Download Monetary Policy

Notebook # 24Economics 15-2
Monetary Policy
Monetary Policy
ESSENTIAL QUESTIONS:
• What is the purpose of the Federal
Reserve System?
• What are the structures of the Federal
Reserve System?
•What are the functions of the Federal
Reserve System?
Monetary Policy
GPS STANDARDS:
SSEMA2- Explain the role and functions of the Federal
Reserve System.
b.) Define Monetary Policy
c.) Describe how the Federal Reserve use the tools of
monetary policy to promote price stability, full
employment, and economic growth.
l
The Federal Reserve System
• What is the main function of the Federal
Reserve? How does the Fed perform this
function?
1. The function of the Fed is to control the
money supply.
2. The primary instrument the Fed uses to
affect the money supply is the Federal Open
Market Committee (FOMC):
a. they make decisions about whether or not
to raise or lower interest rates
b. or whether or not to expand or contract
the money supply
l
Other Functions of The Federal Reserve
1. The Fed monitors member banks’ reserves.
2. The Fed oversees foreign banks operating in
the United States as well as the international
operations of U.S. member banks operating
in foreign countries
3. The Fed approves bank mergers like when
Wells Fargo bought out Wachovia.
l
Functions of The Federal Reserve
• Why might the Fed disapprove of a merger
between two large banks?
• Because it might limit competition between
banks.
l
Other Functions of The Federal Reserve
5. The Federal Reserve is responsible for
extending truth-in-lending disclosures to
millions of individuals who purchase or
borrow from corporations, retail stores,
automobile dealers, and lending institutions.
(they tell us the truth about using credit &
credit cards)
6. The Federal Reserve is responsible for
issuing paper currency.
7. The Federal Reserve is responsible for
providing financial services to the federal
government.
l
Monetary Policy
• Federal Reserve actions intended to stabilize
the economy make up what is called …
Monetary policy.
•One of the Federal Reserve System’s most
important responsibilities is that of
Monetary policy.
•Monetary policy is the expansion or
contraction of the money supply in order to
influence the cost and availability of credit.
l
Monetary Policy
• Also, the Fed does not hesitate to change
interest rates whenever the economy’s health
is threatened.
•Monetary policy is a structured process.
•In order to understand it better, it helps to
understand the fractional reserve system that
our banking system is based on.
l
l
Monetary Policy:
Fractional Bank Reserves
• The United States has a:
1. fractional reserve system which requires
banks and other depository institutions to
keep “only” a fraction of their deposits in the
form of actual monetary legal reserves.
l
l
Monetary Policy:
Fractional Bank Reserves
• The United States has a:
1. The legal reserves consists of coins and
paper currency that banks hold in their
vaults.
2. Under this system, banks are subject to a
reserve requirement which is a rule stating
the percentage of every deposit that has to
be set aside as legal reserves (money).
l
l
Monetary Policy:
Fractional Bank Reserves
• Banks earn money by lending out that
portion of their deposits that need not be held
as reserves.
• Your “physical” money is not at the bank but
is being used to provide bank loans to
businesses and consumers
l
l
Monetary Policy:
Fractional Bank Reserves
To earn its profits, a bank usually needs to
charge 2-3 percent more for its loans than
the rate of interest it pays for its saving
accounts and time deposits, interest bearing
deposits that cannot be withdrawn by check.
l
Tools of Monetary Policy
• The Fed can affect the money supply by
changing the reserve requirement.
•This means the Fed increases the supply of
money. (The Fed can affect the money supply
by buying and selling government securities
(open market operations).
•The Fed can affect the money supply by
changing the discount rate, the interest rate the
Fed charges on loans to financial institutions.
l
Monetary Policy
• Every piece of paper money issued in the
United States used to have has the name of
one of the 12 Federal Reserve banks on it.
•Most money in a region had the name of the
closest Federal Reserve bank.
•Now, newly printed money just says, “United
States…Federal Reserve System.”
Tools of Monetary Policy
l
•
What is the purpose of monetary
policy?
1.The purpose of monetary policy is
to influence the cost and
availability of credit
2. To keep the economy healthy
l
Monetary Policy
• Changes
in the money supply
affect the interest rate, the
availability of credit, and the
price level.
l
Monetary Policy
1. In the short run, monetary policy
affects interest rates and the availability
of credit.
2.In the long run, it affects inflation and
economic growth, which is one of the
Fed’s major concerns.
l
Monetary Policy: Short-Run Impact
Changes in the money supply affect
interest rates.
Increases
in the
money
supply
lowers the
interest
rate.
l
Monetary Policy: Short-Run Impact
Changes in the money supply affect
interest rates.
Decreases
in the
money
supply
raises the
interest
rate.
Figure 15.7b
Effects of Low Interest Rates

Generally, low interest rates
stimulate the economy
because there is more
money available to lend.



Consumers buy cars and
houses.
Businesses expand, buy
equipment, etc.
Why does the Fed lower
interest rates?

If inflation is in check, lower
rates stimulate economic
activity, thus boosting economic
growth.
Effects of High Interest Rates

The Fed raises interest
rates as an effective way
to fight inflation.



Inflation—a sustained rise
in the general price level;
that is, all prices are rising
together.
Consumers pay more to
borrow money,
dampening spending.
Businesses have difficulty
borrowing; unemployment
rises.
Pages