Transcript Monetary EOCT

The Federal
Reserve and
Monetary
Policy
The Federal Reserve &
Monetary Policy

Monetary policy includes all the Federal
Reserve actions that change the money
supply in order to influence the economy.
Its purpose is to curb inflation or to reduce
economic stagnation or recession.
Creating the Fed


govt struggled to stabilize economy until
Federal Reserve Act
Central bank—a nation’s monetary authority


monetary means “relating to money”
Federal Reserve System—central bank of the
U.S., called the Fed

independent organization within govt;
established 1913
The Structure of the Fed
Elements

of the Fed
Board of Governors—sets policy; supervises
operations of the Fed

chairman is most influential member and
spokesperson

12 district banks carry out policy; serve as central
bank for regions

Member banks: all nationally-chartered banks;
state banks may apply

must buy district bank stock; cannot sell in open
market
Serving the Banking System
1:
Check Clearing
2: Lending Money
3: Regulating & Supervising Banks
Serving the Federal govt
1:
Paying govt Bills
2: Selling govt Securities
3: Distributing Currency
Creating Money

Creating money—how money enters
circulation through deposits, loans

Fed establishes required reserve ratio (RRR)
for banks
 fraction
reserve
of bank’s deposits that it must keep in
The Fed’s Monetary Tools
Monetary
policy—actions the Fed takes
to change money supply
 purpose
is to influence the economy
The Fed’s Monetary Tools
Open

Market Operations
Open market operations—sales and purchase of
govt securities

Fed buys securities to expand money supply; sells to
contract supply

Federal funds rate (FFR)—interest rate banks
charge one another

Fed signals intent to buy or sell by announcing a
target for the FFR

if lowers target, Fed buys bonds; if raises target, it sells
bonds
The Fed’s Monetary Tools
Adjusting

the Reserve Requirement
Fed changes required reserve ratio to
change the money supply
 increase
in RRR reduces money supply;
decrease expands it
 RRR
averages 10–12% for transaction deposits,
0–3% for time deposits
The Fed’s Monetary Tools
Adjusting

Discount rate—interest rate Fed charges on loans
to other banks


affects money supply because it determines reserves
banks have to lend
Prime rate—interest rate banks charge their best
customers


the Discount Rate
other borrowers pay 2-3 percentage points above
prime
If discount rate rises, so do prime, business &
consumer rates
Approaches to
Monetary Policy

Expansionary monetary policy—plan to
increase the money supply

Contractionary monetary policy—plan to
reduce the money supply
Approaches to Monetary
Policy
Expansionary


Policy
In recession, Fed increases money supply to
increase aggregate demand
Fed can buy bonds on open market,
decrease RRR or discount rate
 most
common practice is to buy bonds to
make interest rates fall
Approaches to Monetary
Policy
Contractionary


Policy
Fed decreases money supply to check
aggregate demand, inflation
Fed can sell bonds on open market,
increase RRR or discount rate
 most
common action is to sell bonds to raise
interest rates
Impacts and Limitation of
Monetary Policy
Short-Term
Effects

The short-term effect is a change in the
price of credit

Open market operations influence FFR fairly
quickly
 change

loanable reserves banks have
Easy-money policy lowers interest rates;
tight-money raises them
Impacts and Limitation of
Monetary Policy
Other
Issues

Monetary policy more effective if
coordinated with fiscal policy

Goals of Fed may clash with those of
Congress or President
 governors
serve 14 years; have less political
pressure than politicians