Everything about the Fed changed in 2008. AP macroeconomics needed overhauling. : The Indicator from Planet Money Today on the show, why colleges and high school Advanced Placement Macroeconomics classes had to rip out old textbook pages and write a new chapter.

AP Macro gets a makeover

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SYLVIE DOUGLIS, BYLINE: NPR.

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DARIAN WOODS, HOST:

It's that time of year when teachers are dusting off their textbooks and preparing for their classes to return. But some economics teachers are learning that a core part of what they have been teaching has been wrong.

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WOODS: Jane Ihrig is a senior adviser at the U.S. Central Bank, the Federal Reserve.

JANE IHRIG: Many students only take one economics class in their lifetime. And so whether it's in high school or whether it's in college, let's teach them what's going on.

ADRIAN MA, HOST:

In particular, there is a problem with the way macroeconomics is taught. And macroeconomics - that's the study of things like unemployment, inflation, interest rates. So Jane's workplace, the Federal Reserve - it sets interest rates to manage the economy, to try and keep jobs and inflation at just the right level. But to a lot of us, our understanding of the Fed is all mistaken.

This is THE INDICATOR FROM PLANET MONEY. I'm Adrian Ma.

WOODS: And I'm Darian Woods. Today's show - the quest to better teach the Fed.

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WOODS: One of the biggest things that the Federal Reserve does is set interest rates. The Fed wants to keep inflation under control while also keeping people in jobs. Interest rates may be the most important number for the economy. But starting in 2008, the way that the Fed went about raising or lowering interest rates completely changed.

IHRIG: Some big changes that are happening at the Fed that aren't really incorporated into the classroom yet.

MA: And several years later, it became clear the Fed was committed to this new way of tweaking interest rates. And so Jane tried to get the word out.

IHRIG: I worked with two co-authors and wrote a paper for economists on the new tools because we knew, even in the economics profession, it just was not well understood - the Fed's new framework.

MA: And in her paper, Jane described the old way the Fed used to work - this sort of old-fashioned lesson that you might see in a lot of econ textbooks - and it's that the Fed changes interest rates through these actions called open market operations.

WOODS: So to understand open market operations, first, you need to know that the central bank is kind of like a bank for banks. So, like, Chase or Wells Fargo will have accounts with the Fed, and that's where they put their cash. And that cash is called reserves. And retail banks will also lend part of their reserves to each other overnight through the system with the Fed. Like, maybe one bank had a lot of people's checks coming in, and it needs to cash them out. So this bank might borrow from another bank for a sliver of interest. And by the way, this is still true.

IHRIG: You know, your bank needs to have the funds to pay my bank back. So, you know, there's just a lot of liquidity needs that banks have every day.

MA: But in the old way, you have a situation where the Fed decides it wants to, say, raise interest rates. Maybe there's too much inflation.

WOODS: Just an example, right, Adrian?

MA: Right - just hypothetically speaking.

WOODS: So in this old world and the old textbooks, the Fed would sell Treasury bonds to the banks at a sweet deal. It would be a very cheap price. And the bank thinks, I could make some money by buying these Treasury bonds from the Fed. And then the banks would have lots of Treasury bonds, but they wouldn't have very much cash in their reserves. And so that meant when the banks were lending to each other, they would need a higher interest rate because there's not much cash floating around. Cash is really hard to get.

MA: So to recap, the Fed wants to raise interest rates, so it sells Treasury bonds so that banks have less cash. That means the banks charge other banks a higher amount of interest for that remaining cash, and the higher interest rate flows through the rest of the economy, hitting car loans and business loans and everything else. And the economy slows down, and inflation goes down. Are you with us? There are a lot of links in this chain, and it's kind of indirect.

WOODS: So you can kind of think of this as, like, the Fed is paying a plumber to fix the pipes. You know, the plumber, or in this case the banks, is doing the dirty work.

MA: That all changed, however, in 2008. When the economy started crashing in the Great Recession, the Fed was scrambling to stimulate the economy and started buying massive amounts of Treasury bonds from the banks. And so it was doing basically the same thing - open market operations, buying or selling bonds from banks to indirectly control the speed of the economy.

WOODS: But this time, the scale was just enormous. Instead of billions, it was hundreds of billions and then trillions of dollars' worth of buying. So these banks were just flooded with cash, and that meant that they weren't so interested in the Fed buying or selling small amounts of bonds to them. So, like, really, a rough analogy would be, like, if you're a plumber - again, in this case, the banks - became a multi-millionaire. Like, they're not going to respond to your $300 callout to, you know, tighten the water pressure of your shower.

IHRIG: And so now the question is, well, how do you raise rates when some people call the amount of reserves in the banking system superabundant, you know, or super ample?

MA: So the Fed decided to raise interest rates directly. Now the Fed's main way of controlling interest rates is just to change the rate of interest on the cash that banks hold with the Fed on those reserves balances - kind of simple. The Fed lowers or raises interest rates more directly with banks rather than playing around with this old indirect way - the open market operations. Basically, instead of hiring a plumber, the Fed is doing the plumbing itself.

IHRIG: And so I wrote this article. It was put out in the Journal of Economic Perspectives. But that's really targeted to economists, not the broader community that teaches about monetary policy.

MA: So getting this idea in front of her peers was one thing. But Jane's end goal was really to get this new idea to the sort of young economists in training - right? - the people who are taking Advanced Placement macroeconomics in high school.

WOODS: AP macro is a university-level course that's taken at high school. It's for the kids that are just hopelessly in love with econ.

MA: And there are a lot more of them than you might think. Well over 100,000 kids take AP macro each year, and so the outdated curriculum was a big problem. And so Jane needed somebody who she could reach out to in the economics education community. And she found one one day at the Fed with Scott Wolla. Scott is an economics education coordinator there.

SCOTT WOLLA: Which is really, you know, kind of my dream job.

WOODS: But just telling teachers the new way wasn't enough. For one thing, the AP exam still required you to know the old open market operations stuff, so teachers still had to teach that old indirect way. So Scott and Jane called up the College Board. The College Board runs the AP macroeconomics curriculum and exam.

WOLLA: They were well aware of the problem - very receptive. They realized, you know, that this change had occurred, and there was a mismatch.

MA: But then they told Scott and Jane that this is a pretty major change. It rewrites the entire curriculum in textbooks and exams on how banking and the Fed works. So change is not going to happen overnight. Plus, econ teachers need to be taught this stuff, too.

IHRIG: I think that spurred Scott and me to start putting a lot of material out on the St. Louis website to try to build those resources for the teachers.

MA: Teachers like Mike Kaiman. Mike teaches at Timberland High School in Missouri.

WOODS: How does that feel for you as a teacher, you know, not knowing that you'd been teaching from textbooks that basically were out-of-date?

MIKE KAIMAN: I felt exactly like the kids. Just - what are we doing?

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MA: Mike found a solution, though, by teaching both ways. Here's the answer for the AP exam, and here's how it really works.

WOODS: But Mike doesn't need to do that anymore. A couple of months ago, Mike and Scott and Jane heard the news that they'd been hoping for for years. The AP Macro curriculum was getting updated, starting now. Here's Scott from the Fed.

WOLLA: I don't know if there was virtual champagne, but there was definitely, you know, a hooray.

WOODS: But then, you know, of course, the teachers are like, oh, my gosh, I have to learn a lot. You know, Scott and Jane, please help me.

WOLLA: I did say, Jane, that there's been a shift in the demand curve for this kind of knowledge.

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WOODS: And Mike, the teacher, he's also pretty excited to be teaching the new curriculum - if his school colleagues will let him.

KAIMAN: I have teachers in the building who are like, why do you do this? Why do you inflict this pain on kids? And I go, because it's important. It's how you end up paying however many percentage points on your student loans when you go to college or a mortgage or anything like that.

WOODS: We will put a link to Scott and Jane's teaching materials on this episode's webpage, so just go to npr.org/money. This episode was produced by Nicky Ouellet and engineered by Robert Rodriguez. Thanks to Mary Claire Pete (ph). Viet Le is our senior producer, and Kate Concannon edits the show. THE INDICATOR is a production of NPR.

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