UNIT 4 . Financial Sector (15–20%)
Textbook chapter 13,14,15




IV. Financial Sector [10-20% of AP Exam]
A. Money, banking, and financial markets [7-15%]
1. Definition of financial assets: money, stocks, and bonds
2. Time value of money
3. Measures of money supply
4. Banks and creation of money
5. Money demand
6. Money market
7. Loanable funds market
B. Central bank and control of the money supply [3-5%]
1. Tools of central bank policy
2. Quantity theory of money
3. Real versus nominal interest rates

WATCH THIS
http://www.youtube.com/watch?v=iYZM58dulPE&feature=related
http://www.youtube.com/watch?v=mII9NZ8MMVM

INTERESTING PART 1-5
http://www.youtube.com/watch?v=vVkFb26u9g8&feature=fvw

US Debt
http://www.youtube.com/watch?v=Jjv-MtGpj2U&feature=watch-vrec

History of Money
http://www.youtube.com/watch?v=D0IJCGuNtqk


EXAM HINT
When I look over the AP exams, the loanable funds market undergoes changes when there's more or less saving, more or less government borrowing, or more or less foreign investment. I don't see questions in which a change in the money supply is connected to a change in loanable funds. Rather, *any* change in the interest rate on either graph is usually connected to a change in interest-sensitive spending (which changes AD, which then changes price/output, which can then affect inflation/unemployment) or a change in firms' ability to borrow money for investment (which connects to capital stock, which then influences AS/LRAS/PPC/long-run growth).
If I did get a question that asked first for a change in the money supply and then an impact on loanable funds, I would connect the money supply to the supply of loanable funds, as the interest rate changes would correspond to each other. I would not expect a change on a LF graph to lead to a change on the MS graph.

With that in mind, your presenter is correct to a large degree. The AP exam does not like to deal with "could be" but rather with "will be". Reasoning on the FRQs is direct, and complete in a few steps. Connecting from MS changes to LF changes could involve too many steps for the level of reasoning students are typically asked to do. I tend to fight more battles against overthinking questions, and making a connection between MS and LF would lend itself to encouraging overthinking, in my opinion.

" When the Fed sells bonds, the banks are loaning money to the USG". USG = United States Govgernment.
When the Fed sells a bond, it is on the open market, on the bond market, and the purchaser is exchanging cash, a liquid asset which pays zero interest, for a bond which is a contract between the original issuer (used to be almost exclusively US Government bonds that the Fed bought and sold, no longer as true) and the entity in possession of the bond. This bond pays interest (likely) in part because it is not as liquid as cash. But the cash did nott go to the USG, it went to the Fed.
Going back to how the Fed got the bond...If the Fed has a USG bond in its possession, the Fed didn't necessarily lend the money to the USG by buying the bond. They bought the bond on the open market which consists of newly issued bonds and bonds up for resale by their current owners. So there is no guaratee that the Fed bought it directly from the USG (Treasury). If the Fed or anyone else bought their bond directly from the Fed, then Yes, they are lending money to the USG.
Once the Fed has this USG bond and the Fed decides to resell it. Who ever buys it is no longer the lender to the USG. They are buying an asset from the Fed, and cash is exchanged from the buyer to the seller, which is not the USG. ( The Fed is not considered the USG for intro macro purposes)
Think of this situation. GM issues stock. This is a newly approved issuance of stock, it has never been owned before. Who ever buys that stock (most likely a brokerage house who then plans to resell it at a modest profit to clients) is sending their purchase price dollars to GM. Once the stock is out, issued, when ever it is traded cash goes to the seller of the stock, and the stock goes to the buyer of the share. GM gets nothing from the secondary market for its securities. (Well nothing is an exaggeration. If their stock goes up, people feel good about the company and that may cause increased sales

To understand how monetary policy works, students must understand the definitions of both the money
supply and money demand and the factors that affect each of them. Here the course introduces students
to the definition of money and other financial assets such as bonds and stocks, the time value of money,
measures of the money supply, fractional reserve banking, and the Federal Reserve System.
In presenting the money supply, it is important to introduce the process of multiple-deposit expansion,
and money creation using T-accounts, and the use of the money multiplier. In learning about monetary policy,
it is important to define money demand and examine its determinants. Having completed the study of
money supply and money demand , the course should proceed to investigate how equilibrium in the
money market determines the equilibrium interest rate,how the investment demand curve provides
the link between changes in the money market and changes in aggregate demand, and how changes
in aggregate demand affect the money market. Students should have an understanding
of financial markets and the working of the loanable-funds market in determining the real interest rate.
It is alsoimportant that students develop a clear understanding of the differences between the
money market and the loanable funds market.Having an understanding of the financial markets
, students should identify and examine the tools of central bank policy and their impacts
on the money supply and interest rate. Students should understand the distinction between
nominal and real interest rate. Students should also be introduced to the quantity theory
of money, and examine and understand the effect of monetary policy on real output, price level, and economic growth.






Learning Outcomes
  1. Define and list factors influencing money demand
  2. Define money supply and other financial assets
  3. Demonstrate understanding of the time value of money
  4. Define a fractional banking system
  5. Explain the role of the Federal Reserve System in the economy
  6. Identify and examine the tools of central bank policy and their impact on money supply and interest rates
  7. Describe the process of money creation and multiple-deposit expansion
  8. Given data, determine the size of the money multiplier and assess its impact on the money supply
  9. Distinguish between nominal and real interest rates
  10. Define the quantity theory of money







HOMEWORK

APE POWER POINT PROJECT 50 points (groups of 2 ok )
-John Maynard Keynes is doubtlessly one the most important figures in the entire history of economics.
- Research why this statement is said about Keynes, why was his work so influential?
- How does the work of Keynes influence Aggregate Demand and Supply?
- Is there any controversy over his work by modern economists?
-Outline the main points from Keynesian economics
-What is the “Keynesian model” include graph



ASSIGNMNET1
http://128.241.192.223/uploads/APMacroUnits34.pdf
i will print these for you



ASSIGNMNET 2
FEDREAL RESERVE SYSTEM
http://www.youtube.com/watch?v=Kj9-kRv0e6s&feature=player_embedded#!
http://www.youtube.com/watch?v=VBRZYrblZ24&feature=related


Directions: Go to the Fed 101 Website ( //http://www.federalreserveeducation.org/fed101/index.htm// ) and answer the following questions.

History

1. Who was allowed to issue paper money during the 1800’s?

2. Why did some people lose faith in the banking system before the Federal Reserve System was in place?

3. When was the Federal Reserve Act passed, and which U.S. President signed it into law?

Structure

4. Why is the Fed considered a decentralized central bank that is both public and private?

5. What are the “checks and balances” in place when a Fed governor is appointed to the board?

6. What are the three primary roles of the 12 Federal Reserve Banks?

Monetary Policy

7. What is the primary focus of monetary policy?

8. What decision does the Federal Open Market Committee (FOMC) make when it meets?

9. What economic conditions may lead to inflation?

Bank Supervision

10. Who establishes laws that govern the supervision and regulation of banking institutions that operate in the U.S.?

11. Why does the Fed attempt to make banks both safe and sound?

12. What are Fed bank examiners looking for when they examine a bank?

Financial Services

13. What is the Fed’s role in the U.S. payments system?

14. Why is the Fed considered a banker’s bank?

15. Why is the Fed considered the government’s bank?

Fed Today

16. What is the Fed’s mission?

17. What changes have taken place to allow the Fed to process billions of transactions per year?

18. Why are other central banks interested in how the Fed operates?






WEB RESOURCES
1) http://welkerswikinomics.com/downloads/Unit%203.4%20Demand%20and%20Supply%20Side%20Policies.pdf
2) http://www.phxcentralhigh.org/education/sctemp/4fe0349561420fa2280a3bebf7f3c357/1257268350/AP_Macro_Unit_4_Notes_PDF.pdf

3) http://welkerswikinomics.wetpaint.com/page/Macroeconomics+Unit+III+-+The+Financial+Sector

4) So you want to be the chairman of the FED Game http://www.frbsf.org/education/activities/chairman/

5) Shows many indicators graphically - good site
http://bullandbearwise.com/FedFundsChart.asp








APE CHAPTER 11 INCOME & EXPENDITURE
1)Households are constantly confronted with consumer choices-including how much to spend- this has a powerful effect on the economy as consumer consumption accounts for 2/3 of total spending on final goods and services- thus changes in consumer spending can produces significant shifts of the curve. Explain why this is so critical…………………………………………………………………………................
…………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………..
2)Explain the relationship between current disposable income and spending……………………………...
……………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………
2) Define the consumption function .…………….................................................................................
3) Write out the simple version of the CF………………………………………………………………...........
4) Rewrite the CF to include individual households…………………………………………………………...
5) Since MPC is defined as external image clip_image002.pngc/external image clip_image004.pngyd, the slope of the CF is.................................................................
6) In reality, actual data never fits the equation perfectly, why………………………………………………
7) In macroeconomics there is a relationship that holds true for the economy as a whole called the aggregate consumption function, which shows the relationship between…………………………………
………………………………………………………………………………………We assume it has the same form as the household-level consumption function C=A+MPC ´YD, write out the meaning for each symbol
C=……………………………………………….. YD=…………………………………… A=…………………………………………………………. CF analogous to ……………………………………
8) What is the life-cycle hypothesis?..................................................................................................
9) Swings in investment spending (IS) are much more dramatic than those in consumer spending look at fig11-6 to see this
10) The most important factors that effect IS are ……………………………&..................................
11) Planned investment spending is …………………………………………………………………....
12) The three principle that determine the level of IS are………………………………………………………
13) In the loanable funds market show a match between potential lenders-households- that are deciding whether to spend (consumption) of lend out their disposable income (interest). The supply of the loanable funds is ……………………… sloping because………………………………………………….
………………………………….. On the other side firms must decided whether to borrow and the demand curve for the loanable funds slopes……………………….. because…………………………………
……………………………………………………………Firm face a trade-off, as they must decide to use past profits or new loans to fund projects. If they choose to use past profits it is called………………………...................
14) There is a negative relationship between interest rates and planned investment spending why is this the case……………………………………………………………………………………………..
15) Suppose a firm has enough capacity to continue to produce the amount it is currently selling but doesn’t expect its sales to grow in the future. Then it will only engage in IS ……………………………..
…………………………………………………………..If, however, the firm expects rapid grow in the future it will undertake IS …………………………………………………………………………………………. We can see another negative relationship here between current level of capacity and investment spending which is ………………………………………………………………………………………………
16) Define Inventory…………………………………………………
Unplanned inventory investment…………………….
Actual investment spending…………………………………………………………………………………
17) Underlying assumptions of the multiplier are 1)……………………………………
2)....................................................................................................
3)…………………………………………….........................................
4)……………………………………………………………….................
19) In an economy with no government & no foreign trade there are only 2 sources of AD
a)……………………………. b)………………………… therefore GDP= C+I and YD=GDP.
20) The aggregate consumption function shows the relationship between disposable income (YD) and consumer spending and is shown by C=A+MPC´YD. We now add planned aggregate spending, which is the ………………………………………. Households, unlike firms, don’t take unintended actions so planned aggregate spending is equal to …………………………………………………………………….. (AE=C+I). The level of planned aggregate spending in a given year depends upon the level of real ………………………..................................................................................................................
21) Planned aggregate spending can be different to from real GDP only if there is unplanned inventory investment in the economy. Look at Table 11-2 to understand this.
22) The general relationship among real GDP, planned aggregate spending, and unplanned inventory investment is GDP=C+I OR we could expand this out to GDP= C +I (planned &unplanned investment) and GDP= AE planned + I unplanned.
23) The economy is in income-expenditure equilibrium when…………………………………………...
24) Income-expenditure equilibrium GDP is the.……………………………......................................
25) Explain the Keynesian cross……………………………………………………………………………………………………………
…………………………………………………………………………………………………………………………………………………………….
……………………………………………………………………………………………………………………………………………
26) When planed spending by households and firms does not equal the current aggregate output by firms. There is a self-adjusting process in the economy that moves real GDP over time to the point at which real GDP and planned aggregate spending are equal. And that self-adjustment mechanism operates through inventories. That’s why changes in inventories are considered…………………………………………………
…………………………………………………………………………………………………………………………………………….
27) Read the section “The paradox of thrift” pg 687) and make notes………………………………………...........
………………………………………………………………………………………………………………………………………………………
………………………………………………………………………………………………………………………………………………………





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APE UNIT 4 Introduction to Money and the Banking System

When one thinks of economics, people usually think of money. So far, we have said nothing about money but yet nearly all economic transactions involve money.

Definitions
°Money is anything generally accepted in payment for goods and services
Individuals decide how to allocate income between spending and savings.
- Income is a flow of earnings per unit of time (e.g., earned per year)
- Wealth is the accumulation savings over time. Wealth is a stock variable – a dollar amount at a
point in time.


Functions
1) Medium of exchange – an object used to pay for goods and services
° Eliminates the need for a double coincidence of wants
° To function effectively, money must be
- easily standardized
- widely accepted
- divisible
- easy to transport
- relatively non-perishable

2) Unit of account – used to measure the value of a good or service
°E Facilitates understanding how much goods and services are worth
Store of value – an object used to store purchasing power

3) Money is a liquid asset, making it an attractive way to hold one’s wealth. That is, it’s
much easier to convert money from your checking account into cash than it is to
convert a 20-year bond into cash.

Payments system
Commodity money – an object that has intrinsic value but is also used in transactions
°Precious metals (e.g., gold and silver coin)
Fiat money – currency issued by a government as legal tender with no
intrinsic value
° Paper money (see examples below)
The standardized currency we see today was not in place until the Federal
Reserve Bank was established in 1913. Below are some examples of various
forms of paper money used in the United States. The information below (and
more images of U.S. currency) is available at http://www.frbsf.org/currency/

Other forms of money
° Checks, electronic payment, electronic money (e.g., debit cards, borders
cards)
° Checks are promises to pay money on demand
° Difficult for fraudulent behavior compared to currency and precious
metal
° Can be written for any amount
° Lowers transactions costs (shipping money)
° Less liquid
° Need to be cleared (takes 3 business days) through the clearing system
° Checks can bounce—need some trust
°Electronic Funds/Cash
°Debit cards are used like checks but immediately debits the account of
the buyer and credits the account of the seller (eliminates the need for
trust)
° E-money is money stored electronically on cards or computer
accounts.

Measurements of Money
° Important to measure money to effectively conduct monetary policy
Monetary aggregates
° Maintained by Federal Reserve, reported monthly
M1 = currency (C) + checkable deposits (D)+travelers checks
M2 = M1 + savings deposits + money market deposits
(MMMF)

Liquidity is the ease with which an asset can be converted into cash.
Credit cards are excluded from economists’ definitions of money. There are some assets
that are close substitute for money (near money). One example is: Securities issued by
the US government e.g. Treasury bill.

The Banking System
Why do banks exist?
Banks intermediate between lenders (savers: households) and borrowers (debtors: firms).
Banks channel savings into investments. E.g. suppose you are a saver, would you lend
your money to a stranger? No. You know nothing about that person. How do you know
they will pay you back with interest? Instead, you will keep the money in your pocket.
° Traditionally, banks specialize in collecting deposits and lending funds.
° Banks collect information on borrowers and monitor borrowers on the lenders
behalf.

° Banks are the backup source of liquidity to all other institutions, financial and
non-financial;
° Banks are the transmission path for monetary policy.


Why Do Banks Exist?

° Asymmetric Information: one party has more information about a transaction
than the other party.
-Adverse Selection: Individuals taking a loan are more likely to be a riskier
group of borrowers (or be a bad credit risk) relative to the general
population. Adverse selection occurs before the transaction.
- Moral Hazard: An individual changes their behavior after the transaction.
° Banks minimizes moral hazard and adverse selection.
- Screening: establish good credit risks from bad credit risks (credit ratings
can help). When applying for a loan, give the loan officer information on
assets, liabilities, income etc.
- Monitoring: bank asks for collateral to minimize moral hazard and write
restrictive covenants into the loan contract to limit a borrower’s activities.
- Long-term relationships: A borrower may have a savings account with the
bank, or have business history with a bank. These relationships are
important especially for firms—lowers their borrowing costs and makes it
easier to obtain a loan. Makes it easier for lender to monitor borrower
activities especially if monitoring procedures have already been
established. Also, lenders can collect information easily–lowers their
lending costs.
- Collateral moral hazard because the borrower knows he will be penalized
if he defaults on the loan. Collateral is a promise to a lender as
compensation if the borrower defaults. The borrower must post something
of value for collateral (e.g., the borrowers home or financial assets).

Bank Regulations
Banks are regulated closely because of the importance of banking on the whole economy.
The government regulates banks to protect consumer, prevent systemic risk and moral
hazard arising from government guarantees.

° Nearly all banking systems use the fractional reserve banking system. This means
a bank keep a fraction of its deposits at the bank and loans out the rest to other
banks or customers.

° Since banks earn interest of their loans, banks have an incentive to loan money.
So, there is trade-off between increasing profits and bank soundness and safety.
Safeguards (regulation):

° Deposit Insurance: FDIC insures up to $100,000 in deposits for each individual holding account at the bank, regardless of what happens to the bank. Began in the1933 after lots of bank failures. FDIC did not receive deposit insurance responsibility for S&Ls until 1989 (after the S&L crisis).Designed to create banking stability and prevent bank runs of 1930-32.Due to a few bank failures, people tried to convert deposits into cash. As banks attempted to meet cash demands, loans fell as
banks attempted to convert assets into cash, causing liquidity tofall further. As more banks could not meet cash demands rumors increased causing confidence in the banking system to erode.

° Bank Supervision: government (FDIC, Fed, Office of the Comptroller of the
Currency) conducts bank examinations and can intervene if the bank is failing.

° Reserve Requirements: banks must hold a certain fraction of their funds in reserve
(10%). Regulation D: Sets uniform requirements for all depository
institutions to maintain reserve balances either with their Federal Reserve
Bank or as cash in their vaults. Why? Reserves exist to prevent banks from lending out all their deposits.If a bank does not maintain credibility, it will be subject to a bank run (when depositors
attempt to with draw their accounts simultaneously).

The Bank Balance Sheet
The balance sheet is an accounting statement that lists the values of assets on the left hand side and the liabilities on the right hand side.
Assets: an item of values an individual (bank in this case) owns. Banks typically hold their assets in the form of reserves, securities and loans.
° Loans are the largest component because they earn the highest interest (have
highest default risk).
° Securities earn less interest than loans but have less default risk (issued by the US Treasury).
° Reserves are the most secure asset. (Held at the Fed or as cash in their vaults.)
Liabilities: an item of value that an individual owes (in this case a bank).
° The majority of liabilities are deposits.
Net worth: Assets - Liabilities = equity for stock holders (profit)

Example 1: Wells Fargo, quarter ending 12/31/0 Suppose the reserve requirement is 10% of deposits. What are required reserves for Wells Fargo?
$8,300,000 0 $83,000,00 0.10 Reserves Required = °— =
How come Wells Fargo is holding $8,500,000 in reserves when it needs only to hold
$8,300,000 in required reserves?
Excess Reserves: Any reserves in excess of required reserves. In example 1 excess
reserves are Reserves-required reserves=$200,000.
Banks tend to hold very little in excess reserves because they can earn more interest on
loans or securities. In the US, banks do not earn interest on reserves unlike ESCB’s (still
acts like a tax b/c interest is very low). So reserves act like a tax on banks.

Example 2: Wells Fargo, quarter ending 1/31/01
Suppose deposits increase by $3,000,000. Find the new level of required reserves
Required reserves increase by $300,000.
$8,600,000 ) $3,000,000 0 $83,000,00 ( 0.10 Reserves Required = + °— =
Suppose the rest is lent out, what will Wells Fargo balance sheet look like?
Loans increase by $3,000,000-$300,000=$2,700,000
Reserves $8,500,000 Deposits $83,000,000
securities $8,500,000 Net Worth
Loans $79,000,000 Equity $13,000,000
Total $96,000,000 Total $96,000,000
Assets Liabilities
Reserves $8,800,000 Deposits $86,000,000
securities $8,500,000 Net Worth
Loans $81,700,000 Equity $13,000,000
Total $99,000,000 Total $99,000,000
Assets Liabilities
Recall, M1 includes deposits, so if deposits increase, M1 increases.

Money creation:
Example 3
Suppose Bank of America (BofA) lends $200,000 to firm holding an account at Citibank.
The firm then deposits the funds into its account at Citibank. Assume Citibank hold no
excess reserves. What happens to Citibank’s balance sheet? (Assume 10% rr ratio)
By how much does the money supply (M1) increase? $200,000
Now suppose Citibank loans out the additional $180,000 to another firm holding an
account at Chase Manhattan. What happens to Chase Manhattan’s balance sheet?
Now by how much does the money supply (M1) increase?
$200,000+$180,000=$380,000
Chase Manhattan can then loans out the $162,000 to a firm with an account at First
Union Bank. What happens to First Union’s balance sheet?
Now by how much does the money supply (M1) increase?
$200,000+$180,000+$162,000=$542,000
Reserves $20,000 Deposits $200,000
securities Net Worth
Loans $180,000 Equity
Total $200,000 Total $200,000
Assets Liabilities
Reserves $18,000 Deposits $180,000
securities Net Worth
Loans $162,000 Equity
Total $180,000 Total $180,000
Assets Liabilities
Reserves $16,200 Deposits $162,000
securities Net Worth
Loans $145,800 Equity
Total $162,000 Total $162,000
Assets Liabilities

This process will continue until no more loans and deposits are made.
As you can see, an initial change in deposits (or reserves) will get multiplied through the
economy as loans are made (deposits make new loans). This is the money creationprocess.
What is the final change in the money supply?We could go through the process above but that would be tedious. Instead, we have aformula that tells us the final outcome.
Change in money supply (deposits) = (1/rr)°—change in deposits (reserves)m = 1/rr = money multiplier and rr=fraction of deposits held as reserves[Point out the analogy to the simple multiplier]
In example 3 we have:
000 , 000 , 2 000 , 200 ) 1 . 0 / 1 ( = °— = £G s m
[Note: an increase in the money supply that goes into currency is not multiplied only an
increase into deposits is multiplied so the money multiplier is a simplification


The Central Bank
° Three policy tools: Open Market Operations, Discount Rate, and Reserve Requirements
- Open Market Operations: Purchase and sale of securities (primarily U.S. Treasury securities) that affects the amount of available reserves, and hence, the FederalFunds Rate. OMOs are conducted at “the Desk” (Domestic Open Market Desk)at the Federal Reserve Bank of New York.
Federal Funds Rate: The interest rate charged on fed funds (overnight
interbank loans)

- 1) DiscountRate: Interest rate charged on loans from the Federal Reserve district
banks. Discount loans are made through the “Discount Window” located at each
of the district banks.

- 2) Reserve Requirements: Percentage of total deposits that must be held in the form of reserves.
(a) The Board of Governors
– head of the system, current chaired by Bernackee. Located in Washington, D.C. 7 governors appointed by the President (confirmed by the Senate) for one 14-year term. Chairman is chosen among 7 governors to serve a 4 year term. Members serve on the FOMC.Sets reserve requirements and the discount rate. Chairman informs the President and testifies to Congress
(b)Federal Reserve district banks
- 12 district banks;the largest in NY, SF, and Chicago

3) Basic Functions:- Clear checks- Issue new currency and withdraw damaged currency- Administer and make discount loans- Evaluate proposed bank expansions and mergers- Liaisons between the Fed System and Business community- Bank examinations- Collect data and conduct research
- Role in Monetary Policy: Directors support the discount rate set by the BOG- Select commercial banks to serve on Federal Advisory Council- Bank Presidents Serve on FOMC- Approve discount loans
-Federal Reserve Bank of New York The New York Fed plays an important role in the Federal Reserve System. This iswhere open market operations (at “the Desk”) and foreign exchange operationsare conducted. Also, because of its location, it is in charge of examining the largest banks in the U.S. The Desk maintains close contact with the U.S. Treasury and the Board of Governors – each morning a “Conference Call” occursto discuss projections for the current day/week. In addition, the President of theNew York Fed (Bill McDonough), along with the President of the BOG represent
the U.S. at meetings of the Bank of International Settlements.
-Federal Open Market Committee (FOMC)
- The Federal Open Market Committee (FOMC) meets 8 times a year in
Washington, D.C. to set the Federal Funds Rate target and the money supply for the economy.
- Members include: 7 BOG members, president on FRBNY, and 4 presidents of other Fed district banks
-All presidents engage in discussions but only 5 have voting rights
-Beginning in 1994, FOMC announces whether policy will change – it publicly announces the target for the Federal Funds Rate target.

Central Bank Independence
-Central Banks that are less independent have higher rates of inflation.
- There has been a trend toward independence for central banks. Why? Reduces inflation.

Independence of the Fed
1) Factors that make the Fed independent
- Members of the boards have long terms and no one president can chose all
members of the board at one time (they are staggered)
- Fed is financially independent: this is most important. The Fed generates fees for its services.
-Factors making Fed dependent
-Congress can amend Fed legislation
-President appoints Chairmen and Board members and can influence legislation.
- Should the Fed be Independent?
- Case For Independence
- Independent Fed has longer-run objectives, politicians don’t
- Fed can effectively control inflation if it does not have political pressure
- Political business cycles—when policy generates a boom during election year
- If the Fed is too close to the Treasury, it could be pressured to finance deficits before 1951, the Fed supported prices on T-securities). Deficits are less likely to be inflationary.
- Fed is staff with experts, whereas politicians are not as experienced.
-Case Against Independence
-Undemocratic to have monetary policy set outside of the voters hands: the Fed may not be accountable.
- President and Congress are often held responsible for economic-well being yet they do not have direct control over the Fed: Can hinder the coordination of monetary and fiscal policy.
-If the Fed fails, the gov’t is unable to do anything
- Failed as Lender of Last Resort during the GD
- Failed to control inflation during the 1960’s and 1970’s

.