Monetary Policy Tools Describe how the Federal Reserve uses the tools of monetary policy to promote price stability, full employment, and economic growth. Fiscal policy is the collection and spending of revenue through policies created by Congress. Monetary Policy– refers to the actions the Federal Reserve takes to influence the level of real GDP and the rate of inflation. KNOW THE DIFFERENCE!!!!!!

Monetary Policy Tools The Federal Reserve is responsible for putting dollars into circulation. Money Creation – The Federal Reserve Can create money without printing it using the method called “money multiplier effect (KNOW)!” Money Multiplier Effect – is the idea that every one dollar of government (Congress) spending creates more than one dollar in economic activity (fiscal policy). Example – President Obama’s Stimulus Package

Money Multiplier Effect – is the idea that every one dollar of government spending creates more than one dollar in economic activity. –Example – The government spends $10 billion dollars to stimulate the economy. Spending, Demand, income & GDP goes up by $10 billion dollars The businesses that sold the goods & services to the government earned an additional $10 billion dollars. They had to buy intermediate goods & supplies. Let’s assume they spent 80% or 8 billion dollars

–Example – The government spends $10 billion dollars to stimulate the economy. Spending, Demand, income & GDP goes up by $10 billion dollars The businesses that sold the goods & services to the government earned an additional $10 billion dollars. They had to buy intermediate goods & supplies. Let’s assume they spent 80% or 8 billion dollars –The 10 billion has now grown to 18 billion The business that they bought from made money but they also spent money. Let’s assume the same 80% of the 8 billion. –They spent $6.4 billion. The 10 billion has now grown to 24.4 billion.

The money multiplier effect works because the money keeps getting used over and over and it is counted each time it’s used. The Federal Reserve uses monetary policy to influence the level of real GDP and the rate of inflation by working through member banks. They create money by….

Adjusting Required Ratio Reserves. The percentage ratio of deposits that must be kept in reserve by all banks. The lower the reserve ratio the more money banks have to lend. The higher the reserve ratio the less money banks have to lend. –The Federal Reserve raises the ratio to reduce the money banks have to lend to slow the economy or to cause it to contract. –The Federal Reserve lowers the ratio to increase the money banks have to lend to boost the economy or to cause it to expand.

They create money by…. Adjusting the Discount Rate, the interest rate the Federal Reserve charges for loans to commercial banks (KNOW)!!! –If the Federal Reserve raises the discount rate banks have to borrow at a higher interest rate. Therefore they lend money at a higher interest rate. The cost of money is higher therefore businesses and consumers invest less. –If the Federal Reserve lowers the discount rate banks have to borrow at a lower interest rate. Therefore they lend money at a lower interest rate. The cost of money is lower therefore businesses and consumers invest or spend more.

They create money by…. Open Market Operations, the buying and selling of government securities to alter the money supply. –Bond Purchases – The FOMC orders the Federal Reserve to buy government bonds with reserve funds putting more money into circulation. The government puts the money from the sale of bonds into the bank which then is available for investments. –Bond Sales – The FOMC orders the sale of bonds which takes money out of circulation. The government pays off the bonds out of its bank account taking money out of circulation.

They create money by…. Easy Money Policies – Increases the money supply and lower interest rates. Tight Money Policies – decreases the money supply and raises interest rates.