Monetary policy

Change in the money supply

- (1/rr) times change in reserves

Excess reserves

The amount of reserves that a bank can lend out to earn interest - Total reserves minus required reserves

Required reserves

The amount of reserves that a bank must keep on hand to meet regulatory reqrimrnets - Deposits time reserve requirement

Bond

- A financial instrument that obligates a borrower to repay money with interest to a lender - If the FED buys one of these the money supply increases - If the FED sells one of these the money supply decreases

Money market

- A market in which the demand for and supply of money determine an interest rate, or opportunity cost of holding money balances

Expansionary monetary policy

- Actions taken by a country's central bank to expand the money supply and lower interest rates with the objective of increasing real GDP and reducing unemployment - Interest rate declines - Quantity of investment demanded increases - This results in a surplus because the supply of money exceeds the demand - This policy is done when RGDP falls below its long run level (During economic contraction or recession)

Decrease in reserve requirement

- Banks lend out a larger fraction of their deposits which increases the money supply - Decrease in reserve requirement causes money multiplier to increase

Increase in reserve requirement

- Banks must hold more of their deposits in reserve - Lend out a smaller fraction of their reserves decreasing the money supply - Money multiplier decreases

FED buying bonds

- IF the FED does this it creates new money and additional reserves which expands the money supply - Lowers the interest rate - When the money supply expands, the interest rate is lowered - This happens when demand increases

FED selling bonds

- IF the FED does this it takes money out of the economy which reduces reserves which contracts the money supply - Interest rates increase - When the money supply decreases interest rates increase - This happens when demand decreases

Tools of monetary policy

- Open market operations - Reserve ratio - Discount rate

Contractionary monetary policy

- The actions taken by a country's central bank to contract (decline) the money supply and raise interest rates with the objective of decreasing real GDP and controlling inflation - Interest rate increases - Quantity of investment demanded decreases - Price level decreases - Results in a shortage of money because the the demand for money exceeds the supply - This policy occurs when RGDP rises above its long run level of inflation which can harm consumers and producers

Monetary policy

- The actions taken by a country's central bank to influence the supply of money and credit in the economy - Primarily effects the economy by either encouraging or discouraging investments in new capital - The FED can use this to increase interest rates by reducing the money supply

Money multiplier

- The amount by which a $1 change in reserves will change the money supply - Change in money supply / change in reserves - 1/rr

Spread

- The difference between the interest rate a bank earns on a loan and the interest rate it pays

Cyclical asymmetry

- The idea that the aggregate demand for goods and services is more responsive to contractionary monetary policy than to expansionary monetary policy - Monetary policy may be more effective when used to control inflation than to reduce unemployment

Federal funds rate

- The interest rate that banks charge one another for borrowing excess reserves from one another

Discount rate

- The interest rate that banks pay when they borrow money directly from the fed - Loans created from borrowed reserves expand the money supply by creating excess reserves in the banking system - If this is lowered, banks will borrow more reserves and make additional loans, increasing the money supply - If this is increased, banks will likely borrow less reserves and make less loans, decreasing the money supply

Investment demand

- The negative relationship between the quantity of new physical capital demanded by firms and the prevailing interest rate - Represented as upper case i

Interest rate

- The payment made to agents that lend or save money, expressed as an annualized percentage of the monetary amount lent or saved - Sometimes called nominal interest rate or price of money - The Federal Reserve influences this in the economy to potentially help smooth the business cycle - Represented as lower case i

Open market operations

- The purchase or sale of government securities by a central bank - Used to influence the money supply and interest rates

FED raises target of federal funds rate

- When the FED does this, the supply of reserves decreases - The money supply decreases - Interest rates increase

Fed lowers target of federal funds rate

- When the fed does this the supply of reserves increases - The money supply increases - Interest rates decrease

Aggregate demand

A schedule or curve that represents the relationship between the quantity of real GDP demanded in the economy and the price level, all else held constant

Liquidity trap

A situation where increasing the money supply does not lower interest rates, due to a flattening of the money demand curve

Negative shock in the economy

EX; Decrease in consumer confidence - AD decreases - The FED uses expansionary monetary policy to increase the money supply - Interest rates decline - Investment demanded increases causing a small initial increase in AD - Now there is a small shift on the AD curve to the right

Positive shock in the economy

EX; Increase in net exports - Increase in AD (shift to the right) - Instead of waiting for the economy to fix itself the FED uses contractionary monetary policy - This decreases the money supply and shift the money supply curve to the left - Interest rates rise - Quantity of investment demanded decreases causing a small initial decrease in AD

Reserve requirement

The fraction of checkable deposits that banks must keep on hand as reserves, either as currency or on deposit with the federal reserve

Prime rate

The lowest commercially available interest rate

Federal funds market

The market for borrowing and lending reserves between banks

Implementation lag

The time between when a policy is enacted and when it has its full effect on the economy

Recognition lag

The time between when an event affects an economy and the time when we recognize that effect in the data collected

Money market equilibrium

When eh money supply and money demand curves intersect