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Week 10 · Lecture outline

Week 10 — Lecture Outline · The Federal Reserve & Monetary Policy

Principles of Macroeconomics · ECON 2 Fall 2026 · Prof. Ashford Fictional sample

Course: Principles of Macroeconomics (ECON 2) · Silver Oak University (fictional sample) · Prof. Ashford
Objective 7 — money, banking & monetary policy; the Fed's structure and tools; the money market · SLO A & B
Meeting pattern: two 75-min sessions (≈150 min). Segment minutes below total ~150 — scale to your room.

The deck (E), the tutorial (C), and the workshop (P) all teach from this outline. Every number here is pre-computed and independently verified (see the verified box in §4; full re-check in _build/logs/week-10-numbers.txt).

Week at a glance
Big question What does the Federal Reserve actually do, and how do its tools move the interest rate through the money market?
By week's end students can (1) describe the Fed's structure (Board of Governors, 12 regional Reserve Banks, the FOMC) and its dual mandate; (2) name the Fed's four policy tools and state which direction each moves the money supply; (3) read the money market model — downward-sloping money demand, vertical money supply — and shift money supply either direction to find the new interest rate; (4) state why an interest-rate change moves ALONG money demand and never shifts it; (5) reason evenhandedly about Fed independence.
Key vocabulary the Federal Reserve System, Board of Governors, 12 regional Federal Reserve Banks, the Federal Open Market Committee (FOMC), dual mandate, price stability, maximum employment, open-market operations (OMO), discount rate, reserve requirement (RR), interest on reserves (IOR), ample-reserves regime, money demand, money supply, equilibrium interest rate, movement along vs. shift
Materials whiteboard; the Week-10 readings/links; Desmos or a spreadsheet for the money market; an approved chatbot
Timing note 8 segments ≈ 150 min across two sessions. Trim Segment 7 (interaction) if short on time.

Segment 1 — HOOK: "Who actually sets 'the interest rate'?" (12 min)

Open by asking the room: "When the news says 'interest rates went up,' who exactly did that?" Let answers land — someone will say "the banks," someone "the government," someone might already know "the Fed." Reframe: "There's one institution in the U.S. economy whose entire job is influencing the money supply and interest rates — the Federal Reserve, 'the Fed.' It is NOT part of Congress and it does NOT spend money on roads or send tax refunds — that's fiscal policy, a different toolbox entirely (Week 7). The Fed's toolbox is monetary policy, and this week we open it."

Draw the line the week rests on: fiscal policy = Congress and the President (government spending and taxes); monetary policy = the Federal Reserve (the money supply and interest rates). Two different institutions, two different toolkits, one shared goal: a healthy macroeconomy. Mixing them up is one of the classic macro confusions — name it now so it doesn't recur all week.

Segment 2 — PLAIN-LANGUAGE IDEA: the Fed's structure & the dual mandate (20 min)

Teach the structure factually, in plain language, from the Fed's own published description of itself (see the Week-10 readings):

The Federal Reserve System has three main parts: (1) the Board of Governors in Washington, D.C. — seven members who oversee the whole system; (2) 12 regional Federal Reserve Banks spread across the country, each serving its own district; (3) the Federal Open Market Committee (FOMC) — the group that actually meets and votes on monetary-policy decisions, including the Board plus a rotating set of regional Reserve Bank presidents.

The dual mandate — Congress has directed the Fed to pursue two goals at once: stable prices (keep inflation low and predictable) and maximum employment (keep the job market as strong as sustainably possible). Say it plainly: these two goals can occasionally pull in different directions (fighting inflation with tighter policy can cool the job market; fighting unemployment with looser policy can add to inflation pressure) — that tension is exactly why monetary policy is a genuinely hard balancing act, not a mechanical formula. State this factually and evenhandedly: reasonable economists disagree about how the Fed should weigh the two goals in any given moment — we are not adjudicating that here, just naming the mandate.

Memory hook: "Board sets the vision, 12 Banks run the districts, the FOMC pulls the trigger."

Segment 3 — WORKED EXAMPLE #1: the Fed's policy tools & which way each moves the money supply (22 min)

Build this as a two-column board list: TOOL → EFFECT ON MONEY SUPPLY (MS). Every entry below is pre-computed and does not change.

Four tools, taught factually (see the Week-10 readings for the Fed's own description of each):

  1. Open-market operations (OMO) — the Fed buys or sells government bonds in the open market.
    - Fed buys bonds → pays banks with new reserves → banks have more to lend → MS increases (shifts right) → interest rate falls.
    - Fed sells bonds → banks pay the Fed, draining reserves → banks have less to lend → MS decreases (shifts left) → interest rate rises.
  2. The discount rate — the interest rate the Fed charges banks that borrow directly from it.
    - Discount rate ↑ → borrowing reserves from the Fed gets more expensive → banks hold back → MS decreases.
    - Discount rate ↓ → cheaper to borrow reserves → MS increases.
  3. Reserve requirements (RR) — the fraction of deposits banks must hold back (recall Week 9's money multiplier, 1/RR).
    - RR ↑ → banks must hold more, lend less of each deposit → MS decreases.
    - RR ↓ → banks can lend more of each deposit → MS increases.
  4. Interest on reserves (IOR) — the rate the Fed pays banks on reserves parked at the Fed.
    - IOR ↑ → holding reserves at the Fed becomes more attractive than lending them out → banks lend less → MS decreases.
    - IOR ↓ → less reason to sit on reserves → banks lend more → MS increases.

Say it in one line (the SLO-A habit): "Buy bonds, cut the discount rate, cut RR, or cut IOR — MS goes up, rates fall. Sell bonds, raise the discount rate, raise RR, or raise IOR — MS goes down, rates rise." Modern note (one line, factual): today's Fed operates in an ample-reserves regime and administers rates mainly through IOR and related tools rather than constantly trading small amounts of bonds — but all four tools above remain the standard teaching model for how each one moves MS.

Segment 4 — THE MONEY MARKET: where money demand meets money supply (28 min)

Now the week's centerpiece graph. The money market has two curves: money demand (Md), sloping down (people and firms want to hold less money — more bonds — as the interest rate rises, since bonds pay more); and money supply (Ms), a vertical line at whatever quantity the Fed has set (the Fed controls the quantity, not directly the price/rate).

Build the model from the anchor scenario (described-graph walkthrough — draw it as you go):

Money demand: r = 12 − M/100 (M in billions of dollars, r in percent). Money supply is vertical at M = 600.

✅ VERIFIED NUMBERS (pre-computed; do not recompute live — full check in _build/logs/week-10-numbers.txt)

  • Base equilibrium: plug M = 600 into Md: r = 12 − 600/100 = 12 − 6 = 6%. Read it off the graph: where the vertical Ms line at 600 crosses the downward-sloping Md line, r = 6%.
  • The Fed buys bonds → Ms shifts right to M = 700 → r = 12 − 700/100 = 12 − 7 = 5%. (Buying bonds pumps reserves in, MS rises, and the new, larger Ms line crosses Md at a LOWER interest rate.)
  • The Fed sells bonds → Ms shifts left to M = 500 → r = 12 − 500/100 = 12 − 5 = 7%. (Selling bonds drains reserves, MS falls, and the new, smaller Ms line crosses Md at a HIGHER interest rate.)

Read the graph out loud (the four things this graph shows at once):
1. Money demand slopes down — at a high interest rate, people economize on cash and hold more interest-bearing bonds instead; at a low rate, cash's "cost" (forgone interest) is small, so people hold more of it.
2. Money supply is vertical — the Fed sets the quantity of money directly through its tools; it isn't set by a price the way an ordinary supply curve is.
3. The intersection sets r — wherever the vertical Ms line crosses the downward-sloping Md line is the equilibrium interest rate.
4. Only Ms shifts in this chapter's story — the Fed's tools move the vertical line left or right; Md stays put unless something other than the interest rate itself changes (income, price expectations — not this week's focus).

The rule that prevents the #1 mistake this week: an interest-rate change, all by itself, does NOT shift Md — it moves you along the existing Md curve. Md only shifts (the whole line moves) if something changes that isn't the interest rate — like a change in aggregate income. This week's story is entirely about the Fed shifting Ms; Md is the fixed backdrop you read off, never the thing you shift.

Segment 5 — THE TOOLS → EFFECTS MAP + MISCONCEPTIONS (15 min)

Recap the whole map as one clean matching table (this is literally next week's — sorry, THIS week's — quiz matching item):

Tool Direction Effect on MS Effect on r
Buy bonds (OMO) — MS↑ (shifts right) r↓
Sell bonds (OMO) — MS↓ (shifts left) r↑
Discount rate ↑ MS↓ r↑
Discount rate ↓ MS↑ r↓
Reserve requirement (RR) ↑ MS↓ r↑
Reserve requirement (RR) ↓ MS↑ r↓
Interest on reserves (IOR) ↑ MS↓ r↑
Interest on reserves (IOR) ↓ MS↑ r↓

Named misconceptions + cures:
- "Buying bonds sounds like the Fed is spending money on stuff — that's fiscal, right?" No — buying bonds is a monetary tool: the Fed is trading bonds for bank reserves in the financial system, not funding government programs. Fiscal policy (Week 7) is Congress choosing G and taxes.
- "An interest-rate change shifts money demand." No — it moves along the existing Md curve. Only Ms shifts here, and only because the Fed moved one of its four tools.
- "Buy bonds must raise rates — the Fed is 'buying,' so it sounds expensive/tightening." No — buying bonds injects reserves, MS rises, and rates fall. "Buy" and "sell" describe what the Fed does to bonds, and the rate effect runs the opposite direction of the intuitive "buying = tightening" guess.
- "Higher reserve requirements let banks lend more (more reserves sitting around)." No — a HIGHER reserve requirement means banks must hold BACK more of each deposit, so they lend LESS — MS falls.

Segment 6 — TECHNOLOGY WORKFLOW + AI-CRITIQUE (20 min)

Live demo (Desmos or spreadsheet): graph Md: r = 12 - M/100 and the vertical line M = 600; find the intersection (600, 6). Then drag/redraw the vertical line to M = 700 (buy bonds) and read the new intersection (700, 5); redraw to M = 500 (sell bonds) and read (500, 7).

AI-critique moment (do this with the class): Ask an approved chatbot: "Money demand is r = 12 − M/100, with M in billions. Money supply is vertical at M = 600. If the Fed buys bonds and money supply rises to M = 700, what happens to the interest rate? Does buying bonds shift money demand or money supply?" Then audit it together: the right answers are r falls from 6% to 5%, and it is money SUPPLY that shifts (the vertical line moves right) — money demand does NOT shift; the interest-rate change is a movement ALONG the fixed Md curve, not a shift of it. Chatbots frequently say buying bonds raises rates (the "buying sounds expensive" trap), or claim the interest-rate change shifts money demand, or mix up which curve is vertical. Make the class catch the error and state the correct reasoning. The habit all term: the tool drafts, you judge.

Segment 7 — INTERACTION: mini-debate / classify-the-tool (12 min)

Pose four tool-change scenarios, one at a time, thumbs up (MS↑, r↓) or thumbs down (MS↓, r↑): "The Fed sells bonds." (down — MS↓, r↑) "The Fed cuts the discount rate." (up — MS↑, r↓) "The Fed raises reserve requirements." (down — MS↓, r↑) "The Fed cuts interest on reserves." (up — MS↑, r↓). This previews Quiz 10's tool→effect matching item directly and forces the class to commit to a direction out loud before checking.

Segment 8 — CALLBACKS, TEASE & THE WEEK'S WORK (8 min)

  • Callback: every tool this week does exactly one of two things — adds reserves to the banking system (MS↑, r↓) or drains them (MS↓, r↑) — and the money market graph is just a picture of where the resulting Ms line crosses the (unchanging, this week) Md line.
  • Tease next week: "We've found the new interest rate — but so what? Next week we follow that rate all the way to investment spending, the multiplier, and Aggregate Demand itself: the full transmission mechanism from a Fed decision to a change in real output."
  • The week's work: Lecture Tutorial (Fed structure → dual mandate → tools → the money market → movement-along vs. shift), Practice (6 reps), Quiz 10, Discussion 10, Assignment 10, and Workshop 10 (build the money market on Desmos and shift Ms both directions).

Instructor FAQ — common stumbles

  • "Isn't 'the Fed' just another part of the government budget — like fiscal policy?" No — the Fed is the nation's central bank, running monetary policy (the money supply and interest rates); Congress and the President run fiscal policy (spending and taxes, Week 7). Different institutions, different toolkits.
  • "Buying bonds should tighten money, since 'buying' sounds like spending." The direction is the opposite of the intuitive guess: buying bonds pays banks with new reserves, so MS rises and rates fall. Selling bonds does the reverse.
  • "Does a rate change shift money demand?" No — never this week. An interest-rate change is a movement along the existing Md curve. Md only shifts if something other than the rate itself changes (e.g., income) — not this week's story.
  • "Higher reserve requirements sound like banks have MORE reserves to lend — more requirements, more reserves?" Careful: a higher RR means banks must hold back more of each dollar deposited, so they can lend less — MS falls, not rises.
  • "Why is money supply drawn as a straight vertical line instead of sloping like an ordinary supply curve?" Because the Fed sets the quantity of money directly with its tools — it isn't a response to price the way a firm's supply curve is. The graph's vertical line IS the model's way of showing "the Fed picked this quantity."
  • "What's the 'ample-reserves' note about — does it change any of this week's tool logic?" No — it's a modern-operations footnote: today's Fed mostly administers rates via interest on reserves rather than constantly trading small amounts of bonds day to day, but the four tools and their MS-direction effects taught this week remain the standard teaching model.

~ Prof. Ashford's edition · Fall 2026 · built with thecoursemaker.com