AP Econ Interest Rates and Monetary Policy
assuming the fed sells $40 mill in bonds to commercial banks and RR is 20%, the effect will be to reduce
the potential money supply by $200 million
if the fed buys $1 in gov't securities from bank A, then the effect would be an increase in
bank A's excess reserve
assume the RR is 25%, if the fed sells $120 mill in bonds to the public, the money supply will
decrease by $120 and the maximum money lending potential of commercial banking system will decrease by $480 (120 x 1/.25)
tools of monetary policy for altering reserves of commercial banks
discount rate, reserve ratio, open market operations, and term auction facility
assume the RR is 20%, if the fed buys $80 in bonds, the money supply will
increase by $80, maximum will increase by another $320 (80 x 1/.2 - 80)
a decrease in interest rate will cause
increase in the amount of money held as an asset
bond prices and interest rate are ___ related
inversely
The transactions demand for money will shift to the
left when nominal GDP decreases
how does the federal reserve alter the nation's money supply?
manipulating the size of excess reserves held by commercial banks
Accurate description when monetary authorities increase size of commercial banks' excess reserve:
money supply increased, which decreases interest rate, and causes investment spending, output and employment to increase
the most frequently used monetary device for achieving price stability
open market
when would the quantity of money demanded increase
when the interest rate decreases and nominal GDP increases
assume there's 25% RR and fed buys $4 bill bonds. this action has the potential to increase money supply by a maximum of
$16 billion, but also by $16 billion if the securities are purchases directly from commercial banks
assume there's 25% RR and fed buys $200 mill. what's lending maximum
$600, but by $800 if the securities are purchases DIRECTLY from commercial banks
level of GDP will tend to increase when
The Federal Reserve buys government securities in the open market
discount rate
The interest rate on the loans (that the Fed makes) to banks
when the interest rate falls
Total amount of money demanded increases
A consumer holds money to meet spending needs
Transactions demand for money
lowering reserve ratio
Turns required reserves into excess reserves
the fundamental objective of monetary policy is to assist the economy in achieving
a full employment, noninflationary level of total output
major purpose of fed buying gov't securities is to
allow banks to increase their lending
in the cause-effect chain linking changes in the banks' excess reserves and the resulting changes in output and employment in the economy:
an increase in the money supply will decrease rate of interest
lower the reserve ratio
available funds increases & spending increases (increases excess reserves)
if the fed buys gov't securities from commercial banks in the open market,
commercial banks give the securities to the fed, and the fed increases the banks' reserves
the federal reserve can increase aggregate demand by
reducing discount rate
full employment and high inflation
sell gov't securities in open market and decrease gov't spending
the fed could reduce the money supply by
selling gov't bonds in open market
if the fed sells gov't securities to the public,
the fed gives the securities to the public, the public pays for the securities by writing checks that when cleared will decrease commercial bank reserves at the fed
problem: high unemployment, weak economic growth
the fed would buy gov't securities and lower discount rate
fed funds rate
the interest rate thank banks charge one another for the loan of excess reserves
open market operations
the purchase and sale of U.S. government bonds by the Fed
What occurs when monetary authorities sell bonds
there is a decrease in size of commercial banks' excess reserve, the money supply decreases, and interest rates rise, decreases in investment spending and real GDP
a tv reports "the fed will lower discount rate for the fourth time" this shows that the fed is
trying to stimulate the economy