Monetary Policy: The Federal Reserve
Changing the money supply affects the Federal Funds Rate.
- Banks lend each other money that is stored by the Federal Reserve. - Increasing the money supply lowers the rates that banks charge each other.
The Fed responds to recessions by increasing the money supply.
- Buying securities - Charging banks less interest - Lowering interest rates for lending to banks - Lowering reserve requirements
The Federal Reserve can buy and sell securities from banks to influence the supply of money.
- Buying securities gives banks more money to lend. - Selling securities gives banks less money to lend.
The Fed can change the amounts it requires banks to hold in reserve.
- By law, banks must hold some of their funds in reserve. - Changes to reserve requirements affect the amount banks can lend.
Monetary policy is carried out when a central bank manipulates the money supply. Main goals of monetary policy:
- Controlling inflation - Reducing unemployment
The Federal Reserve iis managed by a central board of governors.
- Directors control banks' lending activities. - The Federal Open Market Committee makes monetary policy decisions.
The Federal Reserve is a bank for the nation's financial institutions.
- Lends bank money - Stores money for banks - Regulates banks' behaviors - Processes payments between banks - Serves as a lender of last resort
The Fed can change the interest rates that it charges when it lends them money.
- Lower interest rates give banks more money to lend. - Higher interest rates gives banks less money to lend.
The Fed can change the interest rates that it pays banks for money it is storing.
- Lower rates give banks less money. - Higher rates gives banks more money.
Tools of the Federal Reserve
- Open market operations - Interest rate changes - Reserve requirement changes
The Federal Reserve is the central bank of the United States.
- Was created by the Federal Reserve Act of 1913 - Was established to implement monetary policy - Is often nicknamed "The Fed" - There are twelve district banks located across the United States.
Contractionary monetary policy involves decreasing the money supply. Its goal is to decrease inflation by:
- decreasing the amount of credit available. - increasing interest rates.
Central banks use monetary policy to steer the economy away from recessions and toward growth. Recessions involve:
- increased unemployment. - decreased credit. - decreased growth.
Expansionary monetary policy involves increasing the money supply. Its goal is to lower unemployment by:
- increasing the amount of credit available. - decreasing interest rates.
Identify the goals of the central bank when creating monetary policy.
- influencing the business cycle - encouraging economic growth - avoiding periods of time where little credit is available
Expansionary policy can lead to increased inflation.
Lending and investment increase, causing price changes to speed up.
Monetary policy is based on an expectation of cause and effect.
Liquidity of the money supply -> Amount available for banks to lend & Interest rates charged by banks -> Amount lent by banks -> Amount invested in the market & Rate of growth and inflation
Economists study the money supply by breaking it down into separate categories
These categories are based on the liquidity of money
securities
a means of protection for investments
central bank
the bank within a nation that is responsible for creating monetary policy
reserve
to set aside or hold for another
implement
use to complete a specific action
