SIE chapter 3

Monetary policy vs fiscal policy

Fiscal policy is often used in conjuction with monetary policy to influence the direction of the economy. The goals are the same- full employment and price stability - but the methods are different fiscal policy is set by the president and congress. the federal reserve plays no role in determining the fiscal policy. Fiscal policy is implemented through government spending and taxes Monetary policy is set by the federal reserve, the central bank of the united states, and consists of actions aimed at influencing the money supply and interest rates

Reserve requirement

The reserve requirement is an overnight cash reserve that each federal reserve member bank must maintain each night. this is the most powerful tool. the FRB will reaise this requirement to tighten the money supply and lower it to increase the money supply. if a member bank is short at the end of the night it must borrow cash from another member bank or from the main Federal reserve bank in New York. the power is the multiplier effect that ripples through the economy.

Keynesian theory

John keynes during the depression developed the economic theory taht advocated using fiscal policy to jump start the economy to full employment. He believed that the economy runs at an equilibrium level that is determined by income and spending and aggregate demand.

Monetary policy

Monetary policy is controlled by the Federal reserve board or "the fed". The federal open market committe (FOMC) is the federal reverve systems top policy making body. it referes to actions taken to influence the money supply and credit in the economy which affects interest rates. by raising or lowering short term interest rates it indirectly controls inflation and employment. the primary focus of monetary policy is to promote price stabiliity and full employment If the FRB believes that the econom is growing too quickly it will tighten the money supply to slow the economy. This tightening makes money scarcer and causes interest rates to rise. Expanding the money supply causes interest rates to drop and speeds economic growth. The FRB uses three basic tools to control money supply and attain its monetary policy objectives: 1. Reserve requirement 2. discount rate 3. Open market operations

Discount rate

The Fed sets the discount rate. This is the rate the main federal reserve Bank charges member banks for loans to meet their overnight reserve requirements. If the fed lowers the discount rate, the T-bill and fed funds rates will decline. borrowing at the discount window may be an indication that the borrower is experiencing financial trouble because the main FRB is considered the lender of last resort

Federal funds rate

The federal funds rate, a short term interest rate is the interest rate member banks charge each other for overnight loans in order to maintain their bank reserves at the Federal Reserve. very volatile The Federal Reserves Federal Open Market Committee sets a target for the federal funds rate and conduts open market operations to move rates toward this target. 8 meetings a year

Know this- federal reserve

The federal reserve stimulates the economy by buying bonds in the open market typically when inflation is low and the economy is in recession

Open Market operations (OMO)

The third monetary policy tool that the FRB has at its disposal is open market operations. The open market is also known as the secondary market. OMO is the purchase and sale of securities in the secondary market by the central bank to implement monetary policy OMO is the FRB's most frequently used methods to implement monetary policy, enabling it to influence short term interest rates and reach other monetary policy targets. by adjusting levels of reserve balances in the banking system the fed can offset or support permanent, seasonal, or cyclical shifts in the supply reserve balances which effects interest rates

Federal Open Market Committee (FOMC)

buys or sells treasuries in the secondary market through primary government securities dealers to help stimulate or slow the economy If the Fed is buying treasuries they are putting money into the economy. When FOMC buys securities from member banks the banks receive a credit in their reserve account. Which allows the banks to make more loans effectively lowering intereest rates and increasing or loosening the money supply. This increases the money supply and stimulates the economy. If they are selling treasuries they are pulling money out of the economy. This shrinks the money supply which slows the economy. When the Fed sells securities to banks, they are tightening the money supply which reduces the ability to make loans and effectively raising interest rates

fiscal policy

refers to the tax and spending policies of the federal government that are used to influence the level of economic activity. the principal focus of fiscal policy is stable economic growth and a high level of employment Involves the president and congress passing bills and appropriations that influence economic activity. federal taxation and spending are its primary tools. Congress can lower taxes to increase economic activity or raise taxes to decrease economic activity In addition the federal government can increase spending on capital projects, miliatry and or social programs to stimulate the economy.

Supply side economics

the opposite of keynesian theory. says that as long as the government does not meddle with the economy business will take care of itself. Stable interest rates, money supply and low inflation achieved through monetary policy will enable business to drive the economy to full employment. Growth is promoted through tax cuts and deregulation

Money supply

total stock of money circulating in the economy. The US money supply includes currency and deposits held by the public at commercial banks and other depository institutions such as thrifts and credit unions.