MACRO: Monetary System + Policy

If the reserve ratio for all banks is 12.5 percent, then $2,000 of additional reserves can create up to

$16,000 of new money

What are excess reserves?

Any reserves banks hold over and above the legal requirement

What are the Federal Reserve's two policy objectives?

Full employment and stable prices (low inflation rate)

After 2003, The Federal Reserve usually keeps the discount rate

above the target federal funds rate.

Imagine that the federal funds rate was above the level the Federal Reserve had targeted. To move the rate back towards it's target the Federal Reserve could

buy bonds. This buying would increase the money supply.

The money supply increases when the Fed

buys bonds. The increase will be larger, the smaller is the reserve ratio.

When the Federal Reserve conducts open-market operations to increase the money supply, it

buys government bonds from the public

In the 19th century, when crop failures often led to bank runs, banks would make relatively fewer loans and hold relatively more excess reserves. By itself, these actions by the banks should have

decreased both the money multiplier and the money supply.

Reserve Requirements

- affect how much money banks can create by making loans -To increase money supply: Fed Reduces RR. Banks make more loans from each dollar of reserves, which increases money multiplier and money supply. -To reduce money supply: Fed raises RR, and process works in reverse

quanatiive easing

- fed uses this to increase MS - expansionary monetary policy but focuses on long term interest rates

what are the feds two policy objectives

- max employment - stable prices

intrest on reserves

- to have better control over inflation - encourages banks to hold excess reserves, to hold more if interest is there.

What two things are included in the money supply?

-Money in checking accounts M2 -Cash you have in your hand M1

What is the reserve requirement?

-Regulations on the minimum amount of reserves that banks must hold against deposits -Banks can hold more than the minimum if they want

How do banks influence the money supply?

-Through fractional reserve banking, when you deposit Money, bank keeps the reserve, and the rest is given out on loans. Then loan is deposited into another bank and the cycle continues until no money is left to loan, -Amount of money supply gained is 1/R(reserve ratio)

To decrease the money supply, the Fed could

-sell government bonds. -increase the discount rate. -increase the reserve requirement.

The discount rate:

-the interest rate on loans the Fed makes to banks -When banks are running low on reserves, they can borrow reserves from the Fed -To increase money supply: fed can lower discount rate, which encourages banks to borrow more reserves -To reduce money supply: feds can raise discount rate -Last resort

Term Auction Facility

-the monetary policy procedure used by the Federal Reserve, in which commercial banks anonymously bid to obtain loans being made available by the Fed as a way to expand reserves in the banking system

Open Market Operations

-the purchase and sale of US GOV bond by the FED. - To increase money supply: Fed buys gov bonds paying with new dollars. These new dollars are deposited into banks,increasing reserves, so more loans are made, money supply expands - To decrease money supply: Fed sells gov bonds taking dollars out of circulation

Reserve ratio: 10% Initial deposit :$250 Max amount of deposits could increase max amount that money supply could increase min amount that money supply could increase

1. 250x10=2500 2. 2500-250= 2250 3. 0, if they don't loan it out then nothing can happen

What are the three "tools" the Fed could use to change the money supply? Which one do they use almost exclusively?

1. Open market operations 2. Reserve Requirements 3. The discount rate

Fed's tools of monetary control

1. open market operations 2. reserve requirement 3. discount rate 4. quanative easing 5. term auction facility 6. interest on rates

If the reserve ratio is 5 percent, then the money multiplier is

20.

Suppose a bank has $200,000 in deposits and $190,000 in loans. It has loaned out all it can. It has a reserve ratio of

5 percent.

How would the Fed use open market operations to decrease the money supply

Contractionary Monetary policy - Fed sells bonds - Money Supply decreases - excess reserves decreases - fed funds rate increases - interest rate increases - consumption and investment decreases -AD shifts left - Price decreases,inflation decreases

How would the fed use open market operations to increase the money supply?

EXPANSIONARY MONETARY POLICY - buy bonds - money supply increases - excess reserves increases - fed. funds rate decreases - interest rate decreases - consumption and investment increases - AD shifts right - GDP increases - Unemployment decreases

Who controls the money supply?

Federal Reserve- central bank of the US

When the federal funds rate is above the interest rate paid on excess reserves, banks will:

Loan to other banks

What is it called when the Fed changes the money supply to achieve economic objectives?

Monetary policy

The facility that was created in December of 2007 that banks can use to borrow from the Fed that has less of a stigma for banks compared to borrowing from the discount window is the

Term Auction Facility.

Monetary policy refers to

changes in the money supply to achieve economic goals.

Suppose a person cashes his payroll check and holds all the funds in the form of currency. Everything else held constant, total reserves in the banking system ________ .

decrease

If the Fed sells government bonds to the public, then reserves

decrease and the money supply decreases.

Theoretically, to eliminate a recessionary gap, the Fed could use _____ monetary policy, and to eliminate an inflationary gap, the Fed could _____ use monetary policy.

expansionary, contractionary

According to Keynes, if the money supply rises, the interest rate _____, investment spending _____and the AD curve shifts to the _____.

falls; rises; right

The interest rate charged on overnight loans of reserves between banks is the

federal funds rate.

Under a fractional-reserve banking system, banks

generally lend out a majority of the funds deposited

The money supply decreases if

households decide to hold relatively more currency and relatively fewer deposits and banks decide to hold relatively more excess reserves and make fewer loans.

Theoretically, to eliminate a recessionary gap, the Fed could _____ the money supply, and to eliminate an inflationary gap, the Fed could _____ the money supply.

increase; decrease

The most common definition that monetary policymakers use for price stability is

low and stable inflation.

Open market sales ________ reserves and thereby ________ the money supply.

lower; lowering

According to Keynes, a rise in the money supply will ________the interest rate, causing a ________in investment spending, which then ________Real GDP.

lower; rise; raises

Suppose banks decide to hold more excess reserves relative to deposits. Other things the same, this action will cause the

money supply to fall. To reduce the impact of this the Fed could buy Treasury bonds.

The Fed's open market operations normally involve only the purchase of government securities, particularly those that are short-term. However, during the crisis, the Fed started new programs to purchase

mortgage-backed securities and long-term Treasuries

From before the financial crisis began in September of 2007 to when the crisis was over at the end of 2009, the huge expansion in the Fed's balance sheet did not result in a large increase in monetary supply because

most of it just flowed into holdings of excess reserve.

Monetary policy to eliminate a recessionary gap can be portrayed as a movement:

of the AD curve to the right.

Purchases and sales of government securities by the Federal Reserve are called

open market operations.

In the long run, changes in the money supply affect

prices.

An increase in the money supply might indicate that the Fed had

purchased bonds in an attempt to reduce the federal funds rate.

The Fed can increase the price level by conducting open-market (hint: use the ADAS graph)

purchases and lowering the discount rate.

If people decide to hold less cash and more deposits, the money supply

rises. The Fed could lessen the impact of this by selling Treasury bonds.

Suppose there were a large increase in net exports. If the Fed wanted to stabilize output, it could

sell bonds to decrease the money supply.

If the Fed decides to reduce bank reserves, it can

sell government bonds.

A problem that the Fed faces when it attempts to control the money supply is that

since the U.S. has a fractional-reserve banking system, the amount of money in the economy depends in part on the behavior of depositors and bankers.

A decrease in the money supply might indicate that the Fed had

sold bonds in an attempt to increase the federal funds rate.

A Keynesian would say that the economy self-corrects so slowly in a recessionary gap in moving the __________ that an activist monetary policy is called for. (hint: how would the economy self-correct from a recession?)

the SRAS curve to the right

Fine-tuning consists of

the usually frequent use of monetary policy to counteract even small undesirable movements in economy activity.

How does the fed control the federal funds rate

through open market operations

If the central bank in some country lowered the reserve requirement, then the money multiplier for that country

would increase.

In December 1999 people feared that there might be computer problems at banks as the century changed. Consequently, people wanted to hold relatively more in currency and relatively less in deposits. In anticipation banks raised their reserve ratios to have enough cash on hand to meet depositors' demands. These actions by the public

would reduce the multiplier. If the Fed wanted to offset the effect of this on the size of the money supply, it could have bought bonds.