Chapter 15 Monetary Policy

Money Market – determines interest rate Demand for Money Transactions Speculative Precautionary Supply of money – controlled by the FED Equilibrium

Monetary Chain Change the money supply Change the interest rate Change in borrowing Change in spending (C & I) Change aggregate demand Change GDP, price level, and unemployment

Monetary Policy – changing the amount of money in circulation to affect interest rate Loose (Easy) Policy interest rates are lowered and borrowing increases Tight Policy interest rates are raised and borrowing decreases

Tools Open Market Operations – buying and selling of U.S. Treasury securities to people and banks by the FED Buying bonds involves the FED offering a higher price for them causing interest rates to fall Selling bonds involves the FED offering a lower price for them causing interest rates to rise Bond prices and interest rates are inversely related Changes the Federal Funds Rate − Rate at which banks borrow from each other on overnight loans Discount Rate – rate at which banks borrow from the FED Reserve Requirement – percentage of deposits that cannot be lent and must be held in the FED or the bank itself

Changing the Aggregate Demand Direct Effect – people have more money so they spend more causing the AD to increase Indirect Effect – people with more money might save and cause a banks cash to increase which they want to loan so they lower interest rates, people and businesses borrow and spend more causing the AD to increase Money and Inflation – in the long run increasing the money supply causes inflation In the short run there are other factors (OPEC, Government spending. Taxation)

Monetary Policy in Action Contractionary Gap Buy bonds Lower the discount rate Lower the reserve requirement Expansionary Gap Sell bonds Raise the discount rate Raise the reserve requirement

Theories Monetary Rule – change the money supply at a constant rate every year to insure anticipated inflation Increase the MS by 3% will cause inflation rate to be 3% Inflation Targeting – Setting a certain Inflation Rate as the goal (example: 3% If the actual inflation rate is greater than the target use tight money policy If the actual inflation rate is less than the target use easy money policy