Download Federal Reserve and Monetary Policy

Monetary Policy
• Using the amount of money and credit
available to consumers to influence the
economy
The Federal Reserve System
• The Federal Reserve Bank (The Fed) is central
bank of the U.S.
• designed to oversee the banking system
• and regulate the quantity of money in the
economy
• The U.S. Congress established three key
objectives for monetary policy in the Federal
Reserve Act:
• Maximum employment
• stable prices (control inflation)
• Stabilize interest rates
• Role has expanded to include:
• Regulate the banking and financial systems
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
Monetary Policy
Expansionary Monetary Policy= expand credit =
lower ….
interest rates =
cheaper to ….
borrow money =
economic growth or contraction?
Contractionary Monetary Policy = restrict credit
higher …..
interest rates =
more expensive to ….
borrow money =
economic growth or contraction ?
Three Tools of the Federal Reserve
a) Reserve Requirement
b) Discount Rate
c.)Open Market Operations (Federal Funds Rate)
Reserve Requirement
• the FED requires banks to hold a certain….
• amount of money from circulation
– The bank may not …..
– loan this money to any customers.
– Least used of the three tools
Expansionary Monetary Policy
Using Reserve Requirement
• If the Fed decreased the Reserve
Requirement, then banks would be allowed
to……
• Loan out more money. The Money supply
would….
• Increase. Consumers would ….
• Borrow more and spend more and the
economy would…….
• Expand (grow)
Contractionary Monetary Policy
Using Reserve Requirement
• 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
Expansionary Monetary Policy
Using the Discount Rate
•
•
•
•
If the Fed lowers DR, it is cheaper for…..
banks to borrow money . So banks will …..
pass on savings to customers and lower …..
their interest rates and the money supply
will….
• Increase and there is more spending and the
economy will…..
• Expand (grow)
Contractionary Monetary Policy
Using the Discount Rate
4. Open Market Operations
- Most used tool of the Fed
a)Fed buys and sells US government securities
and US Bonds (define bond –
The government needs money so they
“Borrow “ the money from the public
You buy a $1000 bond from the govt. with 10%
interest.
The govt agrees to pay you back the $1000 plus
$100 from interest
Expansionary Policy = buy bonds
- Fed buys $1000 bond from Joe. So the
money supply …..
- Inceased. Joe gave up his bond but now has
$1000 in cash
Contractionary = sell bonds
- Fed sells $1000 bond to Joe. So the money
supply……
- Decreased. Joe now has a bond but $1000
less in cash
Fed’s effect on INTEREST RATES
Intro to Money Market Graphs
a) Expansionary ; buy bonds ; increase MS ; decrease IR
MS 1
MS 2
Int Rate
MD
Q of Money
b) Contractionary ; sell bonds ; decrease MS ;
increase IR
MS 2
MS 1
MD
When the Fed uses OMO to buy / sell bonds, it is
manipulating the Federal Funds Rate (What is
it?)
Federal Funds –
reserve balances of financial institutions held at
12 Regional Fed Banks
If a bank can not meet its “reserve requirement”
– it can borrow reserve funds from other
banks
a)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…..”
a) Expansionary Monetary Policy (using OMO and the
FFR)
i. FOMC buys securities and the MS will …..
ii. Increase
iii. This will decrease FFR which means banks will ….
iv. Pay less to borrow and therefore will…..
v. Pass on savings to customers and lower their ….
vi. Interest rates and the money supply will ….
vii. Increase. Customers will borrow……
viii.More and spend…….
ix. More and the economy will…..
x. Expand (grow)
• Contractionary