The Federal Reserve

Goals & Challenges

MONEY

• Money- anything used to facilitate the exchange of goods & services between buyers and sellers

2 Kinds of Money

• Commodity money takes the form of a commodity with intrinsic value– Examples: Gold, silver, cigarettes

• Fiat money is used because of Government decree– It does not have intrinsic value– Examples: Coins, currency, check deposits

– U.S. money was backed by gold until 1971

Money Supply

• Total amount of money in circulation

• Federal Reserve “controls” size of the money supply– U.S. uses fiat currency

• Changing the money supply directly affects short term interest rates and future inflation

• Rapidly ↑ Money Supply leads to high inflation

The Federal Reserve

• Central Bank of the United States– Independent from Government

• 2 Primary goals: – #1- Maximum Output & Employment– #2- Stable Prices

• Federal Reserve’s regulates the Money Supply– This is how they change short term interest rates (federal funds rate)

Ben Bernanke Chairman

2 Conflicting Goals?

Maximum output & employment

(High GDP & Low Unemployment)

Stable Prices(low inflation)

What makes these 2-Goals in direct conflict?

High GDP & Low Unemployment (goal #1) increase inflationary pressures (hurts goal #2)

Federal Open Market Committee (FOMC)

• Main policy-making part of Federal Reserve (12 members)– Meets 8-times to vote on Monetary Policy

– Their job is to regulate the money supply