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

Summary

Highlights

• Janet Yellen is highlighted as one of the most influential people on Earth due to her role in guiding U.S. monetary policy. 🌟
• The Fed conducts monetary policy by adjusting the money supply to manage economic growth. 💹
• Expansionary monetary policy makes borrowing easier, which can boost economic activity. 🚀
• Contractionary monetary policy aims to cool down the economy by reducing money supply. ❄️
• Open Market Operations are the Fed's go-to tool for quick money supply changes. 🔧
• Quantitative Easing involves the Fed buying long-term assets to inject money into the economy. 📊

Key Takeaways

• Janet Yellen is a major player because she steers the largest economy in the world through monetary policy! 🌍
• The Federal Reserve (The Fed) plays a key role in regulating banks and controlling the money supply. 💰
• Interest rates can influence borrowing and spending: Low rates mean more spending, while high rates mean less. 📉📈
• The Great Depression was prolonged because The Fed didn’t provide banks with enough liquidity. Oops! 😬
• Quantitative Easing (QE) is like The Fed’s way of making it rain money when times are tough! 💸
• Monetary policy often acts quicker than fiscal policy, intervening when the economy wobbles. 🏃‍♂️💨

Overview

Chapters

• 00:00 - 00:30: Introduction In the Introduction chapter, Jacob Clifford and Adriene Hill host an episode of Crash Course: Economics to discuss monetary policy. They highlight the significance of influential figures recognized annually by TIME magazine. Among the notable figures mentioned, they emphasize Janet Yellen as arguably the most influential person, whose decisions have a global impact affecting billions.
• 00:30 - 01:00: Understanding the Federal Reserve and Monetary Policy This chapter focuses on explaining the role and importance of the Federal Reserve, commonly referred to as 'The Fed,' particularly in the context of its monetary policy. It introduces Janet Yellen as a significant figure due to her influence over the U.S. economy, highlighted through her role in monetary management. The chapter sets the stage by comparing the Federal Reserve with other central banks like the European Central Bank (ECB), emphasizing that while different countries may have their own central banks, they share similar principal functions. The main tasks of these central banks, including the Federal Reserve, are outlined with a specific reference to overseeing and regulating the economy of their respective nations.
• 01:00 - 02:00: Interest Rates and Money Supply The chapter discusses the role of commercial banks in maintaining sufficient reserves to prevent bank runs. It then shifts focus to the conduct of monetary policy by The Fed, which involves adjusting the money supply to influence the economy's speed. This process underscores the significance of The Fed and its Chair. Interest rates are highlighted as the cost of borrowing money, with banks expecting repayment of the principal plus an additional percentage to cover inflation and ensure profitability.
• 02:00 - 03:00: Monetary Policy in Action The chapter titled 'Monetary Policy in Action' explains the concept of interest rates and their impact on different types of loans like car loans, student loans, home loans, and business loans. It describes how low interest rates make it easier for borrowers to repay loans, leading to increased borrowing and spending. Conversely, high interest rates result in reduced borrowing and spending. The chapter highlights the role of The Federal Reserve (The Fed) in manipulating interest rates not by directly setting them but by changing the money supply. By increasing the money supply, The Fed ensures more funds are available for banks to lend, which in turn forces banks to lower interest rates as borrowers seek better loan deals.
• 03:00 - 04:00: Historical Examples and Impact of Policies The chapter discusses the effects of changes in money supply on interest rates and the economy. It notes that an increase in the money supply can lead to lower interest rates and more borrowing and spending, a policy known as Expansionary Monetary Policy. Conversely, a decrease in the money supply leads to higher interest rates and reduced spending, a strategy identified as Contractionary Monetary Policy. Therefore, the central bank adjusts the money supply to either stimulate or slow down the economic activity.
• 04:00 - 05:00: The Great Depression and Banking System The chapter discusses the impact of economic events like the Dot Com bust, 9-11, and the late 1970s inflation on the U.S. economy. It highlights how the Federal Reserve responded to economic downturns by increasing the money supply to lower interest rates, thus encouraging borrowing and spending to spur economic growth. Additionally, the chapter covers the challenges of high inflation rates in the 1970s, and how these historical events influenced monetary policy and the banking system.
• 05:00 - 06:00: Methods to Change Money Supply The chapter discusses the impact and methods of changing the money supply, particularly focusing on how the Federal Reserve manages this. It highlights Fed Chairman Paul Volker's strategy of decreasing the money supply, which led to increased interest rates, reduced consumer spending on big-ticket items like homes and cars, and less business investment. This policy, known as Contractionary Monetary Policy, successfully lowered inflation but also raised unemployment rates. The chapter reflects on the complexity of economic policy decisions, particularly pointing out historical mistakes such as the Fed's actions during The Great Depression, with a notable admittance of error from Fed Chairman Ben Bernanke decades later.
• 06:00 - 07:00: Open Market Operations and the 2008 Crisis This chapter discusses the role of the Federal Reserve (The Fed) during the financial crisis, specifically focusing on confidence and liquidity as critical elements of a healthy banking system. It highlights The Fed's failures leading to the 2008 crisis, drawing parallels with the early years of The Great Depression where allowing large banks to fail caused panic and subsequent bank runs. The emphasis is on the importance of liquid assets, or having immediate cash, rather than being bound up in less accessible assets like stocks, bonds, and mortgages.
• 07:00 - 08:00: Quantitative Easing and Inflation Concerns This chapter discusses the role of central banks, particularly the Federal Reserve (The Fed), in managing money supply, especially in times of financial crisis. It begins with a historical anecdote about the banks' inability to repay deposited money, leading to criticisms of the Fed for not providing emergency loans during the Great Depression. The chapter introduces the concept of Fractional Reserve Banking, where banks only hold a fraction of deposits and loan out the rest. A critical method the Fed uses to influence money supply is by altering the Reserve Requirement, the proportion of deposits that banks must hold as reserves. Lowering the Reserve Requirement increases liquidity by allowing banks to loan out more of their deposits.
• 08:00 - 09:00: Excess Reserves and Low Inflation Debate The chapter discusses the tools available to the Federal Reserve (The Fed) for controlling the money supply. It explains that altering the Reserve Requirement can increase or decrease the money supply. The Fed, being the banker's bank, allows commercial banks to borrow money from it. By changing the Discount Rate, which is the interest rate charged to banks, The Fed influences the ease with which banks can borrow money, thus impacting the money supply. The chapter humorously mentions a 'secret cabal' and Janet Yellen in the context of changes to the money supply, adding a fictional twist to the narrative.
• 09:00 - 10:00: Conclusion: Monetary vs Fiscal Policy The chapter discusses the difference between monetary and fiscal policy, focusing particularly on monetary policy through open market operations by The Federal Reserve. This involves buying or selling short-term government bonds, also known as treasury bills, which are IOUs issued by the government. The purchase of bonds by the Fed from banks boosts liquidity and the money supply, while selling them reduces liquidity and the banks' ability to loan money. The Federal Open Market Committee in the U.S. is responsible for making these decisions.
• 10:00 - 10:30: Final Thoughts and Outro In this chapter, Adriene discusses The Federal Reserve's ability to adjust the money supply quickly, particularly through Open Market Operations. During the 2008 financial crisis, The Fed aggressively purchased bonds to increase the money supply and cut interest rates to nearly zero. Despite these efforts, the economy remained weak, prompting additional actions.

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

• 00:00 - 00:30 Jacob: Welcome to Crash Course: Economics, I'm Jacob Clifford. Adriene: I'm Adriene Hill and today were talking about monetary policy. Jacob: So each year, TIME magazine comes out with a list of the worlds 100 most influential people. Adriene: It includes heads of state, religious leaders, entrepreneurs, artists and activists, singers and actors of the most famous and infamous. There's one person on that list -- someone who is arguably the most influential person on earth -- that most people don't know. Their decisions, good or bad, likely impact billions of people: Janet Yellen.
• 00:30 - 01:00 Jacob: She steers the largest economy in the world. Janet Yellen is a big deal. And she's a big deal because of monetary policy. [Theme Music] Adriene: The Federal Reserve is the central bank of the United States, and it's commonly called "The Fed." Europe has the European Central Bank or ECB, and other countries have institutions that play similar roles. Most central banks have two important jobs. First, they regulate and oversee the nation's
• 01:00 - 01:30 commercial banks by making sure that banks have enough money in their reserve to avoid bank runs. Their second job, and the job we're gonna focus on today, is to conduct monetary policy which is increasing or decreasing the money supply to speed up or slow down the overall economy. Monetary policy is what makes The Fed and The Fed Chair so influential. Jacob: Let's start with interest rates. An interest rate is the price of borrowing money. When banks lend money, they expect to be repaid the amount they lent, which is called the principle, and a percentage of the principle to cover inflation and to make some profit.
• 01:30 - 02:00 That percentage is called the interest rate. The number of car loans, student loans, home loans, and business loans that get made depends on interest rates. When interest rates are low, borrowers will find it easier to pay back loans so they will borrow more and spend more. When interest rates are high, borrowers borrow less and therefore spend less. In the U.S., The Fed doesn't have the power to tell banks what interest rate to charge customers. So instead, The Fed manipulates interest rates by changing the money supply. If The Fed increases the money supply, there'll be plenty of money for banks to loan out. Borrowers will shop around for the best deal on a loan, and banks will be forced to lower
• 02:00 - 02:30 interest rates because they're gonna have to compete or else no one's gonna borrow from them. A decrease in money supply has the opposite effect. Less money supply means the banks have less money to loan out, so they're gonna try and get the highest interest rate possible. So less money -- higher interest rates. If the central bank wants to speed up the economy, they can increase the money supply, which will decrease interest rates, and lead to more borrowing and spending. That's called Expansionary Monetary Policy. If the central bank wants to slow down the economy, they decrease the money supply -- less money available will increase interest rates and decrease spending. That's called Contractionary Monetary Policy.
• 02:30 - 03:00 Adriene: Here's some real life examples. After the Dot Com bust and then 9-11, the U.S. economy was in a slump or a recessionary gap. Output was low, and unemployment was high. To speed up the economy, The Fed boosted the money supply, which lowered interest rates. This made borrowing easier, which increased spending, and as a result, the economy began growing again, albeit slowly. Here's another example. In the late 1970s, prices were rising up to 13% per year. Inflation
• 03:00 - 03:30 is usually more like two to four percent. The Fed Chairman, Paul Volker, decreased the money supply, causing interest rates to shoot up. People bought fewer homes and cars, and businesses invested less. Contractionary Monetary Policy drove down inflation, but with the downside of increasing unemployment. There are just no easy answers here... sorry. During The Great Depression though, The Fed blew it! 73 years later, Fed Chairman, Ben Bernanke admitted, "We did it. We're very sorry. We won't do it again."
• 03:30 - 04:00 So what did The Fed do wrong? Well there are two things that keep the banking system healthy - confidence and liquidity. When customers deposit money in a bank, they need to feel confident they're gonna get their money back. In the early years of The Great Depression, The Fed allowed several large bank to fail, which caused widespread panic and bank runs in other banks. The result was a third of all banks collapsed. The banks failed because they didn't have Liquid Assets, which is a fancypants way of saying the banks had stock, bonds, mortgages, but not cash money. So when depositors rushed
• 04:00 - 04:30 to take money out, the banks couldn't pay. The Fed gets blamed for prolonging The Depression because it didn't give banks emergency loans, which would've increased the liquidity in banks and the money supply in general. But how does a central bank change the money supply? In the U.S., there are three main ways. Let's go to the Thought Bubble... Jacob: When you deposit money in a bank, the bank holds a portion of deposits and loans the rest out. This is called Fractional Reserve Banking. The fraction deposits the banks are required to hold in reserves is conveniently called the Reserve Requirement. The first way The Fed can change the money supply is by changing that requirement. Decreasing the Reserve Requirement
• 04:30 - 05:00 will increase the money supply, and increasing the Reserve Requirement decreases the money supply. The Fed is the banker's bank, so if a commercial bank needs money, they can borrow from The Fed. The second thing The Fed can do to change the money supply is to change the interest rate that it charges banks. That interest rate is called the Discount Rate. Decreasing the Discount Rate will make it easier for banks to borrow, and that'll increase the money supply. Increasing that rate will decrease the money supply. The third way to change the money supply is difficult because it requires Janet Yellen to get approval from the Illuminati, the secret cabal that runs the world.
• 05:00 - 05:30 Nah, I'm just kidding. The third method is called Open Market Operations. This is when The Federal Reserve buys or sells short term government bonds. Now a government bond, or something called a treasury bill, is an IOU issued by the government that says, "I'll pay you back later." Banks hold those bonds because they earn interest and are generally less risky than stocks. If The Fed buys these previously issued government bonds from a bank, it increases that bank's liquidity and increases the money supply. If The Fed issues more bonds, the banks will have less liquidity and less money to loan out, and that'll decrease the money supply. In the U.S., deciding how many bonds to buy and sell is done by the Federal Open Market Committee.
• 05:30 - 06:00 Adriene: Thanks Thought Bubble! With these options at its disposal, The Fed can increase or decrease the money supply pretty darn quick. The option they use most often is Open Market Operations. During the 2008 financial crisis, when the economy was in severe recession, The Fed went straight to work, buying massive of bonds. Boosting the money supply and dropping interest rates to practically zero. But it wasn't enough - the economy was still in bad shape, so The Fed did something very
• 06:00 - 06:30 uncommon in the history of central banks. It increased its monetary stimulus through something called Quantitative Easing. We call it Q.E. at work because Q.E. rolls off the tongue more easily than Quantitative Easing. Plus, who knows how to spell quantitative? Basically it's when central banks buy up longer term assets from banks. So not only was The Fed buying regular treasury bills, it was also buying things like home loans aka Mortgage Backed Securities. They did all this with made-up money. This Q.E. has raised worries about massive inflation.
• 06:30 - 07:00 When you add a lot of made-up money to the economy, prices can rise. Milton Friedman observed, "Inflation is always and everywhere a monetary phenomenon." So if The Fed has been increasing the money supply steadily since 2008, why has the actual inflation rate stayed so low? Of course, as always, the answer is complicated. Many economists say it's because banks haven't loaned out the money. Remember, banks have to hold about 10% of their deposits in reserve. The other 90% is called Excess Reserves - pretty
• 07:00 - 07:30 straightforward - which is basically the amount that banks are free to loan out. Under normal conditions, banks would prefer not to hold a lot of excess reserves because holding money doesn't make money. But since 2008, excess reserves skyrocketed. This means that banks held the money, and it never really got into the system. Why? Some say it's the stricter lending regulations. But also, borrowing a bunch of money for a house seemed a lot scarier. Others suggest that low inflation in the U.S. is the result of uncertainty in Europe, and that's caused foreigners to hold dollars. Some argue that it's because the economy is still sputtering.
• 07:30 - 08:00 One thing's for sure, as the economy continues to pick up speed, we'll see The Fed clamping down on the money supply to increase interest rates. After all, it's The Fed's job to take away the punch bowl just as the party's getting started. Jacob: So now we've talked about the two main ways economists speed up or slow down the economy. Fiscal policy, which is changing government spending or taxes, and now monetary policy, which is changing the money supply. In an ideal world, the economy would always be perfect, and we wouldn't need these tools.
• 08:00 - 08:30 But the world isn't perfect, so sometimes, intervention is necessary. So which one is better? Well, like any clear, unambiguous question in economics, the answer is... it depends. It depends on the severity of the slump. Many economists argue that for your garden variety fluctuations, monetary policy is more effective. It's usually enacted quickly by experts whose only job is to focus on the state of the economy. But in a very severe downturn, fiscal policy might become much more effective. In 2008, the United States did both. It also depends on whether your country's central bank is tangled up in politics. The
• 08:30 - 09:00 U.S. and many other developed nations have worked hard to isolate their central banks from politicians who might be shortsighted. The result is that monetary policy generally works and doesn't have a lot of side effects. Adriene: So the next time you see Janet Yellen in a magazine, listed as one of the most influential people, you can shout, "Hey! I know who that is, and I know what she does!" The people in your dentist office might freak out, but maybe not. Jacob: Maybe they watch Crash Course Economics. Adriene: Thanks for watching - we'll see you next week. Jacob: Thanks for watching Crash Course Economics. It was made with the help of all of these nice people. Now, if you want to support Crash Course as open market operations, head on over to Patreon.
• 09:00 - 09:30 It's a voluntary subscription platform that allows you to pay whatever you want monthly to help Crash Course be free for everyone... forever. Thanks for watching! DFTBA