Economics: Unit 4-Monetary Policy

Monetary Policy

Controlled by the Fed (Federal Reserve Bank)

Influencing the economy though changes in the economy through changes in reserve which influences the money supply and available credit. 

4 Options: 

1. Reserve Requirement: The percent that is said by the Fed of the minimum reserve the bank must keep.
2. Discount Rate: The rate of interest that the Fed charges for overnight loans to banks
3. Federal Fund Rate: The rate that FDINC members charge each other for loans.
4. OMO (Open Market Operations)
• Buy or sell securities (bonds) 

If the Fed buys bonds, then the money supply expands

If the Fed sells bonds, then the money supply decreases

Prime Rate: The interest rate that banks charge their most credit worth borrowers.

• Good credit = low rate

If the Discount Rate and the Federal Fund Rate decrease; Expansionary Monetary Policy

If the Discount Rate and the Federal Fund Rate increase; Contractionary Monetary Policy

	Expansionary on Easy Money	Contractionary on Tight Money
OMO	Buy Bonds	Sell Bonds
Discount Rate	Decrease	Increase
Federal Fund Rate	Decrease	Increase
Required Reserve	Decrease	Increase

Tight Money has a higher interest rate, money will uppreciate

Easy money will depreciate

Assume 10% reserve requirement 

1. $1000 inc ash deposited into checking account
• If initial deposit is not new money, the total change in MS is only the new money created by the banking system. (=$9000)
2. No immediate change in MS
3. Assets: Reserves = $100

1. $1000 Fed purchase of bonds from the public (deposited into checking account)
2. Immediate increase in MS of $1000
3. Liabilities: Checkable Deposits = $1000

Either deposit would increase actual reserves by $1000

Required Reserve = $100 (.10 * $1000 deposit)

Single Bank: Amount of money single bank can create (loan out) = ER; AR - RR = ER

Banking System: Can create money by a multiple of its initial ER

Deposit Multiplier = 1/RR

System Now $ = Deposit multiplier * Initial ER