Monetary Policy

Monetary Policy Def: the Fed’s actions that change the money supply in order to influence the economy. Goals of Monetary Policy Primary: Economic growth at stable prices, defined in terms of GDP and inflation Intermediate goal: Determine at what rate the money supply must grow/contract to achieve the target growth rate of GDP. Short-term operating goal: How much the money supply must actually change.

III. Actions of the Fed There are 3 actions the Fed can take to manage the supply of money: Open Market Operations- Def: the buying and selling of government bonds on an open market. Fed wants to increase the money supply: they encourage you to cash in your government bonds. This will pump more money into your hands and the economy. Fed wants to decrease the money supply: They encourage you to buy more government bonds. This will take your money out of the economy.

b. Reserve Requirement Banks, by law, have to keep some of your deposits on hand to give back to people who demand cash (withdraws). The percentage of each deposit kept at the bank, by law, is known as the reserve requirement. When the Fed increases the reserve requirement, they are contracting (shrinking/tightening) the money supply. How? Because there is less money to be loaned out and more must be held as the bank’s assets.

c. Discount Rate - Def: the interest rate the Fed charges banks to borrow from the Fed. Often times banks need to increase their reserves in order to create loans or meet shortfalls in their reserve requirements. When they aren’t going to be balanced, they call up the Fed and have money deposited into their account. A high discount rate will discourage banks from loaning out money. Think about it as a penalty for borrowing $.