The Federal Reserve System conducts monetary policy to help stabilize fluctuations in the economy. It is geared toward altering money supply and interest rates so it can influence decisions pertaining to lending, borrowing, spending, and investing. These decisions have a direct impact on output, income, employment, and inflation rates. Monetary policy uses the following tools:

• Open market operations
• Reserve ratio
• Discount rate
• Federal funds rate
• Term Auction Facility

Students should understand how the Federal Reserve Board (Fed), financial institutions, and the public act and interact, and how monetary policy works through influencing money supply, credit access, and interest rates to impact aggregate demand and the economy. Students who learn and understand concepts such as Reserve requirement, actual reserves, required reserves, excess reserves, money multiplier, federal funds rate, discount rate, prime rate, open market operations, Term Auction Facility, cyclical asymmetry, and the liquidity trap will be able to connect and relate their academic learning to real world reports, policies, and news pertaining to the economy.

The following activity is designed to help students in economics courses understand how monetary tools are used by the Federal Reserve System to stabilize business cycles and fluctuations. Class participation and interaction promote cooperative and active learning through teamwork and small group discussion.

Context

Group activities and class participation promote cooperative and active learning. Research reveals that students learn better when they are engaged. This activity is appropriate for college and university students learning monetary policy; it is likely to be more effective if class size does not exceed 30 students.  

In this activity, students learn and understand how financial institutions, investors, and borrowers react as the Fed enacts monetary tools in response to business and economic fluctuations. Monetary tools are utilized to influence money supply, interest rates, credit access, and portfolio decisions as factors affecting business cycle and economic outcomes. Students are exposed to concepts such as required and excess reserves, reserve ratio, federal funds rate, discount rate, open market operations, Term Auction Facility, and liquidity trap.

Students are organized into three teams of similar size. Team 1 represents the Fed; Team 2 represents financial institutions; and Team 3 represents the public, representing borrowers, consumers, and investors. Teams are provided with information concerning the state of a hypothetical economy, and each team proceeds according to roles outlined below.

Team Roles

Team 1 researches the structure, functions, and policies of the Fed and prepares a short written report of their findings. In the report, the team also proposes the appropriate policy the Fed should undertake to help stabilize and restore a healthy economic condition. The report specifies the monetary tools to be used by the Fed and the likely outcomes. Also, this team speculates on the reactions of the other two teams.

Team 1 should address the following questions, along with others identified by team members or the instructor:

• What is the current or projected state of the economy?
• What is the appropriate monetary policy for current or projected economic conditions?
• What monetary tools should be used and how should they be used?
• What outcomes are expected from implementing such policy?

Team 2 conducts research and writes a short report on the structure, functions, and roles of financial institutions in the economy. This report specifies how financial institutions would react to the policy enacted by Team 1. Team 2 also outlines the connection between financial institutions and the Fed within the framework of monetary policy.

Team 2 should address the following questions, along with others identified by team members or the instructor:

• What is the current or projected state of the economy?
• What policies is or will the Fed undertake to address the issues facing the economy?
• How should or must financial institutions react to the Fed?s policies?
• How will the Fed's policies impact financial institutions? lending and credit policies?
• In what ways may financial institutions? strategies conflict with the Fed?s strategies and policies?

Team 3 investigates and writes a short report on how the public may react to the Fed policy, as well as reactions to the incentives provided by financial institutions. This team will explore the factors that impact public borrowing, spending, saving, and investing in capital projects.

Team 3 should address the following questions, along with others identified by team members or the instructor:

• How does this group understand the current and projected state of the economy?
• What policies are being undertaken by the Fed?
• What are socioeconomic factors impacting decisions pertaining to borrowing, spending, investing, and saving?
• How is consumption, saving, and investing likely to impact the economy?
• In what ways may consumption, saving, and capital investments conflict with monetary policy?

Class Discussion

Teams are provided a deadline for completion of their reports, and a date is set for a class discussion of the findings. On the day for class discussion, students are divided into small groups comprised of members from each team (e.g., a small group of six would have two representatives from each team). In their small groups, all members present their respective team reports and discuss the perspectives of the various teams. By the end of the activity, each student will have exposure and understanding of the structure, components, and dynamics of monetary policy.

Assessment

To assess student learning and the impact of the activity, the instructor may use the following methods or devise other assessment options:

• Students can prepare group reports on what they have done and learned.
• Students can write individual reports on their specific roles and experiences in interacting within teams and groups, and what they have learned about monetary policy. 

Teaching Notes

• The instructor may assign teams and groups the task of researching the state of the economy in the real world, or may propose a hypothetical economy having a recession or perhaps encountering demand-pull inflation.
• The instructor should decide what sources and references teams and groups may use.
• The instructor should provide teams and groups with timelines and deadlines for the activity.
• The instructor should provide teams and groups with guidelines for in-class as well as out-of-class group interactions.
• The instructor should design and inform students of the assessment process and the criteria by which they will be graded and receive credit for the activity.
• Before groups begin their work, the instructor should ensure that all students understand all components and steps the groups will perform to complete the activity.

Ribhi Daoud is a professor of economics at Sinclair Community College, OH.

Opinions expressed in Innovation Showcase are those of the author(s) and do not necessarily reflect those of the League for Innovation in the Community College.