1. Chapter 13 and 15

2.  Altering the money supply and interest rates to manipulate the economy. Chapter 13

3.  The FED is the part of the government that determines & enacts monetary policy.  The Fed serves as the central bank for the United States. Chapter 13

4.  It is the banks’ bank: it accepts deposits from and makes loans to commercial banks.  It acts as banker for the federal government.  It controls the money supply.  Performs certain regulatory functions for the financial industry. Chapter 13

5.  Reserve requirements  How much money a bank must keep on hand  Discount rate  The rate the Fed lends money to banks  Federal Funds Rate  The interest rate for inter-bank reserve loans – One bank to another  Open market operations  Treasury buys & sells government bonds Chapter 13

6.  Legal reserves  The cash a bank holds in its vault plus its deposits at the Fed.  Excess reserves  If the Fed lowers reserve requirements, banks that hold excess reserves can increase lending.  Such lending increases the money supply. Chapter 13

7.  By altering the money supply the Federal Reserve is able to affect the equilibrium rate of interest. Chapter 13

8.  Altering the money supply changes the equilibrium rate of interest.  This changes consumer, investor, government, and net export spending.  Higher rates  less spending & investment Chapter 13

9.  The buying and selling of government bonds by the Fed to control bank reserves, the fed funds rate, and the money supply.  The FOMC Buys bonds:  Bonds are replaced by cash  Money supply is increased. Chapter 13

10.  The goal of monetary stimulus is to increase aggregate demand with lower interest rates.  Increases investing  Increases larger-ticket consumption  The increase in investment will kick off multiplier effects Chapter 13

11.  Tools:  Increase the money supply.  Reduce interest rates.  Both lead to increase in aggregate demand  which leads to more jobs, etc… Chapter 13

12.  To lessen inflationary pressures, the Fed will apply a policy of monetary restraint. Chapter 13

13. 1. Reluctant Lenders  Banks themselves must expand the money supply by making new loans.  Banks may be unwilling to make new loans because their returns are lower. 2. Low Expectations Chapter 13

14. 3. Liquidity Trap  When interest rates are low, people may decide to hold all the money they can get – waiting for opportunities to improve. 4. Global Money  borrow money from foreigners Chapter 13

15.  The real interest rate is:  The nominal rate of interest minus anticipated inflation rate. Chapter 13

16.  MV = PQ  M = money supply  V = velocity of circulation  P = Prices of products sold  Q = Quantity of products sold ▪ PxQ = nominal GDP Chapter 13

17.  Monetarist believe velocity of money (V) is stable. – change (M) will change spending  Some monetarists claim that Q, as well as V, is stable. - If true, changes in the money supply (M) would affect only prices (P).  A stable Q means that the quantity of goods produced is primarily dependent on production capacity, labor-market efficiency, and other structural forces  leads to a “natural” rate of unemployment Chapter 13

18.  The Keynesian cure for unemployment is to expand M and lower interest rates.  Monetarists fear that an increase in M will lead to higher P. Chapter 13

19.  What Keynesians and Monetarists argue about is which of the policy levers – (M) or (V) – is likely to be effective in altering aggregate spending.  Monetarists point to the money supply (M) as the principal lever. Chapter 13

20.  If (V) is constant, changes in total spending can come about only through changes in the money supply.  If the government raises taxes or borrows more money, it effectively crowds out consumers and investors who would otherwise be spending or borrowing. Chapter 13

21.  Monetarists favor fixed money supply targets. Chapter 13

22.  Keynesians reject fixed money supply targets.  Keynesians advocate targeting interest rates, not the money supply. Chapter 13

23.  The Fed uses a mixture of monetarist and Keynesian policies instead of the strict monetarist approach.  Focus on Federal Funds Rate Chapter 13