Download Federal Reserve and Monetary Policy

Federal Reserve and Monetary Policy
1. Amount of money in economy determines
amount of spending
• Too much = inflation
• Too little = recession
Fed manages money supply by…..
• Influence lending among banks and other
financial institutions
2. Monetary Policy
a) Expansionary = expand credit, MS, growth
(easy money)
b) Contractionary = restrict credit, MS, growth
(tight)
3. Three Tools
a) Open Market Operations (Federal Funds
Rate)
b) Discount Rate
c) Reserve Requirement
4. OMO
- Most used
a) Fed buys and sells US government securities
-US Bonds
b) Expansionary- buy bonds
- Fed buys $1000 bond from Joe
- Joe now has $1000 = increase in MS
c) Contractionary – sell bonds
- Fed sells $1000 bond to Joe
- Joe now has a bond but $1000 less in cash =
decrease in MS
• (pg 1 ; last two paragraphs)
Fed’s affect on INTEREST RATES
Intro to Money Market Graphs (text 736,738,741)
a) Expansionary ; buy bonds ; increase MS ; decrease IR
MS 1
MS 2
Nom. Int
Rate
MD
Q of Money
b) Contractionary ; sell bonds ; decrease MS ;
increase IR
MS 2
MS 1
MD
• (Fed Reserve Packet: 1st page ; last paragraph and 2nd page ;
first paragraph)
Federal Funds Rate (What is it?)
a) Federal Funds – reserve balances of financial
institutions held at 12 Regional Fed Banks
b) If a bank can not meet its “reserve
requirement” – it can borrow reserve funds
from other banks
c) FFR – the interest rate banks pay when they
borrow from each other
5. FOMC sets “TARGET” rate for FFR
- Uses OMO to adjust MS to adjust FFR “at or
near target”
a) How does this affect you, me, and the rest of
the economy?
Use of OMO and FFR……. “sets off a chain of
events…..”
• Fed Res. Packet pg. 2 section 5 (bottom left column)
a)
i.
ii.
iii.
iv.
v.
Expansionary Monetary Policy
FOMC buys securities
Increase MS
Decrease FFR…….which leads to
Increase banks lending and borrowing….leads to..
Increase willingness of banks to let you borrow at
lower rates ….which leads to
vi. Decrease in other interest rates throughout the
economy
vii. Increase in MS
viii. Increase Consumption, Investment…AD and LRAS
• Fed Res. Packet pg. 2 section 6. Discount Rate
• Banks borrow directly from Fed
• Least powerful of 3 tools – but a change in DR
does signal a change and can create a desired
reaction
• Lower DR……..
• Lower other IR….increase MS
7. Reserve Requirement
- Most powerful ; least used
- Expansionary = lower RR
Problems Controlling Money Supply
• Can not control behavior of consumers
– How much will they spend? Save? Borrow?
– Can not control behavior of banks
– Can not make the banks lend money