Download Slide 1

A Simplified Balance Sheet of a Private Bank
Assets
Loans
Government bonds
Reserves
$ 70 million
$ 20 million
$ 10 million
Liabilities
Deposits
$ 100 million
A Simplified Balance Sheet of the Federal Reserve
Assets
Government
$ 750 billion
bonds
Liabilities
Currency in
circulation
Bank reserves
$ 700 billion
$ 50 billion
An Open Market Purchase of Government Bonds by the Fed
(a) Change in the Fed Balance Sheet
Assets
Government bonds
+$ 10 million
Liabilities
Bank reserves +$ 10 million
(b) Change in ABCBank’s Balance Sheet
Assets
Government bonds
$ 10 million
Reserves
+$ 10 million
Liabilities
A Loan by ABCBank Becomes a Deposit in XYZBank
(a) Next Change in the ABCBank’s Balance Sheet
Assets
Liabilities
Loans
+$ 10 million
Reserves
$ 10 million
(b) Change in XYZBank’s Balance Sheet
Assets
Reserves
+$ 10 million Deposits
Liabilities
+$ 10 million
Federal Funds Rate
Supply of
Federal
Funds
6%
E
Demand for
Federal
Funds
Quantity of Federal Funds
Borrowed and Lent
Federal Funds Rate
Original Supply of
Federal Funds
New Supply of
Federal Funds
6%
5%
E0
E1
Demand for
Federal
Funds
Quantity of Federal Funds
Borrowed and Lent
Federal Funds Rate
Supply of Federal
Funds
B
E0
E1
Target Rate
5%
A
Demand for
Federal
Funds
Quantity of federal funds
borrowed and lent
Interest Rate (%)
10
9
8
7
6
5
4
3
2
1
0
Prime
Rate
Federal
Funds
Rate
Interest rate (r )
r0
r1
II
II0
II1 Intended
Investment (II )
Interest rate (r )
r
II0
II0
II1
II1 Intended
Investment (II )
Aggregate Demand and Output
E1
AD1 (with new, lower
interest rate, r1)
AD0 (with old
interest rate, r0)
E0
45
Y0
Y1
Income
Expansionary
monetary policy
Lowers
interest rates
Investment is
encouraged
Aggregate
demand rises
Equilibrium
GDP rises
Federal Funds Rate (%)
7
6
5
4
3
2
1
0
Private Fixed Investment
(billions of 2000 dollars)
1600
Nonresidential
Investment
1400
1200
1000
800
600
400
200
0
Residential
Investment
Interest rate (r )
II1
II0
A
Original Target Rate
8%
B
5%
New Target Rate
II1
II0
Intended
Investment (II)
Price of Bonds
(and interest rate)
$ 100 (i = 5%)
Supply of
Bonds
E
Demand for
Bonds
Quantity of Bonds
Price of Bonds
(and interest rate)
Supply of
Bonds
E1
$103 (i = 2%)
$ 100 (i = 5%)
E0
New Demand
for Bonds
Original Demand
for Bonds
Quantity of Bonds
Interest Rate (%)
7
6
Federal
Funds
Rate
5
4
3
2
1
0
3 month
T-bill
Interest Rate (i )
i0
i1
Money
Supply
E0
E1
Money
Demand
Quantity of Money
Interest Rate (%)
10
9
8
7
6
5
4
3
2
1
0
Nominal 30-Year
Mortgage Rate
Real 30-Year
Mortgage Rate
Federal
Funds Rate