PSC 101 Monetary Policy

Summary

Highlights

• Money acts as a universal exchanger, simplifying market transactions. 🔄
• Hyperinflation, historically in Germany and Hungary, destabilizes economies and governments. 🌍🔥
• The Federal Reserve employs tools like open market operations for monetary policy. ⚙️
• Cryptocurrencies are commodities, not typical currency, affecting the financial world differently. 💰
• Appreciating monetary policy helps one understand economic stability and inflation control. 📈

Key Takeaways

• Money is essential as a universal medium of exchange. Without it, our modern economy would fall apart. 💸
• Increased money supply without proper control can lead to hyperinflation, as seen in historical cases like Germany and Hungary. 🇩🇪💥
• The Federal Reserve manages monetary policy using tools like open market operations, influencing rates, and reserve requirements. 🔧
• Cryptocurrencies, for now, don't impact traditional money supply like M1 or M2, acting more like commodities. 📉
• Understanding monetary policy helps appreciate efforts to balance economic stability, inflation, and employment rates. 📊

Overview

Chapters

• 00:00 - 04:30: Introduction to Monetary Policy and Significance of Money In this chapter, Dr. Hart introduces the concept of monetary policy and discusses the significance of money. Money is described as the universal medium of exchange, essential for facilitating the fluidity of economic exchanges. Without money, modern economies would not operate smoothly, and individuals would rely on bartering, exchanging goods and services directly.
• 04:30 - 10:00: Barter Economy and Evolution of Money The chapter delves into the limitations of a barter economy by illustrating a scenario where goods or services are exchanged directly for other goods or services. It paints a picture of a modern world without money, highlighting its impracticality. For instance, the text discusses how paying for gas would be impossible if a gas station only accepted raw fish as payment, emphasizing how essential money is in facilitating smoother and more feasible transactions in today's world.
• 10:00 - 15:00: Role of Money in Modern Society The chapter discusses the challenges faced in a society without money, using the example of medieval Europe where people had to barter goods and services. The lack of money complicates trade and economic interactions, highlighting money's role as a convenient medium of exchange.
• 15:00 - 30:00: Hyperinflation and Historical Examples The chapter discusses the indispensable role of money in the modern economy, likening it to essential tools like hammers and handsaws. Money serves as a measure of economic value and provides information on the cost of goods.
• 30:00 - 46:00: US Federal Reserve System and Monetary Policy Tools The chapter explains the role of money in determining prices and facilitating transactions. It highlights that without money, prices cannot be established. Money simplifies and depersonalizes social relations by transforming a system based on obligations into one based on exchange. Historically, essential goods and services operated on this model.
• 46:00 - 56:00: Cryptocurrencies and Money Supply The chapter explores the evolution of money and its impact on societal structures. Initially, clans and tribes were essential for survival, providing necessary economic structures. However, as money, viewed as a form of technology, proliferated, these social structures became less necessary. This shift allowed individuals, particularly in modern Western societies, to thrive independently.

PSC 101 Monetary Policy Transcription

• 00:00 - 00:30 hello this is Dr Hart and this is video about monetary policy what is the purpose of money money is the Universal Medium of exchange it enables the fluidity of economic exchanges without which a modern economy is impossible so without money you could not buy and sell things very easily in fact you would probably have to barter you would have to exchange things for
• 00:30 - 01:00 things or services for services or goods for services so in a modern world without money you would be stranded put it another way modern world is impossible without money so imagine you need to put gas in your car and you pull out a gas station and uh they tell you well we only accept payment in raw fish and you say well you people are crazy I don't have raw fish so you go to another station and they tell you well we only
• 01:00 - 01:30 accept payment in plywood this situation as ludicrous as it might sound is what you would get in certain periods in certain places like in much of medieval Europe where there is no money and so you have to try to get around that by exchanging goods for goods or services for services this really is a problem money is a very handy tool so just like political
• 01:30 - 02:00 parties would be a tool of Elections so money would be the tool of the modern economy and so it's just like a hammer or a handsaw it's not something that you can get rid of because it simply is too useful in the modern world money is also the finder of Market or marker of economic value so money tells you what things cost how else would you know when you buy a cup of coffee
• 02:00 - 02:30 they tell you it costs let's say $4 well what is it that makes the price known it's money money itself money marks the price without money there's no price and uh finally money simplifies and depersonalizes social relations replacing a system of obligation with simple system of exchange so in the olden days essential goods and services
• 02:30 - 03:00 were provided by Clans and tribes and as money proliferated along with other Technologies because money is a form of Technology uh tribes and clans became unnecessary they are no longer essential to survival and not just to survival in fact to thriving we tend to think of ourselves in modern W Western societies as individ indviduals who Thrive because
• 03:00 - 03:30 of our individual efforts now money goes a long way toward that because money is what gives you Independence it's what gives you power people who do not see what this is headed eventually are blind this is headed in the direction uh where I don't know we if we want to go to because um at at the end of this journey even even the nuclear family is under threat I mean divorce rate is approximately 50%
• 03:30 - 04:00 that's in the United States in some countries it's a bit higher in some it's a bit lower but partly what makes the dis the dissolution of the nuclear family so easy is because people have the means I.E the money to to leave uh to leave a marriage to leave a relationship that makes them unhappy when you may say well it's a good thing and it is from the individualistic point
• 04:00 - 04:30 of view uh but where this may bring us is to a world uh where atomized individuals are reality and human connection genuine human connection is replaced mostly perhaps not entirely but mostly by a system of transactional relationships we have to hear
• 04:30 - 05:00 um use a very important footnote and say that barter transactions still do occur in a man economy so our economy is a money economy and it's an economic system where money is the primary medium of exchange so in a money economy people exchange goods and services for money which then can be used to purchase other goods and services so it's different from Barter but barter can still occur for example one college student can tell
• 05:00 - 05:30 another I will give you my new electric guitar if you give me your old laptop let's let's have this exchange and such an exchange would be perfectly lawful and exchanges of this nature occur on a regular basis but they cannot be the foundation of the economy they occur within the larger context of a money economy and in a money economy one of the things that you have to watch out for very closely is the supply of money
• 05:30 - 06:00 because if there's too much supply of money then you have hyperinflation and you have a ludicrous situation where money loses all of its economic value so how do you maintain the proper money supply modern economies rely on their respective central banks to do so in the United States the Federal Reserve
• 06:00 - 06:30 System or the FED for short is the Central Bank the FED is a bank for banks for private Banks and also for the federal government the FED is also a regulatory agency in this video I only consider the uh monetary policy side of it how the FED regulates the money supply not its broader regulatory function the united states is divided into to 12 districts with a Fed branch
• 06:30 - 07:00 in each district the FED also has the seven member Board of Governors each Governor is appointed by the president and confirmed by the senate for a single fixed term of 14 years there's an exception to this if a governor retires early or dies and is replaced by another Governor that Governor can complete that term and then be appointed in his or her own right
• 07:00 - 07:30 in which case you know that Governor would serve more than one full term Governor's terms are staggered so that the new governor is appointed every two years the chair of the Federal Reserve is appointed by the president typically from among the existing members of the Board of Governors but this is not a legal requirement the term of service for the chair is 4 years the chair can be reappointed every 4 years subject to the
• 07:30 - 08:00 Senate confirmation and there are no term limits the FED has a dual mission to strive for Full Employment and to maintain very low inflation to try to minimize it so you can see here the 12 Federal Reserve Districts and uh there's a branch in uh each district located typically in a major city in that particular
• 08:00 - 08:30 geographical District so there is a a branch in Boston New York Philadelphia Cleveland Richmond Atlanta Chicago St Louis Minneapolis Kansas City Dallas and San Francisco why are there so many meaning 12 Federal Reserve District Banks first Regional representation when the Federal Reserve System was created created in 1913 the United States was already a
• 08:30 - 09:00 vast and diverse country with different Regional economies so having multiple banks ensured that different parts of the country could have their unique economic conditions and needs represented this Regional approach uh helps in better understanding and addressing the economic issues that are pertinent to different areas of the country number two is decentralization of power multiple Banks help in decentralizing power and and reducing the risk of having a single Central Bank
• 09:00 - 09:30 that could wield too much influence or control over the nation's monetary policy so the structure creates a systems of system of checks and balances making it more resilient and less susceptible to the influence of local or special interest groups three diversity in economic perspectives each district Bank brings its own perspective on the economy based on its Regional characteristics this diversity of viewpoints contributes to a more
• 09:30 - 10:00 balanced and effective National monetary policy effective policy implementation is four so different districts can Implement policies more effectively considering the specific needs and economic conditions of their region this localized approach can be more responsive and adaptive to changing economic scenarios number five historical context at the time of the federal reserve's creation transportation and communication were not as advanced as today having multiple Banks allowed for better management and
• 10:00 - 10:30 oversight of the banking system across the vast geographical expans of the United States six is research and data collection each district Bank collects economic data from its region which AIDS in the formulation of more informed and region specific monetary policies this localized data collection is crucial for understanding the economic health and Trends across different parts of the country number seven is Emergency Management and
• 10:30 - 11:00 stability in case of financial emergencies or crisis having multiple District Banks helps in providing a more robust and stable response system each Bank can act as a support system for others ensuring overall Financial stability employment inflation tradeoff so very low unemployment usually leads to elevated rates of inflation because people in businesses spend more
• 11:00 - 11:30 money so the more people work right or put it another way the fewer people are out of work uh uh out of work the more money there is on hand for the people to spend and as they spend money this puts inflationary pressure on the prices of goods and services the Federal Reserve considers 5.2 to 6% unemployment rate to be the normal Lan run rate of unemployment this is the employment rate
• 11:30 - 12:00 that can be achieved without excessive inflation most economists estimate full employment between five and 5.5% so this 5 to 5.5% is considered Fric frictional unemployment this is for people who are legitimately between jobs if you have unemployment rate that's greater than that what you have is structural unemployment meaning there's a mismatch between um the demand of the employers on one hand and the skills available in
• 12:00 - 12:30 the labor force okay so what we see here is basically German hyperinflation between uh 1921 and 1923 the greatest problem occurred in 1923 it had a devastating economic and psychological effect the hyperinflation peaked in 23 and it was over in early 1924 however it did so much damage to
• 12:30 - 13:00 the image of democracy that it made it easier for the Nazis to win actually win a plurality of seats 8 years later in reog in 1932 and Hitler was appointed Chancellor in January of 1933 and it took him about a year to consolidate power abolish other political parties and become a dictator in 1934 so approximately a decade after the end of Germany's hyperinflation the Nazis were in power because you know
• 13:00 - 13:30 hyperinflation damaged the image of democracy even though it was precipitated by the form of government the Imperial form of government which preceded democracy and that was because Imperial Germany did not want to impose an income tax instead it financed World War I by borrowing hoping to repay the debt after the end of the war which it was hoping to win and it was hoping of
• 13:30 - 14:00 course to impose penalties on um on its defeated enemies particularly France like it did after the Franco Prussian war in 1871 Germany was hoping to get money from France and others but uh fate dealt at a very different card it lost the war and it had to pay reparations in fact unreasonable reparations to try to do so it uh uh printed money when the belgians
• 14:00 - 14:30 and the French occupi the industrial region of rur in Germany and the German Workers refused to work to protest the occupation the German government called them patriots and continued to pay them even though they were not producing anything does this remind you of anything so when you work and you get paid for not working uh so this is what happens you just print more money you do not make things affordable and you don't help the
• 14:30 - 15:00 situation out what happens simply is that um you you lose value your currency loses value and uh you create hyperinflation things are only made worse if the printing of money is not matched by the concurrent and Commander rise in the value of goods and services the only thing that is actually accomplished in the real world is that the value of the economic value of money
• 15:00 - 15:30 is lost it's that simple you cannot simply print your way out of a difficult financial situation the cost associated with printing too much money is hyperinflation which is destructive to the economy and as we saw in the case of Germany can be very destructive to the country's political system and ultimately to the world all right let's go to the next segment so Germany's experience with
• 15:30 - 16:00 hyperinflation was not the only one obviously in the world between August of 1945 and July 1946 Hungary experienced the worst case of hyperinflation ever recorded by the way there's no uh bright line definition of hyperinflation there's no like a percentage that says this is the cut off percentage everything that is above it is Hy inflation everything that's below
• 16:00 - 16:30 it is not but generally speaking most economists consider uh 50% a month to be hyperinflation so in Hungary inflation in this period of time summer 45 to Summer 46 inflation reached uh 13 I think quadrillion yeah 13 quadrillion a month which really is not com comprehensive ible birational human
• 16:30 - 17:00 mind 13 quadrillion per a month the largest note that they have ever printed was the 100 million note um so obviously hungary's uh hungary's hyperinflation was caused by the fact that its economy was very badly damaged it all of its bridges were destroyed during World War II and most of the railroads just most of the infrastructure was destroyed detroy and the Soviet Union imposed also High
• 17:00 - 17:30 reparation costs so the hungarians were printed manone like crazy and the result was expected and that's devastating hyperinflation we also had hyperinflation in Venezuela particularly in uh n n in 2018 uh 2018 saw the inflation rate of 65,00 % on an annual
• 17:30 - 18:00 basis so economic policies by the Socialist government um full of corruption a bloated uh government spending and excessive printing of money led to this miserable situation it's an incredibly High inflation 60 over 65,000 per a year then we had um hyperinflation in Zimbabwe Peak month for that particular
• 18:00 - 18:30 country uh was November of 2008 when the inflation rate reached uh 79.6 billion per a month or 89.7 6 illion annual rate and the largest note that Zimbabwe ever issued was 100 trillion doll that's a single piece of currency 100 trillion so so they seem to have eaten if I'm not
• 18:30 - 19:00 mistaken the Hungarian hyperinflation all right now let's bring back to the United States so if you do live in the United States you can appreciate now how lucky you are with regard to price stability even uh after the 2022 inflation which reached you know about 8% % and 2023 inflation rate which
• 19:00 - 19:30 is about 3.8% on an annual basis although it's hard to believe because it feels you know much greater than that but over time here you can see uh over a century over over half a century about 53 years from 1970 through 2022 and you can see that the normal rate is just about 4% so uh during this period of time so the
• 19:30 - 20:00 Federal Reserve as a as of the end of 2023 is trying to get the inflation rate down to 2% a year which is low and uh you know 2% was not often achieved in the history of this country uh but the this is where the FED is trying to bring it down because inflation has been such a problem such a huge problem in uh 202 too and of course in this era in this
• 20:00 - 20:30 modern era of the past 50 years plus inflation rate peaked uh at approximately 14% during the uh later days of Jimmy Carter's presidency then it remained stubbornly High uh even for the first two years of Reagan's presidency the in the inflation did uh remain in double digits but um for us today we think double
• 20:30 - 21:00 digit inflation rate is unacceptable even 8% is unacceptable which is why the Federal Reserve has been acting so aggressively trying to bring uh the inflation rate down so what are the policy tools that are available to the FED uh if it wants to change the money supply well first of all uh it can order the treasury
• 21:00 - 21:30 Department to create more money uh this would increase the supply of money in circulation the Bureau of Engraving and printing be actually prints currency the US men coins uh both regular and commemorative coins both of these agencies are part of the Treasury Department the FED can also change the discount Target rate it can lower if it wants more money in circulation or
• 21:30 - 22:00 it can increase it if it wants less money in circulation the discount rate is the rate at which private Banks borrow from the Federal Reserve and the way borrowing occurs is private Banks accounts are credited essentially with digital US dollars so the FED doesn't have its own currency but it simply digitally adds money to the reserves of
• 22:00 - 22:30 the uhu private Banks and then the private Banks can spend that money uh by lending it to businesses and consumers who borrow this money and who who have this money in their checking accounts or spend it so there's more money in circulation the supply of money increases that way the FED can also change the FED funds rate to lower it if it wants to increase the supply of money or to raise
• 22:30 - 23:00 it if it wants to decrease it so the FED funds rate is the rate at which private Banks borrow from each other overnight to cover the reserve requirement at the Fed so all all banks that are members of the Federal Reserve System have to maintain a certain percentage called The Reserve ratio on account with the fed and this applies to all all federally chartered chartered Banks and to those
• 23:00 - 23:30 State chartered banks that agreed to become members of the Federal Reserve System so federally chartered banks are required to be uh members of the system and are required to have a Reserve balance on account with the FED but uh State chartered banks are not required but they choose to because there are certain benefits to
• 23:30 - 24:00 doing so so if a bank Falls below its required uh ratio of assets that it has to maintain of liquid assets that it has to maintain on balance with the Federal Reserve um then it can borrow from another bank overnight and the rate at which such a bank borrows is called the FED funds rate so the lower this rate the more freely private banks will be lending money to businesses and
• 24:00 - 24:30 consumers because if they fall short of the reserve requirement they'll be able to borrow from another bank cheaply because their fed funds rate is low borrowing is cheap they will be able to um borrow cheaply to cover that requirement conversely If the Fed funds rate is high then private Banks would be less willing to lend a lot of money because they don't want to fall short of the reserve requirements and then pay high interest rate as as
• 24:30 - 25:00 the FED funds rate to borrow from another bank to cover the reserve requirement for uh the FED can actually change the reserve requirement itself if it lowers it it increases the supply of money in circulation because now Banks private banks have to have less money on reserve they can do something else with it like they can lend it to businesses and consumers who in turn will have more
• 25:00 - 25:30 money on hand and would be able to spend it leading to more money in circulation so um what happens here is obviously self-explanatory uh conversely the FED can raise the reserve requirement and then this will uh take money out of circulation in the United States the reserve requirement is rarely changed so the United States can go for many years without altering it at all in other countries like China this is as
• 25:30 - 26:00 much more this is a much more frequently taken step and in China it can happen several times a year okay number five the FED can buy or sell government bonds using omo open market operations so when the FED buys bonds from private banks that that own them it credits those banks with money with digital US Dollars and now private Banks have more money on hand which means that they can land more to
• 26:00 - 26:30 businesses and consumers leading to more money in circulation and then when the FED is ready to sell those back to them those banks are obligated to buy them back so uh they they would buy them back leading to uh less money in circulation because the banks would give up money in exchange for buying back bonds a quanti quantitative easing is the Sixth and last step it's very similar to open
• 26:30 - 27:00 market operations but on a much larger scales and it also involves assets besides or in addition to um government bonds so it can involve buying uh Securities like corporate bonds or mortgage back Securities and let's say corporate bonds and mortgage back Securities typically are not part of omo they're not part of open market operations but they they are
• 27:00 - 27:30 part of quantitative easing So you you're buying these Securities as as the FED you're buying these Securities and you're also buying government bonds that are on the larger basis and so quantitative easing is a rare step and it tends to occur when other steps have been implemented and have failed to produce desired results
• 27:30 - 28:00 what exactly is the money supply and uh we've been talking about money supply how does the FED manage it what does it really mean so the FED tries to manage M2 money supply M2 consists of M1 plus savings deposits time deposits meaning CDs on certain size only and money market mutual funds excluding those held by institutional investors so M2 is a key
• 28:00 - 28:30 economic indicator because it represents money that is readily available and for spending and for saving so the FED monitors M2 to understand money supply Trends assess economic health and make decisions on monetary policy so M1 would be cash and coin so paper currency and coin in circulation that's M1 M2 is both of those plus savings
• 28:30 - 29:00 deposits CDs under certain size and money market mutual funds because all of these are considered Near money okay so uh this is what the FED monitors in the past the FED used to report on M3 as well but it stopped doing so in 2006 M3 is a collection of the money supply that includes everything that is
• 29:00 - 29:30 M2 uh plus large time deposits institutional money market funds short-term repurchase agreements and larger liquid funds M3 is closely associated with larger financial institutions and corporations than with small businesses and individuals M3 was traditionally used by economists to estimate the entire money supply within an economy and by governments to direct policy and control inflation over medium
• 29:30 - 30:00 and longterm periods but as I said since 2006 the FED just stopped publishing M3 um but other sources continue to publish M3 figures so who actually makes monetary policy the federal uh Open Market Committee fomc is the monetary policymaking body of the Federal Reserve System so f MC is composed of 12 members
• 30:00 - 30:30 the seven members of the Board of Governors the president of the Federal Reserve Bank of New York and four of the remaining 11 Reserve Bank presidents so of the remaining four Regional Bank presidents of the remaining 11 there is a rotation so at a different meeting there's like a different fors they they rotate the president of the uh Reserve Bank of New York never rotates he's a permanent member of that because New
• 30:30 - 31:00 York is such an important financial center of the United States and in fact of of the world the chairman of the Board of Governors serves as the chairman of the fomc the president of the Federal Reserve Bank of New York like I said is a permanent member of the committee and serves as Vice chairman of the committee the presidents of other Reserve Banks fill the remaining four voting positions on the fomc on a rotating basis all of the Reserve Bank presidents
• 31:00 - 31:30 including those who are not voting at a particular meeting attend actually attend fomc meetings participate in discussions and contribute to the assessment of the economy and policy options so when do these policy makers meet the fomc schedules eight meetings per year once about every 6 weeks the committee May also hold on scheduled meetings as necessary to review economic
• 31:30 - 32:00 and financial developments the fomc issues a policy statement following each regular meeting that summarizes the committee's economic Outlook and the policy decision at that meeting four times per year the chairperson holds a press briefing after the fomc meeting to present the fomc's current economic projections and to provide additional context for the fomc policy decisions a full set set of minutes for each fomc meeting is published 3 weeks after the
• 32:00 - 32:30 conclusion of each regular meeting and complete trans transcripts of fomc meetings are published five years after the meeting how does the FED pay for its operations so I'd say there are four sources first interest in government debt the federal the FED actually holds a lot of us treasuries and uh and the interest received from these Securities is a major source of income for the FED
• 32:30 - 33:00 second there's interest on foreign currency Investments the FED holds foreign currency Investments the interest on these Investments is a another source of Revenue interest on loans to depository institutions so the FED lends money to Banks and other financial institutions like we discussed a few minutes ago at the discount rate that's called discount window borrowing the interest earned on these loans can uh contribute to the income of the fed
• 33:00 - 33:30 and then there's also fees for services provided to private Banks the Federal Reserve charges fees to financial institutions for services like check processing electronic payments the use of its automat automated Clearing House facilities so after its expenses are paid the Federal Reserve turns over the majority of its earnings to the US Treasury how was the monetary policy implemented
• 33:30 - 34:00 in the US before the Federal Reserve existed you already probably know about the first and the Second National Bank but I'll leave in the description a link to how uh policy was implemented um initially it was the first then Second National Bank then just different State uh management tools because President Andrew Jackson um got rid of the Second National Bank and then finally we got our Federal Reserve in 1913 so in depth
• 34:00 - 34:30 in depth for this material you can consult a variety of sources like I said there'll be a link in the description what about cryptocurrencies what role do they play in this picture of uh controlling money supply cryptocurrencies do not have a direct impact on the traditional measures of money supply like M1 or M2 they have some indirect impact on the broad Financial system so we have to understand that the traditional system
• 34:30 - 35:00 of national currencies and the the current and the existing new system of uh cryptocurrencies are separate systems cryptocurrencies operate completely independently of the traditional banking system and independently of any Central Bank issued money therefore they do not directly impact traditional measures of money supply like M1 and M2 this is all true
• 35:00 - 35:30 because cryptocurrencies like Bitcoin they're not a legal tender so in the United States you cannot normally pay with Bitcoin for goods and services uh in most countries cryptocurrencies are not that most transactions in most countries uh for most of such transactions Bitcoin would simply not be accepted or any cryptocurrency would not be accepted therefore cryptocurrencies
• 35:30 - 36:00 are not really money what they really are a Commodities they're much closer in nature to things like soybean Futures than they are uh to to money so people invest in cryptocurrencies people essentially Deb on the increase or decrease in the value of cryptocurrency instead of uh acquiring acquiring it as as the legal tender so
• 36:00 - 36:30 transactions in cryptocurrencies do not directly impact uh the amount of US dollars in circulation now at some point in the future this may change but uh it's not on on the horizon just yet thank you