Monetary vs Fiscal Policy
Monetary policy deals with changes in
the amount of money in supply
Fiscal policy deals with how money is
taxed and spent
Monetary Policy
Why We Can’t
Just Print More Money
Monetary = Money
• The amount of money in an economy is
important...
• If you have TOO MUCH:
– It can cause inflation (high prices).
• If you have TOO LITTLE:
– It can cause a recession (unemployment).
Who Manages the Money Supply?
The Federal Reserve (called the “Fed”)
The Fed can increase or decrease
the money supply by using 3 tools
When the Fed does this it is called:
MONETARY
POLICY
Tool #1 - Discount Rate
The interest rate that the Fed charges
banks for short-term loans
An interest rate is the price a borrower pays for the
use of money they borrow from a lender.
Scenario #1
If discount rate is high, then borrowing
money becomes more expensive
Discount Rate- The interest rate that the Fed
charges banks for short-term loans
Scenario #1 continued
If discount rate is high, then borrowing
money becomes more expensive
This means there will be fewer loans and
less money in the economy
Tool #2 - Reserve Requirement
The percentage of deposits (money)
that banks must hold in their vault
Scenario #2
If the reserve requirement is high, then
banks have less money to lend
Money Supply Will...
If the reserve requirement is low, then banks
can lend out more money
Money Supply Will…
Scenario #2
If the reserve requirement is high, then
banks have less money to lend
Money Supply Will...DECREASE
•Economy Will…
If the reserve requirement is low, then banks
can lend out more money
Money Supply Will…INCREASE
•Economy will….
Scenario #2
If the reserve requirement is high, then
banks have less money to lend
Money Supply Will...DECREASE
•Economy Will…SLOW DOWN
If the reserve requirement is low, then banks
can lend out more money
Money Supply Will…INCREASE
•Economy will….SPEED UP
Tool #3 - Open Market Operations
The buying and selling of securities
(bonds) issued by the government
Scenarios
During a slow economy, the Fed buys
back bonds to put cash back out there
During an booming economy, the Fed
sells bonds to take cash out of economy
Business Cycle
• Low Money Supply = Slow Economy
– Needs More Money
– To stop recession from rising unemployment
• High Money Supply = Booming Economy
– Needs Less Money
– To stop inflation from rising prices
Evaluating Fed Actions
The Federal Reserve (“Fed”) manages money supply
RAISE
Discount Rate
LOWER
Discount Rate
RAISE
Reserve Requirement
LOWER
Reserve Requirement
BUY
Securities/Bonds
SELL
Securities/Bonds
Evaluating Fed Actions
The Federal Reserve (“Fed”) manages money supply
RAISE
Discount Rate
LOWER
Discount Rate
RAISE
Reserve Requirement
LOWER
Reserve Requirement
BUY
Securities/Bonds
SELL
Securities/Bonds
Slow Down
Evaluating Fed Actions
The Federal Reserve (“Fed”) manages money supply
RAISE
Discount Rate
Slow Down
LOWER
Discount Rate
Speed Up
RAISE
Reserve Requirement
LOWER
Reserve Requirement
BUY
Securities/Bonds
SELL
Securities/Bonds
Evaluating Fed Actions
The Federal Reserve (“Fed”) manages money supply
RAISE
Discount Rate
Slow Down
LOWER
Discount Rate
Speed Up
RAISE
Reserve Requirement
Slow Down
LOWER
Reserve Requirement
BUY
Securities/Bonds
SELL
Securities/Bonds
Evaluating Fed Actions
The Federal Reserve (“Fed”) manages money supply
RAISE
Discount Rate
Slow Down
LOWER
Discount Rate
Speed Up
RAISE
Reserve Requirement
Slow Down
LOWER
Reserve Requirement
Speed Up
BUY
Securities/Bonds
SELL
Securities/Bonds
Evaluating Fed Actions
The Federal Reserve (“Fed”) manages money supply
RAISE
Discount Rate
Slow Down
LOWER
Discount Rate
Speed Up
RAISE
Reserve Requirement
Slow Down
LOWER
Reserve Requirement
Speed Up
BUY
Securities/Bonds
Speed Up
SELL
Securities/Bonds
Evaluating Fed Actions
The Federal Reserve (“Fed”) manages money supply
RAISE
Discount Rate
Slow Down
LOWER
Discount Rate
Speed Up
RAISE
Reserve Requirement
Slow Down
LOWER
Reserve Requirement
Speed Up
BUY
Securities/Bonds
Speed Up
SELL
Securities/Bonds
Slow Down