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PSU ECON 104 - Housing Bubble and The Fed

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Econ 104 1st Edition Lecture 24Outline of Last Lecture I. Shifts in SRASII. Sticky PricesIII. Stagflation IV. Antioxidant and redox regulation of gene transcription Outline of Current Lecture II. Housing Bubble III. Great Recession IV. Money vs. BarterV. Balance Sheet of a Bank VI. Simple Deposit Multiplier VII. Federal Reserve Current LectureI. 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 II. 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’si. Lenders: Banks can no longer sell mortgages ii. Wall Street: Investment banks can no longer sell CDO’siii. 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.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 III. 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 markettransactions 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 PPFIV. Money a. Money = M1i. Coin and currency, checkable deposits, and traveler’s checksb. How do banks create money i. Accept deposits and make loans ii. This in turn increases checking account deposits (increases M1)V. Balance sheet of a bank a. Assetsi. 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 RRii. 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 = 1002. ER: 9003. Deposits = 1,000ii. Suppose BOA makes a loan to Sally who wants to buy a used car for $9001. BOA writes Sally a check for $900 which she deposits at BOAa. BOA has increased the money supply by $900iii. Sally writes a check to Toyota; Toyota deposits the check at its account at PNC bank; Sally’s account and BOA reserves decrease by 9001. 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 increasein m1 = 900 + 810 = 1710 a. This process continues when 1000=RR and ER=0VI. 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 BOA1. (1000 X (1/.10) = 10,0002. With rr = .10 the increase in M1 is 10 times the initial increase in reserves VII. 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 VIII. 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 IX. 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 Booma. The Fed decreases the money supply with an Open Marketsales (OMS) of treasury securities to the public (In the bond


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