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The Fed’s tools to manipulate the economy
Monetary Policy The Fed’s tools to manipulate the economy
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Inflationary Gap or Inflation
Price Level LRAS SRAS E AD Real GDP If our economy is operating at point E what economic problem do we have? Inflationary Gap or Inflation
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Recessionary gap or recession
Price Level LRAS SRAS E AD Real GDP If our economy is operating at point E what economic problem do we have? Recessionary gap or recession
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Copy this slide in your notes!
Inflationary Gap Recessionary Gap Price Level LRAS LRAS Price Level SRAS SRAS E E AD AD Real GDP Real GDP To help remedy these problems we should. . . Money supply Money supply Copy this slide in your notes!
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Let’s see how we can adjust reserve requirements.
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Reserve Requirements Assume Reserve requirement of 10% $90
Reserves $100 Reserves $90 Deposit $1,000 Deposit $900 Depositor 1 Barrower 1 Barrower 2 Loan $900 Loan $810 What is the multiplier? 1/rr = 1/.1 = 10 How much has the money supply increased ? $900 x 10 = $ 9,000
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NO Reserve Requirements Money supply increase $9,000
Assume Reserve requirement of 10% Reserves $100 Reserves $90 Deposit $1,000 Deposit $900 Depositor 1 Barrower 1 Barrower 2 Loan $900 Loan $810 Money supply increase $9,000 If the economy is experiencing inflation do we want to put $9,000 more into the money supply? NO
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What happens if we raise reserve requirements?
Assume Reserve requirement of 20% Reserves $200 Reserves $160 Deposit $1,000 Deposit $800 Depositor 1 Barrower 1 Barrower 2 Loan $800 Loan $640 What is the multiplier? 1/rr = 1/.2 = 5 How much has the money supply increased ? $800 x 5 = $ 4,000
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What happens if we lower reserve requirements?
Assume Reserve requirement of 5% Reserves $50 Reserves $48 Deposit $1,000 Deposit $950 Depositor 1 Barrower 1 Barrower 2 Loan $950 Loan $902 What is the multiplier? 1/rr = 1/.05 = 20 How much has the money supply increased ? $950 x 20 = $ 19,000
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To help remedy these problems we should. . .
Inflationary Gap Recessionary Gap Price Level LRAS LRAS Price Level SRAS SRAS E E AD AD Real GDP Real GDP To help remedy these problems we should. . . Money supply Reserve Requirements Money supply Reserve Requirements
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The Fed also controls the discount rate
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Hi, I’m FED chairman Janet Yellen
Hi, I’m FED chairman Janet Yellen. I’ll lend you money but you have to pay me back the amount of the loan PLUS the discount rate.
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The Discount rate is low!
A low discount rate encourages spending When the discount rate is low borrowing money is cheap
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The Discount rate is high!
NOBODY will borrow money now, it is too expensive. I’m a penny pincher! A high discount rate discourages spending
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To help remedy these problems we should. . .
Inflationary Gap Recessionary Gap Price Level LRAS LRAS Price Level SRAS SRAS E E AD AD Real GDP Real GDP To help remedy these problems we should. . . Money Supply Reserve Requirements Discount Rate Money supply Reserve Requirements Discount Rate
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The FED controls open market operations
That means they buy and sell bonds
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. . . the money supply will _____. shrink
If the Fed sells bonds . . . Money the FED has is not part of the money supply, Money that people have is part of the money supply. BONDS . . . the money supply will _____. shrink
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. . . the money supply will _____. grow
If the Fed buys bonds . . . Money the FED has is not part of the money supply, Money that people have is part of the money supply. BONDS . . . the money supply will _____. grow
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To help remedy these problems we should. . .
Inflationary Gap Recessionary Gap Price Level LRAS LRAS Price Level SRAS SRAS E E AD AD Real GDP Real GDP To help remedy these problems we should. . . Money supply Reserve Requirements Discount Rate _______ bonds Money Supply Reserve Requirements Discount Rate ________ bonds buy sell
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