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Monetary Policy

Monetary Policy. Using the amount of money and credit available to consumers to influence the economy. The Federal Reserve System. The Federal Reserve Bank (The Fed) is central bank of the U.S. designed to oversee the banking system and regulate the quantity of money in the economy.

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Monetary Policy

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  1. Monetary Policy • Using the amount of money and credit available to consumers to influence the economy

  2. The Federal Reserve System • The Federal Reserve Bank (The Fed) is central bank of the U.S. • designed to oversee the banking system • and regulate the quantity of money in the economy

  3. The U.S. Congress established three key objectives for monetary policy in the Federal Reserve Act: • Maximum employment • stable prices (control inflation) • Stabilize interest rates • Role has expanded to include: • Regulate the banking and financial systems

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

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

  6. Monetary Policy Expansionary Monetary Policy= expand credit = lower …. interest rates = cheaper to …. borrow money = economic growth or contraction?

  7. Contractionary Monetary Policy = restrict credit higher ….. interest rates = more expensive to …. borrow money = economic growth or contraction ?

  8. Three Tools of the Federal Reserve • Reserve Requirement • Discount Rate c.)Open Market Operations (Federal Funds Rate)

  9. Reserve Requirement • the FED requires banks to hold a certain…. • amount of money from circulation • The bank may not ….. • loan this money to any customers. • Least used of the three tools

  10. Expansionary Monetary Policy Using Reserve Requirement • If the Fed decreased the Reserve Requirement, then banks would be allowed to…… • Loan out more money. The Money supply would…. • Increase. Consumers would …. • Borrow more and spend more and the economy would……. • Expand (grow)

  11. Contractionary Monetary Policy Using Reserve Requirement

  12. 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

  13. Expansionary Monetary Policy Using the Discount Rate • If the Fed lowers DR, it is cheaper for….. • banks to borrow money . So banks will ….. • pass on savings to customers and lower ….. • their interest rates and the money supply will…. • Increase and there is more spending and the economy will….. • Expand (grow)

  14. Contractionary Monetary Policy Using the Discount Rate

  15. 4. Open Market Operations • Most used tool of the Fed • Fed buys and sells US government securities and US Bonds (define bond – The government needs money so they “Borrow “ the money from the public You buy a $1000 bond from the govt. with 10% interest. The govt agrees to pay you back the $1000 plus $100 from interest

  16. Expansionary Policy = buy bonds • Fed buys $1000 bond from Joe. So the money supply ….. • Inceased. Joe gave up his bond but now has $1000 in cash Contractionary = sell bonds • Fed sells $1000 bond to Joe. So the money supply…… • Decreased. Joe now has a bond but $1000 less in cash

  17. Fed’s effect on INTEREST RATES Intro to Money Market Graphs • Expansionary ; buy bonds ; increase MS ; decrease IR MS 1 MS 2 Int Rate MD Q of Money

  18. b) Contractionary ; sell bonds ; decrease MS ; increase IR MS 2 MS 1 MD

  19. When the Fed uses OMO to buy / sell bonds, it is manipulating the 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

  20. 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…..”

  21. Expansionary Monetary Policy (using OMO and the FFR) • FOMC buys securities and the MS will ….. • Increase • This will decrease FFR which means banks will …. • Pay less to borrow and therefore will….. • Pass on savings to customers and lower their …. • Interest rates and the money supply will …. • Increase. Customers will borrow…… • More and spend……. • More and the economy will….. • Expand (grow)

  22. Contractionary

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