Download Monetary Policy

Monetary Policy
It influences the Model of the
Economy
Unit Four
• Monetary Policy
– Federal Reserve bank (Central bank)
• It regulates the amount of money in the economy
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Keeps inflation in check
Maintain full employment
Moderate the business cycle
Contributes to keeping GDP growing steadily
– FOMC (Federal Open Market Committee)
• meets 8 times a year and makes monetary policy
decisions .
Unit Four
• Fed’s tools to monitor the economy
– Interest rate manipulation
• Discount rate and Federal Funds rate
• Required reserve ratio’s
• Open market operations
– All increase or decrease the monetary base
• Is the sum of coins, federal reserve notes, and banks
reserves at the Fed.
Unit Four
• Required reserve ratio’s
– Banks and thrifts are required to hold a minimum percentage of
all deposits as reserves.
– If the fed lowers the required reserve ratio interest rates will
fall.
– That means there is more money in the economy
– If fed allows increases in the required reserve ratio interest
rates will rise.
– That means there will be less money in the economy.
Unit Four
• Open market operations
– The sale or purchase of government securities by
the United States
– If the Fed purchases government securities they
are putting money back into the economy and
decreasing the interest rate
– If the Fed sells government securities they are
taking money out of the economy and increasing
the interest rate.
MONETARY POLICY
Expansionary Monetary Policy
Contractionary Monetary Policy
Buying Bonds on the open market
Lowering the Fed Funds Rate
Lowering the Discount Rate
Lowering the Reserve Requirement
Selling bonds on the open market
Raising the Fed Funds Rate
Raising the Discount Rate
Raising the Reserve Requirement
MS’
MD
Quantity of money
MS
Nominal Interest Rate
MS’
Nominal Interest Rates
MS
MD
Quantity of Money
Unit Four
• Discount rate is the overnight interest rate in
which banks can borrow money from the
federal bank.
• Federal funds rate is the interest rate in which
the Fed allows commercial banks to lend to
one another.
Unit Four
• Short run
– Influences both the nominal and real interest rate
– To affect a nominal interest rate does some kind of open market
operation to change it
– By changing the quantity of money that the Fed achieves its
target for the Federal Funds rate
– The expected inflation rate does not change every time the Fed
changes nominal interest rates.
– So Open market operations changes the real interest rate in the
short run
Unit four
How would the Fed relieve inflationary pressure?
– Sell securities on the open market
– Banks a have less reserves to loan out
– Price level increases for loans to consumers and intra banks (Fed
Fund Rate)
– Increases the Interest rate
– Less investment
– Aggregate demand shifts to the left
– Less money in the economy
– Value of the Dollar increases (Exports decrease)
– Called a Fed tightening of monetary policy
Unit four
How does the Fed fight recessionary pressure?
• Buy securities in the open market
• Increase bank reserves to loan out
• Price level decreases for loans to consumers and intra banks (Fed
Funds Rate)
• Decreases the interest rate
• More investment
• Aggregate demand shifts to the right
• More money in the economy
• Value of the dollar decreases (Exports increase)
• Called a Fed easing of monetary policy
Unit Four
• There is a multiplier process
– The change is greater than just the change interest
rate.
– There is a multiplier effect,
– How large or small depends on sensitivity to
interest rates aggregate expenditure is.
Unit Four
• There is a money multiplier
– New money created by an excess of 1$ of
reserves
– M = 1/required reserve ratio
– Excess reserves x multiplier maximum checkable
deposit creation.