Today’s Warm Up

Can nations fix social ills like poverty, homelessness, and starvation by printing more money? Why or why not?

Today’s LEQ: Why was/are there problems with the banking system in command economies?

“There have been three great inventions since the beginning of time: Fire, the wheel, and central banking.”

Recall: Central Bank & Monetary Policy Central Banks – financial institution

established by the nat’l gov’t; tries to maintain price stability through monetary policy

Monetary Policy – controlling the amount of money and the availability of credit in the economy

Functions of the Central Bank Conduct monetary policy Act as the national government’s bank Serve as banker’s bank Regulate some transactions at banks

and other financial institutions

(VISUAL 2)

Central Bank & Monetary Policy

To combat inflation:Decrease money supplyDecrease amount of

credit available

CONTRACTIONARY

To combat deflation:Increase money supplyIncrease amount of credit

available

EXPANSIONARY

Inflation and Money Supply When a country transitions, price

controls are removed and inflation can become a BIG problem (i.e. Soviet Union during the 1990s)Inflation - an increase in the general price

level of any economy (opposite = deflation) Unfortunately, some transitioning

nations thought increasing their money supply could solve the problem… What do you think happened?

Inflation and Money Supply Growth Rates,1987-1997(VISUAL 3)

Central Banking Independence Market economies: central banks

are independent from the legislative and executive branches of the government

Command economies: central planners determine monetary policy

Consider the following scenario… In the year 2012, inflation is a serious

problem in the U.S. economy, so the Federal Reserve System tightens the money supply and reduces the availability of credit, which causes interest rates to rise. Meanwhile, President Obama, all of the House of Representatives, and a third of the Senate are running for re-election.

How do you think these political candidates will feel about the results of the new monetary policy?

Central Banking Independence There is a correlation between high

central banking independence and a low rate of inflation

WHY?Central bank officials who are not elected

can better hold the line against inflation!○ Less pressure to create or print new money to

fund government borrowing for new programs○ Can act in ways that make better sense for

the economy (even if it’s not politically popular)

Activity 2 / Visual 4 – Central Bank and Inflation

What is the relationship between central bank independence and inflation?

Central Banking Independence and Inflation

The BIG Concepts!!! Inflation is directly related to increases

in the money supply Central banks are created by

governments in most nations to conduct monetary policy.

The more independent a nation’s central bank is from political control and pressure, the lower the inflation rate in the nation tends to be (increasing overall prosperity)

Visual 6

Identify the three countries that are most likely to have independent central banks.

Explain your choices.