Unit Four: Monetary Policies

Three Tools of Monetary Policy 

Notes 3/21/16

1. Reserve Requirement

-Only a small percentage of your bank deposit is in the safe. Rest of money has been loaned out.

   *Called Fractional Reserve Banking

-Fed sets amount banks must hold

-RR= Percent of deposits that banks must hold in reserve and NOT loan out

-When the Fed increases the Money Supply, it increases the amount of money held in bank deposits

2. Discount Rate

-Interest Rate the Fed charges commercial banks

-To INCREASE the Money Supply, DECREASE the Discount Rate (Easy Money Policy)

-To DECREASE the Money Supply, INCREASE the Discount Rate (Tight Money Policy)

3. Open Market Operations (OMO)

-Fed is buying/selling bonds (securities)

  *Most widely and often used*

-To INCREASE the Money Supply, BUY bonds

-To DECREASE the Money Supply, SELL bonds

RECESSION?--> Expansionary Policy

-OMO: BUY bonds

-Reserve Requirement: Decrease

-Discount Rate: Decrease

* Money Supply INCREASES, AD INCREASES, GDP INCREASES, iR DECREASES, Loans INCREASES 

INFLATION?--> Contractionary Policy

-OMO: SELL bonds

-Reserve Requirement: Increase

-Discount Rate: Increase

* Money Supply DECREASES, AD DECREASES, GDP DECREASES, iR INCREASES, Loans DECREASES

+Federal Funds Rate: FDIC member banks make overnight loans to other banks

+Prime Rate: Interest rate that the banks charge to their most credit worthy customers

-When a customer deposits cash or withdraw cash from their demand deposit account, it doesn't change the Money Supply. It changes:

   *The Composition of Money

   *Excess Reserves

   *Required Reserves

-Single Bank- Can only loan money from excess reserves

-Banking System- (ER)(Multiplier)= Total Money Supply

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