> > We Buy Anything: an in-class activity demonstrating the Fed's response to the financial crisis of 2008

We Buy Anything: an in-class activity demonstrating the Fed's response to the financial crisis of 2008

Lucy Malakar, Lorain County Community College, lmalakar@lorainccc.edu
Laura Wind-Norton, Nicolet College, lwindnorton@nicoletcollege.edu
This material is replicated on a number of sites as part of the SERC Pedagogic Service Project

Summary

This activity engages students and underscores how quickly and dramatically the Federal Reserve System responded to the financial crisis of 2008. By having students assume the role of various economics players: from commercial banks to foreign governments, this activity highlights how the Fed's operations changed during the crisis. Since the crisis and the adoption of a 0% Federal Funds Rate target, the Fed has shifted toward 'balance sheet' policies.

Learning Goals

1. Students will apply the concepts of modern monetary policy tools to a macroeconomic crisis situation.
2. Students will show the effects of expansionary and contractionary monetary policy.

Context for Use

Students should have a basic understanding of the Federal Reserve system and the basic tools of monetary policy. Students should have been introduced to the Fed's balance sheet. Background of the financial crisis will help to set the stage for the activity. This activity is designed for community college economics students in small to medium class sizes (up to 50 students) in a face-to-face setting.

Description and Teaching Materials

Steps in the activity:

  • Upon entering class, each student gets a piece of paper that describes who they are and what they have to sell (e.g., you are the CFO of Marriot Hotels and have $30 million dollars of bonds they would like to sell or you are the Central Bank of Germany and want to sell 50 million euros).
  • The instructor plays the role of the Federal Reserve System. The instructor will meet with each group/individual to make sure they understand the situation they have been given.
  • Initially, the Fed will only buy short-term Treasuries from member commercial banks (like PNC). This represents the Fed's main monetary policy tool from 1913 until the Fall of 2008.
  • As macroeconomic conditions deteriorate (this might be best illustrated using the timeline link or another timeline of events during the crisis), the Fed begins to buy different types of financial instruments from a wider variety of institutions. This represents the new monetary policy tools that the Fed created in response to the financial crisis. As the Fed is buying these financial assets, one student or a group of students can play the role of an accountant and keep track of the growth of the Fed's balance sheet.
    • To show the market condition deterioration, the instructor could use a timeline of the crisis (one is referenced below). A dynamic or animated timeline would be ideal, but the instructor can do something as simple as indicating the passage of time and suggesting what new event has occurred and what the Fed in now willing to buy.
  • When the Fed is done buying all the assets in the room, students discuss the impact these activities will have on the money supply and the macroeconomy.
  • To illustrate how the Fed can potentially reverse these policies when needed and decrease its balance sheet, when it comes time for Marriott to pay back the Fed (because the bonds have matured) the teacher (Fed) will simply throw that money into the trash. This is done as a visual illustration of the Fed taking the money they initially created back out of the system (as they would have to do in order to reverse the policy.)



Teaching Materials:
- Play money (total amount to correspond to amount of assets that players need to sell). There are a number of online sites that allow you to create and print your own money in the denominations of your choosing.
- Notecards/ sheets of papers representing different assets for Fed to purchase: (see sample template)
o Treasury bills held by banks
o Mortgage-backed securities held by banks/investment companies/others
o Corporate bonds
o Foreign central banks selling currencies
- Scenario for students to understand the needs of their organization (bank, investment firm, corporation, etc)
- Whiteboard or similar to track the balance sheet of the Fed
- Timeline for the financial crisis (to put activity into context)
Student role scenarios (Microsoft Word 2007 (.docx) 14kB Apr5 13)
Traditional and New Monetary Policy Tools (Microsoft Word 43kB Apr5 13)


Teaching Notes and Tips

Students can be grouped to make the activity more manageable. Instructor should meet with each group to insure they understand the crisis their institution faces. Remind students that the Fed doesn't really do cash transactions; reserves are added electronically. To expand the activity, some students could be made to be unwilling lenders that have to be approached first to increase the pressure to find a way for the institution to finance its needs.

Assessment

Students will write a brief reflection about what they learned in the exercise about the Federal Reserve's role as the lender of last resort and its effect on the macroeconomy. A possible prompt for the writing: Based on today's activity, write a paragraph about what the Fed did as a response to the financial crisis and what the Fed was trying to accomplish. An instructor could also use a "muddiest point" assessment: Based on today's activity, what part of the Fed's response to the financial crisis do you still have questions about? This can serve as a basis for a review activity or a follow-up lecture.

References and Resources

Federal Reserve Crisis Response
http://www.frbsf.org/econanswers/crisis.htm
This can help the instructor give the background on the financial crisis. It answers the basic questions regarding what happened in the crisis.

Timeline for the Federal Reserve response to crisis
http://www.frbsf.org/econanswers/crisis.htm
Good visual description of the Fed's policy response.