POLICY TOOLS Federal Reserve

Money Creation Dept. of Treasury makes money Federal Reserve and banks put it into circulation- MONEY CREATION Banks make money by loaning and collecting interest-help stimulate economy Required Reserve Ratio- Amount of money MUST keep on reserve to be healthy Closed or taken over if they cannot

Reserve Requirements Change the amount banks must hold in reserve Causes the amount available for loans to shrink or increase Causes money in circulation to increase or contract Does not do often

Setting Rates Discount rate- is the money made available to banks by the Federal Reserve in times of crisis or tough economic stretches. Insures that loans can be made and banks can meet deposits Insures trust in economic systems Establishes prime rate- rate of interest banks charge for loans/ both short and long term

Open Market Operations Buying and selling of government bonds to influence supply of money. Just done to help lower long term interest on loans Pg

Monetary Policy Monetarism- belief that money supply is the most important aspect on macroeconomics In tough economic times- Fed will follow easy money policy- increase money supply In a rapid expansion period- the Fed may run a tight money policy- reduce money supply. Control inflation-can reduce GDP Figure 16.9 and – good and bad timing

Policy lags It takes time for the policies to trickle into effect Inside lags- delays implementing policies 1. find the problem 2. identify proper policy Outside lags- Time it takes for policy to take effect

Predicting cycles Fed tries to predict cycles and economy Through monetary policy- tries to control inflation Recoveries from tough economy may take 2-6 years. Damage control Case Study Pg 435 Pg