Macroeconomics - Chapter 15

Tools of monetary policy

1. open-market operations 2. reserve ratio 3. discount rate

open-market operations

Fed buying securities from commercial banks & the public (expansionary) Fed selling securities to commercial banks & the public (contractionary)

required reserve ratio (RRR)

amount banks are required to hold onto; raising RRR = less for banks to lend (contractionary) lowering RRR = more loans (expansionary)

Tight Monetary Policy (contractionary) effects -> Problem: INFLATION 1. Fed sells securities 2. raises RRR 3. raises DR

excess reserves = decrease money supply = decrease interest rate = increase investment spending = decrease aggregate demand = decrease inflation declines

Easy Monetary Policy (expansionary) effects -> Problem: RECESSION 1. Fed buys securities 2. lowers RRR 3. lowers DR

excess reserves = increase money supply = increase interest rate = decrease investment spending = increase aggregate demand = increase real GDP = increase by the amount of change times the multiplier

Most frequently used tool of Monetary policy?

open-money operations

Least frequently used tool of Monetary policy?

reserve ratio

Liabilities of federal reserve banks

reserves of commercial banks treasury deposits federal reserve notes

Easy monetary policy and net export effect

interest rates decrease + decrease in foreign demand for dollars + dollar depreciates = Net exports decrease

Tight monetary policy and net export effect

interest rates increase + increase in foreign demand for dollars + dollar appreciates = Net exports increase

discount rate (DR)

interest rates that the Fed charges on loans; raise in DR= discourage banks from borrowing from Fed, doesn't raise their excess reserves, less able to make loans (contractionary) lower DR= encourage banks to borrow, raise their banks excess reserves, ability to make more loans (expansionary)