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Published byImogen Riley Modified over 9 years ago
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By Miles Overton and J-smash Hernandez Per: 1
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Think of the Fed as having three “buttons” to push Every time a button is pushed either the money supply is raised or lowered The first button is the reserve requirement The equation to solve the money supply is : 1/Reserve requirement x Change in reserves of the bank Ex. (5% is the Reserve requirement) 1/.05 x $1,000 = $20,000 (10% is the Reserve requirement) 1/.10 x $1,000 = $10,000 (20% is the Reserve requirement) 1/.20 x $ 1,000 = $5,000
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Notice before when the supply was largest at $20,000 the reserve requirement was at 5% & the supply is smallest at $5,000 when the requirement is at 20% Thus the Fed can increase or decrease the money supply by changing the reserve requirement Lower reserve requirement money supply rises Raise reserve requirement money supply falls
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The second button the Fed can “push” to change the money supply is the open market operations button This 12 member committee ( FOMC) conducts Open market operations which buy and sell government securities by the Fed Open market purchase Money supply rises Open market sale Money supply falls
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The third button the Fed can push can change the money supply is the discount rate button For example if bank M wanted to borrow $2 million dollars, it could borrow from bank J or the Fed If they borrowed from bank J then the bank could charge an interest for the $2 million dollar loan, this is known as federal fund rate If the money is borrowed from the Fed, they will charge an interest rate known as discount rate
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It does not matter which bank M chooses from pending the relationship between federal funds rate and discount rate However, if the federal fund rate is lower than the discount rate then the choice would be bank J But, if the discount rate is lower than the federal rate, the choice would be the Fed The choice may be simple but could possibly have many ramification to it…
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If bank M were to borrow from bank J no new money would be entering the economy However if bank M borrows from the Fed, the Fed then create new money in the process of granting loans The Fed can grant by depositing the funds into a reserve account of the bank The Fed lowers its discount rate to become lower than the federal rate & if the bank borrows money from the Fed supply increases
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If the Fed lowers the discount rate: Lower the discount rate Money supply rises Raise the discount Money supply falls
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FED MONETARY TOOLSMONEY SUPPLY Open market operation Buys government securities Sells government securities Reserve Requirement Raises reserve requirement Lowers reserve requirement Discount rate Raises discount rate Lowers discount rate Increase Decrease Decrease Increase Decrease Increase
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Arnold, Roger A.. Economics: new ways of thinking. St. Paul, Minn.: EMC Pub., 2007. Print.
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