Economics- Chapter 16

The Federal Open Market Committee (FOMC)

makes key monetary policy decisions about interest rates and the growth of the U.S. money supply.

Limits of Monetary Policy

-Timing It can smooth out the bumps or deepen/heighten the troughs and valleys -Inside lags Time it takes to implement monetary policy Problem 1; time to identify a problem Problem 2: time to actually enact policies (more streamlined than fiscal) -Outside lags Time to be effective (longer than fiscal policy)

3 tools of Monetary Control

1) OMOs 2) Reserve Requirements 3) The discount rate

open market operations (OMOs)

Buying & selling government securities to change the supply of money To increase money supply, Fed buys govt bonds, paying with new dollars. To reduce money supply, Fed sells govt bonds, taking dollars out of circulation

prime rate

Rate of interest banks charge on short term loans to their best customers

Structure of the Fed

The Board of Governors, 12 Reserve banks, Member Banks, FOMC

federal funds rate

The interest rate at which banks make overnight loans to one another

bank holding company

a company that owns more than one bank

money multiplier formula

a formula (initial cash deposit X 1 / RRR) used to determine how much new money can be created with each demand deposit and added to the money supply

central bank

an institution that oversees the banking system and regulates the money supply

excess reserves

bank reserves greater than the amount required by the Federal Reserve

monetary policy

the actions that the Federal Reserve System takes to influence the level of real GDP and the rate of inflation in the economy.

reserve requirements

the amount of reserves that banks are required to keep on hand. To increase money supply, Fed reduces RR. To reduce money supply, Fed increaseRR, and the process works in reverse.

check clearing

the process by which banks record whose account gives up money and whose account receives money when a customer writes a check

money creation

the process by which money enters into circulation

reserves

deposits that a bank keeps readily available as opposed to lending them out

Fed functions

provides banking services to US government; banking services to banks; regulates banks; tracks and manages money supply to stabilize economy

outside lag

the time it takes for monetary policy to have an effect

inside lag

the time it takes to implement monetary policy

required reserve ratio

The minimum fraction of deposits banks are required by law to keep as reserves

Monetary v. Fiscal Policy

Monetary policy is typically implemented by a central bank, while fiscal policy decisions are set by the national government.

easy money policy

Monetary policy that increases the money supply

discount rate

interest rate the Fed charges for loans to commercial banks. To increase money supply, Fed can lower discount rate, which encourages banks to borrow more reserves from Fed. Banks can then make more loans, which increases the money supply. To decrease money supply, Fed can raise discount rate.

tight money policy

monetary policy that reduces the money supply