1. Federal Reserve and Monetary Policy
Amount of money in economy determines amount of spending
Too much = inflation
Too little = recession

2. Fed manages money supply by…..
Influence lending among banks and other financial institutions

3. 2. Monetary Policy
Expansionary = expand credit, MS, growth
(easy money)
Contractionary = restrict credit, MS, growth
(tight)

4. Three Tools
Open Market Operations (Federal Funds Rate)
Discount Rate
Reserve Requirement

5. 4. OMO
Most used
Fed buys and sells US government securities
-US Bonds
Expansionary- buy bonds
Fed buys $1000 bond from Joe
Joe now has $1000 = increase in MS
c) Contractionary – sell bonds
Fed sells $1000 bond to Joe
Joe now has a bond but $1000 less in cash = decrease in MS

6. (pg 1 ; last two paragraphs) Fed’s affect on INTEREST RATES
Intro to Money Market Graphs (text 736,738,741)
Expansionary ; buy bonds ; increase MS ; decrease IR
MS 1
MS 2
Nom. Int Rate MD
Q of Money

7. b) Contractionary ; sell bonds ; decrease MS ; increase IRMD

8. Federal Funds Rate (What is it?)
(Fed Reserve Packet: 1st page ; last paragraph and 2nd page ; first paragraph)
Federal Funds Rate (What is it?)
Federal Funds – reserve balances of financial institutions held at 12 Regional Fed Banks
If a bank can not meet its “reserve requirement” – it can borrow reserve funds from other banks
FFR – the interest rate banks pay when they borrow from each other

9. 5. FOMC sets “TARGET” rate for FFR
Uses OMO to adjust MS to adjust FFR “at or near target”
How does this affect you, me, and the rest of the economy?
Use of OMO and FFR……. “sets off a chain of events…..”

10. Expansionary Monetary Policy FOMC buys securities Increase MS
Fed Res. Packet pg. 2 section 5 (bottom left column)
Expansionary Monetary Policy
FOMC buys securities
Increase MS
Decrease FFR…….which leads to
Increase banks lending and borrowing….leads to..
Increase willingness of banks to let you borrow at lower rates ….which leads to
Decrease in other interest rates throughout the economy
Increase in MS
Increase Consumption, Investment…AD and LRAS

11. Banks borrow directly from Fed
Fed Res. Packet pg. 2 section 6. Discount Rate
Banks borrow directly from Fed
Least powerful of 3 tools – but a change in DR does signal a change and can create a desired reaction
Lower DR……..
Lower other IR….increase MS

12. 7. Reserve Requirement
Most powerful ; least used
Expansionary = lower RR

13. Problems Controlling Money Supply
Can not control behavior of consumers
How much will they spend? Save? Borrow?
Can not control behavior of banks
Can not make the banks lend money