Module 27 & 28 & 29 27. The Federal Reserve Monetary Policy 28. The Money Market 29. The Market for Loanable Funds

Module 27: The Federal Reserve - Monetary Policy Functions of the Federal Reserve Provide Financial Services Supervise and Regulate Banking Institutions Maintain the Stability of the Financial System Conduct Monetary Policy What is Monetary Policy?

Module 27: The Federal Reserve - Monetary Policy What does the Fed do? The Reserve Requirement Federal Funds Market - financial market that allows banks that fall short of the RR to borrow reserves from banks holding excess reserves Federal Funds Rate - interest rate at which funds are borrowed and lent in the FFM

Module 27 The Discount Rate Interest rate the FED charges on loans that banks borrowed from the FED Usually 1% above FFR to discourage banks from going to FED To alter money supply, FED can change Discount Rate Changes in money supply Reduce spread b/w FFR and Discount rate = increase money supply Increase spread b/w FFR and DR = lower money supply

Module 27 Open-Market Operation The FED buys and sells US Treasury bills through commercial banks Buys FED buying increases monetary base b/c it increases bank reserves Sells FED selling decreases monetary base b/c it decreases bank reserves Money Multiplier The OMO doesn’t affect the money supply directly, instead it starts the money multiplier.

Module 28 - The Money Market The Opportunity Cost of Holding Money When someone decides to hold money instead of other assets, they are giving up the interest they could be earning while holding other assets. The Money Demand curve Illustrates relationship between the interest rate and the quantity of money demanded. Slopes downward: Higher interest rate = higher opportunity cost of holding money and reduced quantity of money demanded. Ex. If interest rates are low, people will hold money because it’s not losing out on much. If interest rates are high, they could be making a profit by loaning it out.

Module 28 - The Money Market Shifts of the Money Demand Curve Changes in Aggregate Price Level People carry more cash now b/c things cost more and they want to be able to buy it immediately. Increased inflation would shift the curve right bc more money would be needed to purchase the same good. Changes in Real GDP Increase in REAL GDP = shifts right Changes in Technology Cards = money w/out a bank visit Changes in Institutions If banks offer interest rates on checking accounts, demand for money will increase

The Demand for Money

Module 29 - The Market for Loanable Funds Loanable Funds Market A market with people who want to lend money (savers) and those who want to borrow money (firms with investment spending projects). The price that is determined in the market is the interest rate (r)

Module 29 - Supply of Loanable Funds

Module 29 Rate of Return = Revenue from project - Cost of Project / Cost of project X 100 A business will want to loan when the rate of return on its project is greater than or equal to the interest rate The Supply of loanable funds curve will shift right if private savings increases. If government deficit increases, and trade deficit increases, this will increase the demand and increase the supply of loanable funds in the domestic market. (Page 280)

Module 29 Questions. If the nominal interest rate is 5% and the inflation rate is 1%, what is the real interest rate? If the real interest rate is 6% and the inflation rate is 3%, what is the nominal interest rate? If the nominal interest rate is 10% and the real interest rate is 6%, what is the rate of inflation?