Transcript Macroeconomics

Chapter 15: Monetary Policy
Federal Reserve Board Chairperson
Federal Reserve Board (7)
Federal Open Market Committee (12)
Deliberate changes in money supply to
influence interest rates, total level of
spending in economy
Goal is to achieve & maintain price-level
stability, full-employment, & economic growth
Tools of Monetary Policy
Open-market operations
Reserve ratio
Discount rate
Open-Market Operations
Bond markets are open to buyers &
sellers of corporate & government
bonds (securities)
Fed’s Open-market operations consist of
buying bonds from or selling bonds to
commercial banks & general public
The most important instrument for
influencing the money supply
Reserve Ratio
Raising the reserve ratio increases amount of
required reserves banks must keep 
reduces money supply

Forces banks to reduce amount of checkable
deposits
Lowering reserve ratio decreases amount of
required reserves banks must keep 
increases money supply

Transforms required reserves into excess reserves,
enhancing ability of banks to create new money
by lending
Discount Rate
Fed is “lender of last resort”

Short-term loans to commercial banks in need in
its district (12)
Discount Rate: Interest rate Fed charges to
commercial banks
Borrowing from Federal Reserve Banks by
commercial banks increases reserves of
commercial banks & enhances their ability to
extend credit
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Lowering discount rate increases money supply
Increasing discount rate decreases money supply
Easy Money Policy
Aka Expansionary Monetary Policy
To combat recession & unemployment,
Fed decides to increase money supply.
How:
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Buy securities
Lower reserve ratio
Lower discount rate
Tight Money Policy
Aka Restrictive Monetary Policy
To reduce spending & control inflation,
Fed wants to reduce aggregate demand
by contracting supply of money
How:
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Sell securities
Increase reserve ratio
Raise discount rate
Effectiveness of Monetary
Policy
Strengths:
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Speed & Flexibility (v. Fiscal Policy)
Isolation from Political Pressure (14 year terms)
Shortcomings & Problems

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Less control due to changes banking practices
(bank reform & electronic transactions)
Changes in velocity
 Velocity of money: number of times per year average
dollar is spent on goods & services

Cyclical asymmetry: less reliable in pushing
economy from recession
Targeting the Federal Funds
Rate
Focus of Fed’s monetary policy to stabilize the
economy
Interest rates in general rise & fall w/ Federal
Funds rate
Prime interest rate: rate banks charge their
most creditworthy customers, parallels FFR
By changing the FFR, Fed is changing
economy’s overall interest rates
Fed announces changes in monetary policy by
announcing changes for target FFR
Monetary Policy &
International Economy
Net Export Effect
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Expansionary monetary policy (lower FFR)
decreases foreign demand for dollars,
increases net exports & dollar depreciates
Restrictive monetary policy (higher FFR)
increases foreign demand for dollars,
decreases net exports & dollar appreciates