Chapter 12 Monetary Policy

Introduction Monetary Policy – Federal Reserve using the money supply and interest rates to stabilize the economy Introduction Board of Governors formulate policy 12 Districts implement the policy

Types of Monetary Policy Easy (loose) Policy Increase the money supply Decrease interest rates Increase borrowing Increase spending (C+I) Increase aggregate demand Increase GDP Tight Policy Decrease the money supply Increase interest rates Decrease borrowing Decrease spending (C+I) Decrease aggregate demand Decrease GDP

Tools Open market operations - buying and selling govt. bonds (most important) Reserve Ratio (requirement) - % of reserves held in the FED (least used) 1937 – 20% 1958 – 13% 1980 – 12% 1992 – 10% Discount Rate - rate at which banks borrow from the FED (Used in emergencies)

Policy in the Gaps Contractionary Gap (recession): Easy Money Policy to Inc MS, dec ir, inc borrowing and spending (C & I), inc AE & AD and inc GDP Buy Bonds Lower RR Lower DR Expansionary Gap (potential inflation): Tight Money Policy to dec MS, inc ir, dec borrowing and spending (C & I), dec AE & AD and dec GDP Sell Bonds Raise RR Raise DR

Effectiveness Faster and more flexible than Fiscal Policy Can be reversed Less political FED targets the Federal Funds Rate through Open Market Operations

Disadvantages Can’t force banks to borrow or not borrow