1. Chapter 12
Monetary Policy

2. Introduction
Monetary Policy – Federal Reserve using the money supply and interest rates to stabilize the economy
Introduction
Board of Governors formulate policy
12 Districts implement the policy

3. Types of Monetary Policy
Easy (loose) Policy
Increase the money supply
Decrease interest rates
Increase borrowing
Increase spending (C+I)
Increase aggregate demand
Increase GDP
Tight Policy
Decrease the money supply
Increase interest rates
Decrease borrowing
Decrease spending (C+I)
Decrease aggregate demand
Decrease GDP

4. Tools
Open market operations - buying and selling govt. bonds (most important)
Reserve Ratio (requirement) - % of reserves held in the FED (least used)
1937 – 20%
1958 – 13%
1980 – 12%
1992 – 10%
Discount Rate - rate at which banks borrow from the FED (Used in emergencies)

5. Policy in the Gaps
Contractionary Gap (recession): Easy Money Policy to Inc MS, dec ir, inc borrowing and spending (C & I), inc AE & AD and inc GDP
Buy Bonds
Lower RR
Lower DR
Expansionary Gap (potential inflation): Tight Money Policy to dec MS, inc ir, dec borrowing and spending (C & I), dec AE & AD and dec GDP
Sell Bonds
Raise RR
Raise DR

6. Effectiveness Faster and more flexible than Fiscal Policy
Can be reversed
Less political
FED targets the Federal Funds Rate through Open Market Operations

7. Disadvantages
Can’t force banks to borrow or not borrow