Chapter 25 The Government's Use of Monetary Policy

Tool 1: Changing /Adjusting the Reserve Requirement

If the economy is weak, the Federal Reserve will lower its reserve requirement to allow banks to lend out more money. This stimulates the economy. If the economy is too strong, the Federal Reserve will raise its reserve requirement, so banks will have less money to make loans.

Monetary Policy

government policy that controls the nation's money supply to promote economic growth and stability - can be expansionary or contractionary

Open Market

where the Federal Reserve sells or buy bonds The Open Market Committee decides on the policy the Federal Reserve will use to buy or sell bonds

Three tools the Federal Reserve uses to regulate the supply of money and credit in the economy

1. Changing or Adjusting the Reserve Requirement 2. Setting the Discount Rate 3. Buying or Selling Bonds on the Open Market Committee

In an Economic Downturn

1. The Federal Reserve puts more money into circulation 2. Interest rates go down 3. Businesses borrow more because borrowing costs are lowered, stimulating production 4. Consumers borrow more to spend more on cars, homes etc.

In an Economic Upswing

1. The Federal Reserve reduces the money supply 2. Interest rates rise 3. Businesses borrow less 4. Economic growth is slowed to avoid inflation

Federal Reserve's Role

1. To reduce swings in the economy by controlling the ability of banks to lend money 2. To regulate the money supply in circulation by controlling the amount of money that banks could lend

Bonds

A bond is a loan you give to someone in exchange for interests. At the end of the loan, you get your principal back.

Tool 3: Buying or Selling Bonds in the Open Market Committee

In a weak economy, the Federal Reserve will usually buy billions of dollars worth of bonds from private brokers. This pumps money into the economy. When the brokers deposit the money in banks, the banks will increase the money available to lend. This will stimulate the economy. If the economy is growing too rapidly/quickly, the Federal Reserve will sell government bonds. Brokers will pay for the bonds by taking money from their bank accounts. This will decrease the amount the banks have on their hand to lend to borrowers

Discount Rate

The interest rate on the loans that the Fed makes to banks

Tool 2: Setting the Discount Rate:

When the economy is weak, the Federal Reserve lowers the discount rate. Banks will pay less for the money and will borrow more from the Federal Reserve. This will enable the banks to lower the interest rates they charge their borrowers. If the economy is expanding too quickly, the Federal Reserve will raise the discount rate to the banks. The increased rate causes the banks to pay more for the money. This will discourage them from lending money to borrowers at a lower rate.

Federal Reserve Bank -

the central bank of the United States, referred to as the Fed

Reserve Requirement

the money that banks should keep as reserve at the Federal Reserve in the event depositors wish to withdraw their money