FOMC
GDP Review
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pdf
Objectives
 Identify monetary policy tools available to the Federal
Reserve System;
 describe the relationship between bank reserves, interest
rates, and the economic goals of maximum employment and
price stability;
 describe the key components of the Federal Reserve’s dual
mandate;
 identify the ways in which monetary policy tools can be used
to achieve economic objectives; and
 analyze policy strategies given economic conditions
The Fed’s Toolbox
The Fed’s Toolbox
What tools does the Federal Reserve System have at its
disposal?
The Fed’s Toolbox
Slide 1: Vocabulary
Bank reserves – The sum of cash that banks hold in their vaults and
the deposits they maintain with Federal Reserve Banks.
Required reserves – Funds that a depository institution must hold in
reserve against specified deposits as vault cash or deposits with
Federal Reserve Banks.
Excess reserves – The amount of funds held by a depository
institution in its account at a Federal Reserve Bank in excess of its
required reserve balance.
Interest – The price of using someone else's money.
Interest rate – The percentage of the amount of a loan that is charged
for a loan. It is also the percentage paid on a savings account.
What would happen if a bank wanted to make a loan but did
not have enough excess reserves to do so?
The Fed’s Toolbox
Slide 2: Vocabulary
Federal funds market – The market in which banks can borrow or lend
reserves, allowing banks temporarily short of their required reserves to
borrow from banks that have excess reserves.
Federal funds rate – The interest rate at which a depository institution
lends funds that are immediately available to another depository
institution overnight.
Federal Reserve System – The central bank system of the United
States.
Central bank – An institution that oversees and regulates the banking
system and quantity of money in the economy.
The Fed’s Toolbox
Slide 3: Monetary Policy Tools
Monetary policy – The actions of a central bank to influence the cost
and availability of money and credit to achieve the national economic
goals.
• Discount rate – The interest rate charged by the Federal
Reserve to banks for loans obtained through the Fed's discount
window.
• Open market operations – The buying and selling of
government securities through primary dealers by the Federal
Reserve in order to control the money supply.
• Reserve requirements – Funds that banks must hold in cash,
either in their vaults or on deposit at a Federal Reserve Bank.
(last changed in 1992)
• Interest on reserves – Interest paid by Federal Reserve Banks
on required and excess reserves held by banks at Federal
Reserve Banks.
The Fed’s Toolbox
Slide 6: Expansionary Policy
Money
Primary
Federal
Dealers
Reserve Fed Buys Bonds
Investors
Banks
Bank
Reserves
Increase
Bonds
Expansionary monetary policy – Actions
taken by the Federal Reserve to increase the
growth of the money supply and the amount of
credit available.
Interest
Rates
Decrease
Borrowing
Increases
Questions
 What would happened to the level of reserves in the
banking system if the Fed purchases government
securities?
 What likely happens to interest rates when more
excess reserves are available for loans in the banking
system?
 How will consumers and businesses likely respond?
 How will producers respond?
The Fed’s Toolbox
Slide 7: Contractionary Policy
Bonds
Primary
Federal
Fed Sells Bonds Dealers
Reserve
Investors
Banks
Bank
Reserves
Decrease
Money
Contractionary monetary policy – Actions
taken by the Federal Reserve to decrease the
growth of the money supply and the amount of
credit available.
Interest
Rates
Increase
Borrowing
Decreases
The Fed’s Toolbox
Slide 8: Dual Mandate
Dual mandate – The Federal Reserve’s responsibility to use monetary
policy to promote maximum employment and price stability.
• Price stability – A low and stable rate of inflation maintained over an
extended period of time. The Fed has a longer-run goal of 2 percent
inflation.
• Maximum employment – The Fed does not have a specific
unemployment target, but it does regularly publish its forecast for the
longer-run rate of unemployment.
Questions
 Inflation
 Given the Fed’s ability to influence the level of reserves
in the banking system, how do you think the Fed can
provide price stability?
 Employment
 How do you think the Fed can influence employment?
Questions
 Does the Fed set the federal funds rate?
 How does the Fed influence the federal funds rate?
 Does the Fed set the discount rate, the rate banks pay
to borrow reserves from the Fed?
 Is the discount rate usually higher or lower than the
federal funds rate?
Interest on Reserves
 Since 2008, the Federal Reserve has paid interest on
reserve balances held at a Federal Reserve Bank. Both
required and excess reserves can earn interest.
 Banks can choose to either hold reserves on deposit at
a Federal Reserve Bank and earn interest or use their
excess reserves to make loans to businesses and
individuals and charge interest.
 The Federal Reserve can influence banks’ decisions to
hold reserves at the Fed or lend to customers by
increasing or decreasing the interest rate paid on
excess reserves.
Interest Questions
 What would likely happen to the incentive for banks to
lend money if the Federal reserve were to increase the
interest rate it pays on reserves?
Headline: Unemployment Soars While
Deflation Fears Grow
 What should the Fed do?
Headline: Prices Rising:
Inflation Worries Grow
 What should the Fed do?
 What is the name of the market in which banks can
borrow or lend reserves, allowing banks temporarily
short of their required reserves to borrow from banks
that have excess reserves?
 a. The bank reserve market
 b. The federal funds market
 c. The excess reserves market
 d. The required reserves market
 Last week the Second Bank of Middleville borrowed
reserves from the Federal Reserve’s discount window.
For the use of this money, the Second Bank of
Middleville will now be required to pay which of the
following rates?
 a. The reserve rate
 b. The discount rate
 c. The federal funds rate
 d. The monetary rate
 Assume the Second Bank of Middleville has $100,000
in total deposits and has a required reserves ratio of 15
percent. How much does the Second Bank of
Middleville have in excess reserves?
 a. $15,000
 b. $85,000
 c. $100,000
 d. $150,000
 If the Federal Reserve purchases a total of $50,000 in
government securities through two different primary
dealers, what will happen to the level of
money/reserves in the banking system?
 a. Money/reserves will increase by $50,000.
 b. Money/reserves will increase by $100,000.
 c. Money/reserves will decrease by $50,000.
 d. Money/reserves will decrease by $100,000.
Keynes versus Hayek
 Keynes vs. Hayek Round two
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mEdition.pdf