ECON CH15

how the fed controls the money supply

-Open market operations - the buying and selling of U.S. government bonds. -Discount rate lending and the term auction facility - Federal Reserve lending to banks and other financial institutions. -Required reserves and payment of interest on reserves - Changing the minimum RR for banks and other depository institutions; paying interest on any reserves held by banks at the Fed.

Difficulty of central banking

-The Fed has direct control only over the monetary base.•But it is M1 and M2 that have the greatest impact on AD.•It tries to use its control over MB to influence M1 and M2.-M1 and M2 can change independent of what the Fed does.-Aggregate demand can change for other reasons than changes in M1 and M2.

money multiplier

1/reserve ratio

Fed decreases interest rate on reserves

Banks decrease reserves, loans increase, Ms increase

Quality of the discount rate?

Discount window borrowing tends to be used for short-run "tide-me-overs" rather than for long-run monetary policy decisions.

change in money supply

Money Multiplier x Change in deposits

if the fed wants to increase the money supply

They will buy T-bills

The fed also

-Regulates other banks. -Manages the nation's payment system. -Protects financial consumers with disclosure regulations.

What effect does an increase in reserves have on the money supply?

An increase in reserves increases both M1 and M2.

currency

Coins and paper bills used as money

What does the Fed not do?

It does not print money for specific government expenditures.

M2 (largest)

M1 plus savings deposits, money market mutual funds, etc.

Most important function of the Fed

Regulate U.S. money supply (from the slides)

Who controls the fed

The Board of Governors-Seven members for 14 year terms. -The chairperson of the Fed is appointed by the president from among the members of the board for 4 year terms. •The U.S. is divided into 12 regions with a Federal Reserve bank in each. •Federal Open Market Committee (FOMC) - most important policy making body of the Fed-Board of governors-5 presidents of the regional banks

Of the following events that would occur as a part of the Fed using monetary policy to decrease aggregate demand, which would occur first?

The Fed sells bonds in an open market operation. Selling bonds in open market operations would decrease the money supply, which raises short-term interest rates, causing less borrowing and investing. WHY?

The amount of money created depends on

The reserve ratio (RR) - the fraction of deposits held on reserve •RR is determined by how liquid banks wish to be .•The Fed sets a minimum RR. -Money multiplier (MM) - the amount the money supply expands with each dollar increase in reserves.

In 2008, Congress authorized the _____, which allocated up to $700 billion for the purpose of aiding banks.

Troubled Asset Relief Program

Total reserves

Value of accounts banks have at the Federal Reserve System. -Used to trade with other banks -Used for dealings with the Federal Reserve itself. -Not currency but electronic claims-Part of the money supply because these claims can be easily converted into currency.

quantitative easing

When the Fed buys longer-term government bonds or other securities in order to influence long-term interest rates, it is engaging in. Quantitative easing is used when the economy needs an extra boost.

Liquid asset

an asset that can be used for payments or, quickly and without loss of value, be converted into an asset that can be used for payments.

M1

currency outstanding and checkable deposits.

Monetary Base

currency outstanding and total reserves at the Fed.

Discount rate

the interest rate banks pay when they borrow directly from the Fed.

Federal funds rate

•The Fed has greatest influence over the a short-term interest rate called the Federal Funds rate. •Federal Funds rate - the overnight lending rate that banks charge each other. •Monetary policy is usually conducted in terms of the Federal Funds rate.

Money multiplier is not fixed

•When the banks are confident and eager to lend, MM will be higher. •When the banks are fearful and reluctant to lend, MM will be lower.

Fed buys bonds

↓Interest rates. Fed only controls the real interest rate in the short run.