Chapter 13: Monetary Policy

Open Market Operations

*Most frequently used tool* The Fed's buying and selling of Treasury bills and Treasury bonds (the only type of asset that, until recently, the Fed held in any appreciable quantity). 1) To expand the money supply, the Fed buys bonds. 2) To contract the money supply, the Fed sells bonds.

Central Bank

A type of banker's bank whose financial obligation underlie an economy's money supply.

Inverted yield-curve

A yield curve in which the short-term rate is higher than the long-term rate.

Offensive Actions

Actions meant to make monetary policy have expansionary or contractionary effects on the economy.

Reserve Requirement

The percentage the Federal Reserve Bank sets as the minimum amount of reserves a bank must have.

Duties of the Fed

1) Conducting monetary policy (influencing the supply of money and credit in the economy). 2) Supervising and regulating financial institutions. 3) Serving as a lender of last resort to financial institutions. 4) Providing banking services to the U.S. government. 5) Issuing coin and currency. 6) Providing financial services (such as check clearing) to commercial banks, savings and loan associations, savings banks, and credit unions.

Ultimate Targets of the Fed

1) Stable prices 2) Sustainable growth 3) Acceptable employment 4) Moderate long-term interest rates

Yield Curve

A curve that shows the relationship between interest rates and bonds' time to maturity.

Monetary Policy

A policy of influencing the economy through changes in the banking system's reserves that influence the money supply, credit availability, and interest rates in the economy.

Contractionary Monetary Policy

A policy that decreases the money supply and increases the interest rate.

Expansionary Monetary Policy

A policy that increases the money supply and decreases the interest rate.

Secondary Reserves

Assets invested in short-term securities, usually Treasury bills and government bonds. They earn interest and can be used to adjust a bank's reserve position.

Monetary Regime

Is a predetermined statement of the policy that will be followed in various situations.

Fed Funds

Loans of excess reserves banks make to one another.

Taylor Rule

Set the Fed funds rate at 2 percent plus current inflation if the economy is at desired output and desired inflation. If the inflation rate is higher than desired, increase the Fed funds rate by 0.5 times the difference between desired and actual inflation. Similarily, if output is higher than desired, increase the Fed funds rate by 0.5 times the percentage deviation. Fed funds rate = 2 percent + Current Inflation + 0.5 x (actual inflation less desired inflation) + 0.5 x (percent deviation of aggregate output from potential)

Federal Open Market Committee (FOMC)

The Fed's chief body that decides monetary policy. The 12 member group that determines the purchase and sale policies of the Federal Reserve Banks in the market for U.S. government securities

Federal Funds Rate

The interest rate banks charge one another for Fed funds.

Fed Funds Rate

The rate of interest at which these reserves can be borrowed.

Discount Rate

The rate of interest the Fed charges for loans it makes to banks.

Monetary Base

The sum of currency in circulation plus bank reserves (vault cash and reserves with the Fed). It reflects the stock of U.S. securities held by the Fed.