(10869) What's all the Yellen About? Monetary Policy and the Federal Reserve: Crash Course Economics #10

Introduction to Monetary Policy

• Hosts: Jacob Clifford and Adriene Hill

• Focus: Importance of monetary policy and its implementation by central banks

• Featured Figure: Janet Yellen, Chair of the Federal Reserve, impacts billions through her role.

What is Monetary Policy?

• Definition: The process by which the central bank (The Fed) manages money supply to influence the economy.

• Objectives: Speeding up (Expansionary) or slowing down (Contractionary) the economy.

Roles of Central Banks

• Federal Reserve (The Fed): Central bank of the U.S.

• Functions:

  • Regulating commercial banks to maintain sufficient reserves and prevent bank runs.

  • Conducting monetary policy to adjust the economy's money supply.

Interest Rates

• Definition: The cost of borrowing money expressed as a percentage of the principal.

  • Importance: Interest rates influence borrowing and spending behavior.

• Effects of Interest Rates:

  • Low interest rates increase borrowing and spending.

  • High interest rates decrease borrowing and spending.

Mechanisms of Monetary Policy

• Increasing Money Supply:

  • Lowers interest rates, promotes borrowing and spending (Expansionary Policy).

• Decreasing Money Supply:

  • Raises interest rates, reduces borrowing and spending (Contractionary Policy).

Historical Examples of Monetary Policy

• The Dot Com Bust & 9/11:

  • Fed increased money supply, lowering interest rates to stimulate recovery.

• Late 1970s Inflation Crisis:

  • Fed Chairman Paul Volcker decreased money supply, raising interest rates to combat rising inflation, leading to increased unemployment.

• The Great Depression:

  • The Fed’s failure to support banks with emergency loans contributed to widespread bank failures.

Maintaining a Healthy Banking System

• Key Aspects:

  • Confidence: Customers need assurance they can withdraw funds.

  • Liquidity: Availability of cash vs. illiquid assets (stocks, bonds).

• Impact of Bank Failures: Loss of confidence leads to bank runs and further instability.

How the Fed Influences Money Supply

• Methods:

  1. Reserve Requirement:

     • Changes the fraction of deposits banks must maintain as reserves.

     • Lowering this requirement increases money supply.

  2. Discount Rate:

     • The interest rate at which banks can borrow from The Fed.

     • Decreasing this rate increases money supply by making borrowing cheaper.

  3. Open Market Operations:

     • Buying and selling government bonds to adjust liquidity and money supply.

2008 Financial Crisis Response

• Fed Actions:

  • Increased bond purchases (Open Market Operations) to boost liquidity and money supply, reducing interest rates to near zero.

  • Introduced Quantitative Easing (Q.E.):

    • Buying longer-term assets, like Mortgage-Backed Securities, to further inject money into the economy.

• Inflation Concerns:

  • Excess supply of money might lead to inflation, but actual inflation remained low due to high excess reserves held by banks.

Monetary vs. Fiscal Policy

• Monetary Policy: Adjusts money supply quickly, generally effective for mild economic fluctuations.

• Fiscal Policy: Involves government spending and taxation, potentially more effective during severe economic downturns.

• Political Influences: Independence of central banks from political pressures helps the effective implementation of monetary policy.

Closing Thoughts

• Understanding Influence: Recognizing the role of Janet Yellen and central banks in shaping economic fate.

• Community Knowledge: Encouragement to engage and discuss economic topics in daily life.