of check account deposits 2 Excess Reserves ER any reserves held by banks that are not RR ii Loans to households and businesses 1 Mortgage education auto etc 2 Loans are assets because they earn interest b Liabilities i Deposits include households and business checks and savings accounts c Example i Suppose you deposit 1 000 in your checking account at Bank of America BOA 1 RR 1 000 X 10 100 2 ER 900 3 Deposits 1 000 ii Suppose BOA makes a loan to Sally who wants to buy a used car for 900 1 BOA writes Sally a check for 900 which she deposits at BOA VI VII VIII IX a BOA has increased the money supply by 900 iii Sally writes a check to Toyota Toyota deposits the check at its account at PNC bank Sally s account and BOA reserves decrease by 900 1 BOA is all loaned up iv PNC must keep 90 in RR and will lend out 810 in ER and creates new deposits of 810 1 The initial increase of 1000 in the deposits resulted in an increase in m1 900 810 1710 a This process continues when 1000 RR and ER 0 The Simple Deposit Multiplier a Total change checking account deposits change in reserves 1 rr i Where 1 rr is the simple deposit multiplier b Example i 1000 was initially deposited in BOA 1 1000 X 1 10 10 000 2 With rr 10 the increase in M1 is 10 times the initial increase in reserves The Federal Reserve The Fed and Monetary Policy a Is the central bank of the US b Was created by Congress in 1913 Federal Reserve Act i Totally independent of the congress and the President ii Does not have to go to Congress for funding c One of the Fed s major responsibilities is monetary policy The FOMC manages the nation s money supply to conduct monetary policy d The FOMC only as 12 members The Goals of Monetary Policy a Price stability low inflation b High employment U U bar c Stability of financial markets and institutions i To promote the efficient flow of funds from savers to borrowers d Economic growth How does the Fed change money supply a The FOMC engineers Open Market Operations OMO i The buying and selling US Treasury securities bonds to control the money supply 1 Case 1 Recession a The Fed increases the money supply with an Open Market purchase OMP of Treasury securities from the public in the Bond Market 2 Case 2 Inflationary Boom a The Fed decreases the money supply with an Open Market sales OMS of treasury securities to the public In the bond market