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Chapter 15: Monetary Policy. Federal Reserve Board Chairperson Federal Reserve Board (7) Federal Open Market Committee (12) Deliberate changes in money supply to influence interest rates, total level of spending in economy

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chapter 15 monetary policy
Chapter 15: Monetary Policy
  • Federal Reserve Board Chairperson
  • Federal Reserve Board (7)
  • Federal Open Market Committee (12)
  • Deliberate changes in money supply to influence interest rates, total level of spending in economy
  • Goal is to achieve & maintain price-level stability, full-employment, & economic growth
tools of monetary policy
Tools of Monetary Policy
  • Open-market operations
  • Reserve ratio
  • Discount rate
open market operations
Open-Market Operations
  • Bond markets are open to buyers & sellers of corporate & government bonds (securities)
  • Fed’s Open-market operations consist of buying bonds from or selling bonds to commercial banks & general public
  • The most important instrument for influencing the money supply
reserve ratio
Reserve Ratio
  • Raising the reserve ratio increases amount of required reserves banks must keep  reduces money supply
    • Forces banks to reduce amount of checkable deposits
  • Lowering reserve ratio decreases amount of required reserves banks must keep  increases money supply
    • Transforms required reserves into excess reserves, enhancing ability of banks to create new money by lending
discount rate
Discount Rate
  • Fed is “lender of last resort”
    • Short-term loans to commercial banks in need in its district (12)
  • Discount Rate: Interest rate Fed charges to commercial banks
  • Borrowing from Federal Reserve Banks by commercial banks increases reserves of commercial banks & enhances their ability to extend credit
    • Lowering discount rate increases money supply
    • Increasing discount rate decreases money supply
easy money policy
Easy Money Policy
  • Aka Expansionary Monetary Policy
  • To combat recession & unemployment, Fed decides to increase money supply.
  • How:
    • Buy securities
    • Lower reserve ratio
    • Lower discount rate
tight money policy
Tight Money Policy
  • Aka Restrictive Monetary Policy
  • To reduce spending & control inflation, Fed wants to reduce aggregate demand by contracting supply of money
  • How:
    • Sell securities
    • Increase reserve ratio
    • Raise discount rate
effectiveness of monetary policy
Effectiveness of Monetary Policy
  • Strengths:
    • Speed & Flexibility (v. Fiscal Policy)
    • Isolation from Political Pressure (14 year terms)
  • Shortcomings & Problems
    • Less control due to changes banking practices (bank reform & electronic transactions)
    • Changes in velocity
      • Velocity of money: number of times per year average dollar is spent on goods & services
    • Cyclical asymmetry: less reliable in pushing economy from recession
targeting the federal funds rate
Targeting the Federal Funds Rate
  • Focus of Fed’s monetary policy to stabilize the economy
  • Interest rates in general rise & fall w/ Federal Funds rate
  • Prime interest rate: rate banks charge their most creditworthy customers, parallels FFR
  • By changing the FFR, Fed is changing economy’s overall interest rates
  • Fed announces changes in monetary policy by announcing changes for target FFR
monetary policy international economy
Monetary Policy & International Economy
  • Net Export Effect
    • Expansionary monetary policy (lower FFR) decreases foreign demand for dollars, increases net exports & dollar depreciates
    • Restrictive monetary policy (higher FFR) increases foreign demand for dollars, decreases net exports & dollar appreciates