Transcript Monetary and Fiscal Policy

GOVERNMENT POLICY:
MONETARY & FISCAL
POLICY
Adapted from James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts University
©2005 Thomson Business & Professional Publishing, A Division of Thomson Learning
1
2
Monetary Policy - Policy that involves
changing the rate of growth of the money
supply in circulation in order to affect the
cost and availability of credit.
Fiscal Policy - Using taxes and spending to
help the economy grow.
3
4
5
6
7
THE FEDERAL RESERVE SYSTEM:
DEFINITIONS
Federal Reserve System: the central bank of the
United States
Board of Governors: the governing body of the
Fed
Federal Open Market Committee (FOMC): the 12
member policymaking group within the Fed. It has
the authority to conduct open market operations
8
THE FEDERAL RESERVE SYSTEM:
DEFINITIONS
Open Market Operations: the buying and
selling of government securities (bonds) by
the Fed
Monetary Policy: changes in the money
supply, or in the rate of change of the money
supply, to achieve particular macroeconomic
goals
9
FEDERAL RESERVE DISTRICTS AND FEDERAL RESERVE
BANK LOCATIONS
10
STRUCTURE OF THE FEDERAL RESERVE
F. Mishkin, THE ECONOMICS OF MONEY AND THE ECONOMIC POLICY REVIEW. (c) 1998
Frederic S. Mishkin. Reproduced by Addison Wesley Longman. All rights reserved.
THE BOARD OF GOVERNORS OF THE
FEDERAL RESERVE
Coordinates and controls the activities of the
Federal Reserve System
7 Members
14 Year Terms
Appointed by the President with Senate approval
A governor is appointed every other year
President designates one member as President for
a 4 year term
12
THE FEDERAL OPEN MARKET COMMITTEE OF THE
FEDERAL RESERVE
The major policy making group within the Fed is the
Federal Open Market Committee
Authority to Conduct Open Market Operations
(Buying and Selling of Federal Securities)
12 Members
 7 Board of Governors
 5 District Bank Presidents (including New York)
13
FUNCTIONS OF THE FEDERAL RESERVE
SYSTEM
Control the Money Supply
Supply the economy with
paper money
Provide check-clearing
services
Hold depository institutions’
reserves
14
FUNCTIONS OF THE FEDERAL RESERVE
SYSTEM
Supervise Member
Banks
Serve as the
government’s banker
Serve as the lender of
last resort
Serve as a fiscal agent
for the Treasury
15
16
THE CHECK-CLEARING PROCESS
17
FED TOOLS FOR CONTROLLING THE MONEY SUPPLY:
OPEN MARKET OPERATIONS
Open Market Operations: Buying and Selling U.S.
Government Securities in the Financial Markets
U.S. Securities: bonds and bond-like securities
issued by the U.S. Treasury
Open Market Purchase: The buying of government
securities by the Fed
Open Market Sale: The selling of government
securities by the Fed
18
OPEN MARKET PURCHASES
Assume Fed purchases securities from a bank.
The Fed receives the securities from a bank, and the
bank’s reserves increase by the amount of the
purchase (Reserves = Bank deposits at the Fed +
Vault Cash).
When the banks have a reserve increase and no
other bank has a similar decline, the money supply
expands through a process of increased loans and
checkable deposits.
19
OPEN MARKET SALES
Assume the Fed sells securities to a bank.
To pay for the securities, the Fed takes reserves
from the bank.
Because of the decrease in the bank’s reserves, the
bank reduces total loans outstanding, which reduces
the total volume of checkable deposits and the
money supply.
20
OPEN MARKET OPERATIONS
21
THE REQUIRED-RESERVE RATIO
The Fed can also influence the money supply by
changing the required-reserve ratio.
An increase in the required-reserve ratio leads
to a decrease in the money supply
A decrease in the required-reserve ratio leads
to an increase in the money supply.
22
THE DISCOUNT RATE
A bank can borrow from the federal funds market or
from the Fed.
Federal Funds Rate: The interest rate a bank pays
for a loan in the federal funds market.
Discount Rate: The interest rate a bank pays for a
loan from the Fed.
When a bank borrows money from the Fed, the
money supply increases because its reserves increase
while the reserves of no other bank decrease.
23
THE SPREAD BETWEEN THE DISCOUNT RATE AND THE
FEDERAL FUNDS RATE
Banks may believe that the Fed is hesitant to
extend loans to take advantage of profitmaking opportunities.
The bank may not want to deal with the Fed
bureaucracy that regulates it.
The bank realizes that acquiring a loan from
the Fed is a privilege and not a right, and
doesn’t want to abuse the privilege.
24
DISCOUNT RATE VS. FEDERAL FUNDS RATE
If the discount rate is
significantly lower than the
federal funds rate, most
banks will borrow from the
Fed.
An increase in the discount
rate relative to the federal
funds rate reduces bank
borrowings from the Fed.
25
WHICH TOOL DOES THE FED PREFER TO USE?
Tools which can be used to influence the money
supply:
 open market operations
 the required-reserve ratio
 the discount rate
The Fed prefers Open Market Operations
 Open market operations are flexible
 Open market operations can be reversed
 Open market operations can be implemented quickly
26
FED MONETARY TOOLS & THEIR EFFECTS ON THE
MONEY SUPPLY
27