Transcript Chapter 14 presentation 1

Chapter 14
Presentation 1- Monetary Policy
Ways the Fed Controls the Money
Supply
• 1. Open Market Operations (**Most used)
• 2. Changing the Reserve Ratio
• 3. Changing the Discount Rate
Open Market Operations
• Buying or selling government securities
(bonds, treasury bills) by the Fed from the
general public or commercial banks
Buying Securities
• When the Fed buys bonds from the
commercial banks or the public, this
increases the reserves of the bank
• This allows the banks to make more loans
Selling Securities
• When the Fed sells securities, the amount
of reserves in the banking system goes
down
• There is now less money to loan out
Changing the Reserve Ratio
• Raise the reserve ratio- lowers the money
supply by making banks hold more $$
• Lower the reserve ratio- changes the
amount of excess reserves and the
multiplier---allows banks to loan more
money
Changing the Discount Rate
• If the Fed lowers this rate, banks are able
to borrow more and increase their loans to
the public and vice versa
Asset Demand for Money
• The amount of money people hold as a
store of value
• People like to hold money since it is the
most liquid asset
Transaction Demand for Money
• The amount of money people want to hold
to use as a medium of exchange to make
purchases
• People hold cash to buys goods/services
• Varies directly with nominal GDP
Interest Rate
• The payment made for the use of money
Money Market Graph
Sm
Rate of Interest, I percent
10
7.5
5
2.5
Dm
0
50
100
150
200
250
300
Amount of Money
Demanded and Supplied
(Billions of Dollars)
Bond Prices and Interest Rates
• When interest rate fall, existing bond
prices rise
• When interest rates rise, existing bond
prices fall
• Inverse relationship
Bond Prices
• % interest yield = Amount of interest
paid/bond cost
Bond Prices Example
• A $1000 bond pays 5% fixed interest rate
and is selling for face value (which pays
$50). Now the interest rates go up to
7.5%. The new bonds pay $75 interest.
In order to sell the old bond, the sale price
must fall to $667
• 50/X = .075
• X = 667
• The original bond still pays $50 interest