5-3-06: Nebraska’s 5-3-06: Nebraska’s Unemployment RateUnemployment Rate

3.2%3.2%– Down .2%Down .2%

IS THIS IS THIS NECESSARILY A NECESSARILY A ‘GOOD’ NUMBER?‘GOOD’ NUMBER?

Summarize your investment Summarize your investment strategystrategy

Read Bob Bennie’s letter on growth Read Bob Bennie’s letter on growth and value investing.and value investing.

WHICH STRATEGY ARE YOU WHICH STRATEGY ARE YOU USING? USING?

Monetary PolicyMonetary Policy

Chapter 14Chapter 14

How to “fix” a broken economyHow to “fix” a broken economy

Who is Ben Bernanke?Who is Ben Bernanke?

1953 – 1953 – Bachelor’s Degree Bachelor’s Degree

Harvard / PhD from MITHarvard / PhD from MIT Taught econ at PrincetonTaught econ at Princeton Wrote textbooks, articles Wrote textbooks, articles

on econ issueson econ issues Headed National Bureau Headed National Bureau

of Econ Research.of Econ Research.– Collected data for Collected data for

government, industry and government, industry and the Federal Reservethe Federal Reserve

How did Bernanke become the How did Bernanke become the Fed Chairman?Fed Chairman?

Short list for the Short list for the President.President.

Nominated, Nominated, interviewed by the interviewed by the Senate and voted on.Senate and voted on.

7 year term7 year term– TRIVIA: Ben TRIVIA: Ben

Bernanke’s title is:Bernanke’s title is:– Chairman of the Board Chairman of the Board

of Governors of the of Governors of the Federal ReserveFederal Reserve

Federal Reserve Transition Federal Reserve Transition Problems?Problems?

Will there be transition problems Will there be transition problems for Bernanke?for Bernanke?

Something to Remember!Something to Remember!

There are only TWO There are only TWO ways that government ways that government can influence the can influence the economy:economy:– FISCAL POLICYFISCAL POLICY

» What Congress / What Congress / President can doPresident can do

– MONETARY MONETARY POLICYPOLICY

» What Alan Greenspan What Alan Greenspan did and now Ben did and now Ben Bernanke can doBernanke can do

Monetary Policy = The “Fed”Monetary Policy = The “Fed”

Federal Reserve BankFederal Reserve Bank– The government’s The government’s

bankbank

– Regulates all FDIC Regulates all FDIC banks in the countrybanks in the country

– Controls the money Controls the money supply for the country.supply for the country.

» Watches for inflationWatches for inflation

» Keeps money available Keeps money available but valuable to people.but valuable to people.

Federal Reserve DistrictsFederal Reserve Districts

Monetary Policy – 1 More and Monetary Policy – 1 More and Controversial “Duty”Controversial “Duty”

ADVISEADVISE– PresidentsPresidents

– CongressCongress

– The Stock MarketThe Stock Market

– Advice is not always Advice is not always welcomed! welcomed!

How does the Fed control the How does the Fed control the economy?economy?

Controls the money Controls the money supply for the banks.supply for the banks.

INTEREST INTEREST RATESRATES

REVIEW:REVIEW:

What are “INTEREST What are “INTEREST RATES”?RATES”?– How much money How much money

COSTS to get.COSTS to get.» $3000 loan from a bank $3000 loan from a bank

might have 10% might have 10% interest. interest.

You pay $3,300 back You pay $3,300 back to the bank.to the bank.

Profit for banksProfit for banks

So how did Ben Bernanke cause So how did Ben Bernanke cause your stocks to go down?your stocks to go down?

Situation from April 28, 2006Situation from April 28, 2006

Ben Bernanke had Ben Bernanke had recently been reported recently been reported saying:saying:– ““The Fed is finished The Fed is finished

raising interest rates raising interest rates for the time being.”for the time being.”

» 15 increases since 15 increases since Spring 2004 were Spring 2004 were “enough.”“enough.”

But on April 29, 2006But on April 29, 2006

Speaking to a CNBC Speaking to a CNBC reporter, he said:reporter, he said:– ““I think that the I think that the

reporters reporters misunderstood misunderstood my my position on interest position on interest rates for the rates for the foreseeable future.”foreseeable future.”

                                                                         

                           

Result? May 1 and May 3Result? May 1 and May 3

Bernacke’s comments Bernacke’s comments were reported at 2:45 were reported at 2:45 PM. By 3:15 the PM. By 3:15 the DOW fell 70 points.DOW fell 70 points.

Wednesday’s down Wednesday’s down markets were markets were supposed to be supposed to be investor “jitters about investor “jitters about the Fed.”the Fed.”

Why would investors care what Why would investors care what interest rates are going to be?interest rates are going to be?

Why would the Fed keep Why would the Fed keep increasing interest rates?increasing interest rates?

Fears about inflation?Fears about inflation?– Demand-pull inflation?Demand-pull inflation?

– Wage inflation?Wage inflation?

– Fears that there is too Fears that there is too much velocity to the much velocity to the dollar?dollar?

Cramer’s Question:Cramer’s Question: “Does the Fed want to create a “Does the Fed want to create a

RECESSION???”RECESSION???” IF there is inflation in IF there is inflation in

the economy – the economy – YES! The Fed could YES! The Fed could

want to create a want to create a recession.recession.

REVIEW:REVIEW:

What is a RECESSION?What is a RECESSION?– People HAVE money, but People HAVE money, but

don’t feel “safe” about don’t feel “safe” about spending it.spending it.

» Creates unemploymentCreates unemployment

» Bad econ dataBad econ data

» Creates MORE Creates MORE unemployment.unemployment.

– 2 or more business 2 or more business quarters where economic quarters where economic activity decreases.activity decreases.

» OFFICIAL definitionOFFICIAL definition

How could raising interest rates How could raising interest rates cause a recession?cause a recession?

If interest rates go UPIf interest rates go UP– People spend lessPeople spend less

– People don’t take out People don’t take out loansloans

– People SAVE their People SAVE their moneymoney

– Money increases in Money increases in valuevalue

» PURCHASING PURCHASING POWER GOES UP!POWER GOES UP!

» Inflation “deflates”Inflation “deflates”

Opportunity Costs of a Opportunity Costs of a Recession?Recession?

Unemployment goes Unemployment goes up.up.

Wages go Wages go down.down.– More supply than More supply than

demand for workers.demand for workers.

– Less frictional Less frictional unemployment.unemployment.

– Government collects Government collects less taxes and people less taxes and people want more aid.want more aid.

So what does that mean for your So what does that mean for your stock portfolios?stock portfolios?

DO NOT PANIC!DO NOT PANIC!

The Fed has been The Fed has been gently “tapping the gently “tapping the brakes” on the brakes” on the economy since Spring economy since Spring 2004 to slow us down 2004 to slow us down enough that a enough that a recession may not recession may not happen.happen.– OR be very short and OR be very short and

mild.mild.

History of History of RecessionsRecessions in the US in the US

Description for 2006’s Description for 2006’s Economy?Economy?

StrongStrong OutperformingOutperforming BUTBUT

– Soft patchesSoft patches

– Inflationary pressures Inflationary pressures and expectationsand expectations

So, what can the Fed do to keep the So, what can the Fed do to keep the economy going, but not have inflation?economy going, but not have inflation?

Keep interest rates the Keep interest rates the same?same?

Raise interest rates Raise interest rates another .25%?another .25%?– 6%6%

Raise interest Raise interest rates .5%?rates .5%?– 6.25%6.25%

» MOAIRH!MOAIRH! MMother other OOf f AAll ll

IInterest nterest RRate ate HHikesikes

The Goals of the Federal ReserveThe Goals of the Federal Reserve

Regulating the money supplyRegulating the money supply Serving as the government’s bankServing as the government’s bank Bank for banksBank for banks Supervising FDIC banks.Supervising FDIC banks.

– Clearing checksClearing checks– loansloans

The Money Supply: Types of The Money Supply: Types of MoneyMoney

M1: Money that is M1: Money that is readily made into cash readily made into cash or is cash.or is cash.

M2: M1 + savings CDs, M2: M1 + savings CDs, money markets, money markets, savings deposits.savings deposits.

M3 and L: M1 + M2 + M3 and L: M1 + M2 + large CDs, short term large CDs, short term treasury bonds and treasury bonds and otherother““near money.”near money.” 0

100

1stQtr

4thQtr

EWN

The Federal Reserve tries to affect The Federal Reserve tries to affect DEMAND for money, goods, and DEMAND for money, goods, and

servicesservices Specifically – Specifically –

AGGREGATE AGGREGATE demanddemand– Aggregate Demand = Aggregate Demand =

TOTAL demandTOTAL demand» EVERYTHING that is EVERYTHING that is

consumed in the consumed in the economy.economy.

How does the Fed affect How does the Fed affect aggregate demand?aggregate demand?

IF things cost more, IF things cost more, does that affect how does that affect how much we DEMAND?much we DEMAND?

If things cost less – do If things cost less – do we tend to demand we tend to demand more?more?

It all demands on the It all demands on the COST, or the COST, or the purchasing power of purchasing power of our dollar. our dollar.

How does the Fed affect How does the Fed affect aggregate demand?aggregate demand?

The Fed changes the The Fed changes the price of money to price of money to affect:affect:– Consumer demandConsumer demand– Investor demandInvestor demand– How much money How much money

government will want / government will want / getget

– The value of American The value of American exports compared to exports compared to importsimports

IF the Fed wants to help IF the Fed wants to help unemployment or a slow economy: unemployment or a slow economy:

RecessionRecession EASY MONEY EASY MONEY

POLICY: (Loose POLICY: (Loose Money Policy)Money Policy)– Interest rates go Interest rates go

DOWN – money is DOWN – money is CHEAP!CHEAP!

– Consumers spend!Consumers spend!

– Investors spend!Investors spend!

– American exports are American exports are cheaper than imports!cheaper than imports!

Easy Money PolicyEasy Money Policy

Employment goes up!Employment goes up! GDP goes UP!GDP goes UP! Economic Recovery or Economic Recovery or

Peak in the business Peak in the business cycle.cycle.

BUT: If the economic engine is BUT: If the economic engine is running “too hot” and inflation is running “too hot” and inflation is

happening?happening? TIGHT MONEY TIGHT MONEY

POLICY:POLICY:– SLOW the economy SLOW the economy

down.down.

– RAISE the interest RAISE the interest rates so money costs rates so money costs MOREMORE

If Interest Rates Go UP?If Interest Rates Go UP?

Consumer goods cost Consumer goods cost MOREMORE

Loans cost MORELoans cost MORE– People don’t buy on People don’t buy on

creditcredit– People don’t take out People don’t take out

loansloans– Businesses don’t take Businesses don’t take

out loansout loans– Imports cost less than Imports cost less than

American made goodsAmerican made goods

Tight Money PolicyTight Money Policy

Unemployment goes Unemployment goes up.up.

People save more.People save more. Wages go downWages go down Prices go down.Prices go down.

2006: The Fed is engaged in 2006: The Fed is engaged in Tight Money Policy - kindaTight Money Policy - kinda

Have 15 “tiny” Have 15 “tiny” increases in the price increases in the price of money been enough of money been enough to affect behavior?to affect behavior?

What does the Fed What does the Fed want out of us?want out of us?

So, what can the Fed do to keep the So, what can the Fed do to keep the economy going, but not have inflation?economy going, but not have inflation?

Keep interest rates the Keep interest rates the same?same?

Raise interest rates Raise interest rates another .25%?another .25%?– 6%6%

Raise interest Raise interest rates .5%?rates .5%?– 6.25%6.25%

» MOAIRH!MOAIRH! MMother other OOf f AAll ll

IInterest nterest RRate ate HHikesikes

Concerns about the future:Concerns about the future:Inversion of the Yield Curve Inversion of the Yield Curve

Yield Curve Inversion: A signal Yield Curve Inversion: A signal of recession?of recession?

USUALLY: The USUALLY: The longer you put money longer you put money into a CD / Bond – the into a CD / Bond – the more money you more money you should get more should get more interest. Right?interest. Right?

With the present curve With the present curve the answer is the answer is WRONG!WRONG!– What does this mean??What does this mean??

» WE DON”T KNOW!WE DON”T KNOW!

Ben Bernanke’s Tools for the Ben Bernanke’s Tools for the EconomyEconomy

Open Market Open Market Operations.Operations.

Discount RateDiscount Rate Prime ratePrime rate Reserve RequirementsReserve Requirements

Open Market OperationsOpen Market Operations

If Bernanke wants to get more money into If Bernanke wants to get more money into the economy he BUYS government bonds the economy he BUYS government bonds from banks. from banks. – Banks have more money to loan to customers.Banks have more money to loan to customers.– People then have more money to consume and People then have more money to consume and

invest.invest.– A way to quickly “inject” money or take it out of A way to quickly “inject” money or take it out of

the economy.the economy.

Reserve RequirementReserve Requirement

Money that must be held by banks in their Money that must be held by banks in their vaults or at the Fed. vaults or at the Fed. -Raise the reserve requirements on a bank. They -Raise the reserve requirements on a bank. They

have LESS money to loan to customers. have LESS money to loan to customers.

Less money is available – it makes the price of Less money is available – it makes the price of money (the interest rate) go up. SCARCITY. money (the interest rate) go up. SCARCITY.

Makes C and I go down. Makes C and I go down.

FOMC Meetings: Where the Fed FOMC Meetings: Where the Fed gives people a “peek” at what they gives people a “peek” at what they

are doingare doing

KEY INTEREST RATESKEY INTEREST RATES

DISCOUNT RATE: DISCOUNT RATE: – What it costs for banks to What it costs for banks to

borrow from the Fed.borrow from the Fed.» 5.75%5.75%

PRIME RATE:PRIME RATE:– Rate for best customers!Rate for best customers!

FED FUNDS RATE:FED FUNDS RATE:– What it costs for banks to What it costs for banks to

loan money to each other.loan money to each other.» Currently: 4.75%Currently: 4.75%

Problems with Monetary Policy?Problems with Monetary Policy?

Economic forecasting Economic forecasting might not be quite might not be quite correct.correct.

Greenspan’s priorities Greenspan’s priorities might not be the might not be the publics.publics.

Lack of coordination Lack of coordination with fiscal policies.with fiscal policies.

Remember: The FED is not Remember: The FED is not YOUR bankYOUR bank

It is the government’s It is the government’s bankbank

It is the bank for banksIt is the bank for banks They won’t open an They won’t open an

account for you!account for you!