Tools to adjust the Money Supply

Adjusting the Reserve Requirement Raising the Reserve Ratio Banks must hold ______ reserves Banks create ______ money as they ______ lending Money supply _______ How would you characterize this monetary policy? Lowering the Reserve Ratio

The Discount Rate The Discount Rate is the interest rate that the FED charges commercial banks in an emergency. It is usually ~1% higher than the FFR. To increase the Money supply, the FED should _________ the Discount Rate (Easy Money Policy). To decrease the Money supply, the FED should _________ the Discount Rate (Tight Money Policy).

Tools to adjust the Money Supply

Open market Operations FED buys or sells government bonds (securities), known as alternately as T-bonds. * Most widely used monetary policy. To increase the Money supply, the FED should _________ government securities. To decrease the Money supply, the FED should _________ government securities. ***When the government sells bonds, you give them money. This decreases the money supply!

Trace out the effects of a $50 billion dollar bond purchase from the federal reserve bank given a required reserve ratio of .1 on: 1. The monetary base. Demonstrate graphically how this will affect: 2. The money market. 3. AD and AS. 4. Under what circumstances might this seem like an appropriate policy?

As of October 2014, the Fed ended its long term bond-buying program As of October 2014, the Fed ended its long term bond-buying program. At its height, the program called for the purchase of $85 billion in government securities every month. How will the end of this program affect the money supply? Interest rates? How would you characterize this policy? Why would the Fed end it?

The Keynesian 3 Step Transmission Showing the Effects of Monetary Policy Graphically The Keynesian 3 Step Transmission

Quantity of money demanded and supplied Money Market Loanable Funds Sm1 Sm2 10 8 6 10 8 6 Real rate of interest, i Real rate of interest, i Dm Quantity of money demanded and supplied Amount of investment, I AD and AS AS If the Money Supply Increases to Stimulate the Economy… Price level Interest Rate Decreases P2 Investment Increases P1 AD & GDP Increases with slight inflation AD2(I=$20) AD1(I=$15) Real domestic output, GDP

Quantity of money demanded and supplied Money Market Loanable Funds Sm2 Sm1 10 8 6 10 8 6 Real rate of interest, i Real rate of interest, i Dm Quantity of money demanded and supplied Amount of investment, I AD and AS AS If the Money Supply Decreases to contract the Economy… Price level Interest Rate increase Investment decrease AD & GDP decrease Real domestic output, GDP

Loanable Funds Market The private sector supply and demand of loanable money. This shows the effect on real interest rate

Loanable Funds Market What is the result of deficit spending? Government borrows from private sector Increasing demand for loanable funds Increases the real interest rate. This is the Crowding Out Effect!!

Other responsibilities of the FED: Clearing check for members banks Holding deposits of member banks Making loans to member banks Serving as a bank to the federal government

Trace out the effects of a $200 billion dollar bond sale from the federal reserve bank given a required reserve ratio of .2 on: 1. The monetary base. Demonstrate graphically how this will affect: 2. The money market. 3. AD 4. Under what circumstances might this seem like an appropriate policy?