Chapter 14 Presentation 1- Monetary Policy

Ways the Fed Controls the Money Supply 1. Open Market Operations (**Most used) 2. Changing the Reserve Ratio 3. Changing the Discount Rate

Open Market Operations Buying or selling government securities (bonds, treasury bills) by the Fed from the general public or commercial banks

Buying Securities When the Fed buys bonds from the commercial banks or the public, this increases the reserves of the bank This allows the banks to make more loans

Selling Securities When the Fed sells securities, the amount of reserves in the banking system goes down There is now less money to loan out

Changing the Reserve Ratio Raise the reserve ratio- lowers the money supply by making banks hold more $$ Lower the reserve ratio- changes the amount of excess reserves and the multiplier---allows banks to loan more money

Changing the Discount Rate If the Fed lowers this rate, banks are able to borrow more and increase their loans to the public and vice versa

Asset Demand for Money The amount of money people hold as a store of value People like to hold money since it is the most liquid asset

Transaction Demand for Money The amount of money people want to hold to use as a medium of exchange to make purchases People hold cash to buys goods/services Varies directly with nominal GDP

Interest Rate The payment made for the use of money

Money Market Graph Rate of Interest, I percent Amount of Money Demanded and Supplied (Billions of Dollars) DmDm SmSm

Bond Prices and Interest Rates When interest rate fall, existing bond prices rise When interest rates rise, existing bond prices fall Inverse relationship

Bond Prices % interest yield = Amount of interest paid/bond cost

Bond Prices Example A $1000 bond pays 5% fixed interest rate and is selling for face value (which pays $50). Now the interest rates go up to 7.5%. The new bonds pay $75 interest. In order to sell the old bond, the sale price must fall to $667 50/X =.075 X = 667 The original bond still pays $50 interest