Monetary Policy and The Federal Reserve Chapter 15

In Plain English Video Take notes Focus on the Board of Governors (BoG) Federal Reserve Banks (RB) Federal Open Market Committee (FOMC)

Fed Funds Rate FDIC member banks loan each other overnight funds in order to balance deposit accounts each day. The ir they use to loan each other is the FFR. Currently at .5%

Discount Rate FDIC banks may borrow short term loans directly from the FED This is the discount window and is set above the FFR (currently 1.0%) Banks do not like to use the window—the FED is the “last resort”

Prime Rate ir that banks charge their most “credit worthy” borrowers Historically, the Prime Rate has been 3% higher than the FFR So it is 3.5% today

Easy Money Policy (expansionary) The Fed wants the money supply to grow Lower all interest rates = people will borrow more SEE GRAPH -- DOCUMENT CAMERA

Tight Money Policy (contractionary) The Fed wants to get money out of the system Increase all interest rates = people borrow less Why take money out? INFLATION SEE GRAPH -- DOCUMENT CAMERA

Required Reserve The amount of money the Fed requires each bank to hold (amount they are not allowed to loan) Currently at 10%

Excess Reserve The amount of money the bank can loan

The Money Multiplier 1/rr (required reserve)

Reserve Multiplier example Assume Bank A receives a deposit of $1,000. Bank A has a required reserve (rr) of 10%. They must put $100 in the vault but can lend out $900. Someone borrows the $900, uses it and it ends up in Bank B. Bank B must now put $90 in the vault but can lend out $810 to a new person