1. Monetary Policy Wrap-up

2. Open-Market Operations
Most impactful action of the 3 monetary policy tools
To increase money supply:
Fed buys government securities (bonds) with “new money” from banks/public
Public
Market &
Banks
Federal Reserve
Gov’t bonds
$$$
“New” Money

3. Fed Buying Bonds $4.5 Trillion (2016) $700 billion
Earning “interest income”
$700 billion

4. Practice Fractional Reserve Banking Question
Bob Deposits $10,000 into bank #1
Assume banks hold no excess reserves
Reserve requirement = 5.0%
Create T-account for Bank #1
Calculate total increase in bank deposits?
Calculate total increase in money supply?
Assets Liabilities
Required
Reserves
Excess
Loans
Total
Demand
Deposits
If instead, the Fed buys $20,000 in bonds from Bank #1
Calculate increase in money supply & bank deposits

5. Expansionary Monetary Policy
Money Market
AS/AD Model
MS2 i2
MS1
Price
Level
LRAS1
Nominal
Interest
Rate
SRAS1
Affects AD
AD2 P2 Y2 i1 E1 E2 P1 E1 E2 MD
AD1 Y1
Real
GDP
Qty of $
↓ Discount Rate (banks borrow more from Fed)
↓ Reserve Requirement (banks must hold less reserves => more loans)
Open Market Operations: Buy Securities => ↑ MS => ↓ i-rate
End Result: nominal i-rate falls => I ↑ & C ↑ => AD ↑ & Px Level ↑

6. Monetary Policy Review Sheet

7. Contractionary Monetary Policy
AS/AD Model
Money Market
LRAS1
Nominal
Interest
Rate
MS1 i1
MS2
Price
Level
SRAS1
Affects AD
AD2 Y2 P1 E1 i2 E2 P2 E2
AD1 E1 MD Q2 Y1 Q1
Real
GDP
Qty of $
↑ Discount Rate
↑Reserve Requirement (banks must hold more reserves => less loans)
Open Market Operations: Sell Securities => ↓MS => ↑ i-rate
End Result: ↓ MS => ↑ nominal i-rate => borrowing $ is more expensive => I ↓& C ↓ => AD ↓ & Px Level Falls

8. DEMAND FOR MONEY Demand for money = desire to “hold” money
(Similar to M1)
Money Market
Nominal
Interest
Rate
As interest rates ↑ => cost of holding money ↑
(so demand curve is downward sloping) MD
You hold money for:
Transactions Demand
Precautionary Demand
Speculative Demand
Qty $

9. Shifting Money Demand
You rarely shift MD…. But shifts in Money Demand can occur
Price Level changes
↑ Px level shifts MD right (need more $ when purchasing power ↓)
2) Preference to “hold cash”
↑ preference shifts MD right
Money Market
Nominal
Interest
Rate MS
If MD shifts => the Fed can offset any shift through
Monetary policy.
The Fed. Controls MS to “target” the federal funds rate MD
Qty $

10. Practice Test

11. Bernanke Interview Part I

12. Quantitative Easing Fed controls only short term interest rates
Fed controls only short term interest rates
Which are already at ZERO percent (liquidity trap)
Traditional monetary policy can’t do anymore
Goal: is to solve the credit crunch
Get banks to make loans again…
Strategy: buy Gov’t & Mortgage bonds to lower long term interest rates
Lower long term interest rates => lead to more investment
Lower mortgage rates => lead to more houses sold